Good morning, and welcome to The RMR Group Fiscal First Quarter 2024 Earnings Call. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations. Please go ahead.

Good morning, and thank you for joining RMR's First Quarter Fiscal 2024 Conference Call. With me on today's call are President and CEO, Adam Portnoy; and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and quarterly results, followed by a question-and-answer session. I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, February 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, which can be found on our website at www.rmrgroup.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we may discuss non-GAAP numbers during this call, including adjusted net income, adjusted earnings per share, distributable earnings, adjusted EBITDA and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. Generally Accepted Accounting Principles to adjusted net income, adjusted earnings per share, distributable earnings, adjusted EBITDA and the calculation of adjusted EBITDA margin can be found in our financial results. I will now turn the call over to Adam.

Thanks, Kevin, and thank you all for joining us this morning. Before providing an update on our first quarter results, let me first discuss the macro commercial real estate environment. There is no question that commercial real estate has been under pressure since the Federal Reserve began raising interest rates in early 2022. The higher cost of capital has resulted in significant headwinds to property values and a deterioration in capital markets activity. However, as I sit here today, we are currently seeing positive signs as the U.S. economy continues to perform well with strong GDP growth, a healthy labor market and declining inflation. With anticipated interest rate cuts later this year, we believe we are entering a generally more favorable environment for commercial real estate. Looking across our diversified portfolio, I also see several encouraging trends and we are highly confident in the strength, diversity and durability of our platform and the opportunity for our clients to benefit as the commercial real estate sector normalizes. Turning now to our quarterly results. RMR reported a strong first quarter that reflects the continued strength and stability of our operations through all real estate cycles. We delivered sequential growth and adjusted earnings per share that exceeded the high end of our guidance. This quarter, we reported distributable earnings of $0.53 per share, adjusted EBITDA of $25.3 million and adjusted EBITDA margin of 52.1%. Our results also continue to demonstrate the strong alignment between RMR and our clients. We remain focused on assisting our clients with the execution of their business plans and expect to capitalize on the significant upside that exists from a possible recovery in share prices at some of our publicly traded clients. To put this into context, all of our managed equity REITs are paying base business management fees…

Thanks, Adam, and good morning, everyone. For the first quarter, we reported adjusted net income of $0.49 per share, adjusted EBITDA of $25.3 million and distributable earnings of $0.53 per share. Our results exceeded the high end of our guidance, primarily due to construction management fees coming in stronger than expected as well as improvements in the enterprise values of certain of our managed equity REITs. As Adam highlighted earlier, we closed the CARROLL acquisition on December 19. While we remain excited about the long-term contributions of the acquisition to our platform, for calendar 2024 we expect earnings accretion from RMR Residential to begin in the back half of the year, given the lack of transaction volume across the residential real estate sector. Our residential platform is built to manage far more than its current $5.5 billion in AUM, which will result in breakeven results for the first 6 months of calendar '24. Turning to this quarter's results. Recurring service revenues for the quarter were $46.2 million, which was up almost $900,000 sequentially. This increase exceeded our expectations primarily due to enterprise value improvements at our managed equity REITs and increases in construction management activity within SVC's hotel portfolio. As it relates to next quarter, based upon the current enterprise values of our managed equity REITs, projected declines in construction volumes and approximately $5.5 million in RMR Residential revenues, we expect service revenues to be between $48 million and $50 million. Turning to expenses. Cash compensation this quarter was approximately $34.8 million, an increase of $456,000 sequentially due to annual merit increases that were effective October 1, and $1.5 million in compensation related to the partial month impact of RMR Residential, partially offset by strategic actions we've undertaken over the last 12 months to streamline our operations. Looking ahead to…

[Operator Instructions] The first question comes from Bryan Maher with B. Riley Securities.

Adam and Matt. Maybe to start on a big picture basis, Adam, you touched upon this earlier in your prepared comments. We read an article last week, I guess it was in Barron's on a large real estate PM runs $80 billion, talking about how -- whereas 2024 still faces challenges, they see recovery in 2025. Seems to be somewhat consistent with what you started off the call with. Can you give us a little bit more color on what kind of green shoots you're seeing out there to give you that positivity?

Sure. Thank you for that question, Bryan. I think that is correct. I think the biggest positive impact that can happen for real estate is a reduction in interest rates. And then maybe the second biggest positive that can happen for real estate, especially around office and maybe some pockets of retail real estate is a unfreezing or unthawing of capital markets and access to capital markets activity. I think RMR, we have been very fortunate, given the depth of our platform and our experience and relationships throughout the country and Wall Street, that we were able to access capital on pretty attractive rates that I think many of our peers would not be able to do given, just given our expertise in the area. That all being said, I think it's really macro conditions that need to improve. And I think the fact that -- I think, pretty universally believed is that the Fed is not raising rates anymore. I believe there's a pretty robust debate about how fast or when they will reduce interest rates. I think all that is much more positive for commercial real estate. And we have seen just the fact that we were able to get 19 banks to participate in a secured financing at OPI and office REIT. Yes, OPI is a strong -- has a strong portfolio. It is well managed, but it's still in an asset class that gets heightened scrutiny no matter where you are in what part of the capital markets with -- because it's office, the fact that 19 banks came along for that is also an indication that there is some thawing going on in the capital markets. So I see all those as positive signs. In terms of fundamentals and operations, look, I think office leasing…

And just a follow-up. On RMR Residential, I mean, this is kind of new to us, maybe a little bit less so to you. How should we think about that back half of the year growth? And does that come organically? Does it come from bolt-on acquisitions? And what kind of capital might you need to deploy to get that growth?

So RMR Residential, as I said in my prepared remarks, we inherited or acquired a fund, what we call Fund VII that is a -- it's a general partnership fund, and I won't go into the details. But what that means is -- we have about $200 million of untapped equity there that, that fund life time does -- we have until the end of '25 to deploy that capital. So we have a fair amount of runway, 2 years to put that money out. Because it's a GP fund, you bring in LPs and you put leverage on, that's how you get to the $3 billion of buying power. So we're -- that's largely organic. And we don't -- the other areas where I think you could see us grow is -- in '24 and as we get further into '25, we are basically setting up really, really well to possibly raise our first true what I call private capital co-mingled, closed-end funds, however you want to talk about it, vehicles. And I think we're gearing up to do that. I think the 2 areas that we are going to be best positioned to try to raise a fund around that is going to be in the loan fund or a fund that's basically making loans, a leverage fund and then perhaps in residential. I think in the residential space, I think we have more -- we have plenty of runway to put money to work under our existing vehicle. And so that's all organic, what I just went through, Bryan. That's -- I'm not talking at all about M&A there or acquisitions. And I think on the M&A front, we have $200 million of cash. We have no corporate debt. We will be opportunistic, but we're also very focused at the moment on successfully integrating the RMR Residential platform and getting it to be a significant contributor to our earnings and EBITDA in the second half of the year as well as thinking about ways to organically raise funds and strategies that we think will be particularly appealing to investors. Now anything else around that...

I guess what I would add, Bryan, is as we think of the back half of the year, as some of the thawing plays out that Adam touched on. I can tell you, we've engaged with all the partners, the legacy partners. They are committed to continuing to do business with the CARROLL team that we've inherited and are really pleased with, and the organization can quickly put capital out as that thawing plays out. When we think of their historical run rate, which was part of what attracted to us, they've had -- they can easily do $1 billion a year. And in '21, the organization -- the legacy organization put $3 billion to work. So once this thawing plays out, we believe the partners are very aligned with the team that we've inherited and are happy with the RMR addition. And we think as that thawing plays out, we can quickly accelerate EBITDA growth at the residential platform.

[Operator Instructions] The next question comes from Tyler Batory with Oppenheimer.

Just to put a finer point on the RMR Residential commentary there. Can you talk about the EBITDA contribution from that business this year? And longer term, Adam, I think some pretty helpful commentary in terms of -- with the outlook for second half of this year and certainly 2025 as well. Any chance you could be a little bit more specific in terms of putting some numbers around that and kind of remind us what you're thinking longer term in terms of the financial impact of really ramping up the residential side of things?

Sure. So really, in our prepared remarks, we talked about it. The first half of the calendar year, which gets you through June of this year, we expect it to -- largely, it will be a breakeven business. That's our expectation. We -- just because it's breakeven doesn't mean we're out trying to do stuff. We just think as it ramps up -- and part of the issue here is we're sort of restarting a business that has been kind of dormant unfortunately, for about 1 year and getting its acquisition machine up and running again. And then you have the backdrop of over the last year and the first half of this year, not a lot of transaction activity. When we announced the CARROLL acquisition, we put out a presentation, I think we talked about $10 million roughly of EBITDA.

$11 million to $13 million.

$11 million to $13 million of EBITDA is what we were expecting as a run rate. I think part of our expectations at the time were twofold. One, we thought we were actually going to close sooner than we did. It took a little longer to close. So we didn't close till the -- almost the end of the year. We thought we would have done that maybe beginning of the fourth quarter last year and ended up being at the end of the fourth quarter. And the other thing that was different than our expectations was the general market conditions continued to stay very muted, meaning there wasn't a lot of transaction volume to look at our activity. So it's actually played out that part of the market cycle is taking longer. We are still bullish that this business will generate over $10 million of EBITDA per year. I think that really starts happening third and really fourth calendar quarter of '24, is when we are expecting that to really ramp up. And as we get into '25, I think we will see possibilities of EBITDA even greater than that $10 million or $11 million to $13 million number. I think it really can ramp up as the business matures, as we raise more -- as we put capital out, as we raise more third-party capital there as well. So that's sort of the finer point. Matt?

Yes. That was everything.

Okay. Okay. Great. My follow-up, just a quick one. The construction fees, why a little bit better than you thought in fiscal Q1? And what are you expecting next quarter and the rest of the year for that line item?

Yes. The construction -- estimating construction activity is never an exact science, whether it be permitting, spend, the delays, supply chain. So it's just a matter of things accelerated as we hit the end of the year, and that tends to happen for us. And I think many real estate operators, people use up their budget as they approach the end of the calendar year. So it just -- a number of things fell into place favorably with some hotel renovations that were underway, which was a good thing. And then when you start the year over, it tends to start the hockey stick again as much as we've tried to minimize that over time. People restart their budgets and certain spend slows down. So next -- this quarter, we generated about $5 million in construction fees. Next quarter, we expect that to be about $4 million and then we expect it to ramp back up again as the year plays out. We may not get all the way back to $5 million, but we'll clearly trend back towards that number as the calendar quarters play out.

Our next question comes from Ronald Kamdem with Morgan Stanley.

Just going back to RMR Residential. So the -- so the understanding that you're going to be in the market, basically, the GP is going to be in the market fundraising for LPs. And as that capital gets deployed, that's when the EBITDA starts to ramp in the back half of this year and into 2025? And then -- do I have that correct? And is -- can you talk about what the -- because there was an earnout, I think, with the announcement. Can you talk about how the earnout sort of factors in what we should be looking at for that?

Sure. Yes. So first off, yes, generally, the way you described it is how we're thinking about it is. Then we will be deploying capital as we get into the second half of the year, and that will accelerate more as we get into '21. The earnout is based on what we refer to as the Fund VII and deploying that capital and how much of that capital gets deployed by the end of '25. And there are certain parameters around it.

Yes. It's really ratably, Ron. As the 200 -- the first $50 million doesn't count to the earnout, but everything above $50 million starts, that $20 million gets earned ratably from $51 million forward. So it aligns everyone here, we're getting that money out. And then on -- I guess, Ron, can I just say on the EBITDA and contribution of deployment. I think it's just important to remind folks on the RMR Residential side, how they make money and earn revenue is largely property management and construction management as deals are acquired and they're a manager. But the big hit to revenues is on acquisition fees. So as that money is deployed and new deals are made, the residential business under the current construct of their GP fund, they're getting about 65 basis points on each acquisition from an acquisition fee. So ramping this business up and putting money out will immediately generate sizable impacts to revenue.

Got it. And my second question is a 2-parter, but it's kind of unrelated, but so part 1 is really just on -- I think you talked about sort of sovereign wealth funds sort of interest in some of the assets. Just curious from your -- like how are those conversations going with the sovereign wealth funds in terms of some of your assets? And are there more opportunities to do JVs? And part 2, which is unrelated, just -- so the EBITDA guidance for the second fiscal quarter, it's -- I guess it's $21 million to $22 million or $23 million. Is it dipping all because of the G&A? Or is there anything else we should be mindful of?

I'll take the second part. It's dipping because of the revenue hit. I think -- this quarter's results speak to the flow-through and the power of this platform because we -- revenues grew so rapidly, we saw almost a direct bottom line benefit and now the inverse is happening next quarter. We have a certain infrastructure, construction revenue -- construction fees are down. The REIT's enterprise values are stable but not increasing. And that has a direct flow through adversely to EBITDA, which is driving the decrease. There's a little bit of cost headwinds, but it's really at the revenue line, which is dipping pretty sizably.

With regards to the sovereign wealth fund relationships the company has, the existing ones, those are largely in what I would call core, core plus vehicles, which have -- which are generating core, core-plus type returns. Sovereign wealth funds in our relationships and I think, generally, given the current environment and sort of the lack of capital in the marketplace, their return expectations have increased and they're now increasingly looking for, what I'd call, closer to value-add type returns. So call it, mid-teens or low-teen returns, which are historically different than what you would normally receive in a core, core-plus vehicle. So saying all that, our existing vehicles are fine. Those relationships are fine there. We expect to continue to manage them for some time. But we don't think there's going to be a lot of growth in today's environment in those existing joint ventures just because the return hurdles, that the sovereign wealth funds that our relationships are with are just higher. And I also think that's generally speaking for sovereign wealth funds as a blanket statement and sort of institutional capital that we've been interacting with is the return expectations are higher. And that sort of ties back to what I've said a couple of times, I think, during the call, which is the areas where we're trying to organically grow are areas where we think we can raise private capital around the debt fund I mentioned and maybe on a residential discretionary fund, which will probably come later in the year or into '25. But those are all types -- the funds I'm talking about generate those type of returns that we call it mid-teens or low-teen returns on a sort of a value-add basis or -- type returns. And so that's why we're focused on that because that's also what the market is looking for and the sovereign wealth funds that we have relationships as well as ones that we just talked to. Those are the sort of the return criteria they're looking for. I would tell you, broadly speaking, sovereign wealth funds today are looking at more debt strategies as I think -- most people that are putting money to work in real estate, if they are putting money to work are looking at private credit strategies or debt funds, which is why we're focused on that part of our business as well.

This concludes our question-and-answer session. I would now like to turn the conference back over to Adam Portnoy, President and Chief Executive Officer for any closing remarks.

Thank you all for joining us today. Operator, that concludes our call.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.