Apartment Income REIT Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
July 29, 2022

There are 10 speakers on the call.

Operator

Afternoon. Thank you for attending. My name is Matt, and I will be your moderator for today's call. At this time, I would like to welcome everyone to the Air Community Second Quarter 20 20 2 Earnings Conference Call. All lines will be muted during the presentation portion of the call with an opportunity for questions and answers at the end.

Operator

20. I would now like to pass the conference over to our host, Lisa Cohn, President and General Council of Air Communities.

Speaker 1

Thank you, Matt, and good day. My name is Lisa Cohn, and I am President and General Counsel of Air Communities. 2017. During this conference call, the forward looking statements we make are based on management's judgment, including projections related to 2022 expectations. 2019.

Speaker 1

These statements are subject to certain risks and uncertainties, a description of which can be found in our SEC filings. Actual results may differ materially from what may be discussed today. We will also discuss certain non GAAP financial measures, such as funds from operations. These are defined and are reconciled to the most comparable GAAP measures in the supplemental information that is part of the full earnings release published on Aehr's website. 2018.

Speaker 1

Prepared remarks today come from Terry Considine, our CEO Keith Kimmel, President of Property Operations John McGrath, our Co CIO and Chairman of our Investment Committee and Paul Belden, our Chief Financial Officer. Other members of management are also present. All of us will be available during the question and answer session, which will follow our prepared remarks.

Speaker 2

Results. We'll now turn the call to Terry Considine. Terry?

Speaker 3

Thank you, Lisa, and thanks to all of you for your interest in Aehr.

Speaker 2

In the

Speaker 3

past few months, Aehr has largely completed its separation from the old Aimco, 18 months ahead of schedule. At Aehr's IPO, 12% of Aehr NAV was entangled with Aimco, now it is less than 30 basis points. The acceleration of the Aimco note and the cancellation of the Aimco master lease of 4 properties created noise in the quarter, making modeling more difficult. But there are important milestones in simplifying Aehr's business, which is growing steadily. Aehr was designed to be the most efficient and effective way to invest in public ownership of multifamily real estate.

Speaker 3

With the separation from old Aimco now behind us, we can see more clearly what Aehr will be. We can see the strength of the Aehr operating platform, what Keith calls the Aehr Edge. For example, challenged by inflation, Air costs were essentially flat. Our emphasis on customer selection and satisfaction results in stable communities with good neighbors and pure leading margins. Coupled with low G and A, Aehr enjoys the highest conversion of rent to free cash flow.

Speaker 3

Rent growth matters a lot. What matters more is how much of that revenue gets through distribution to our investment for shareholders. We can also now see the safety of the Aehr business model. Thanks to Paul. Aehr has low financial leverage, limited refunding and repricing risk.

Speaker 3

The business model also has none of the supply chain risks and ongoing cash requirements of unfinished developments The safety of the Aehr business and its laser focus on ownership of stabilized properties Our paired trade discipline makes clear that acquisitions are accretive and leverage neutral. And after reinvestment of more than $1,000,000,000 our excellent portfolio is now even better. Average monthly rents approached $2,600 third among the apartment rents. But more important to shareholders,

Speaker 4

And when considering investments, we regularly compare a proposed purchase

Speaker 3

to the buyback of Aehr shares. And in the Q2, we purchased about 3,000,000 shares for $125,000,000 Economists debate whether we're in a recession. When we look inside the business of Air, We see no sign of recession, none, not now. But you and I both know that a recession will come someday and maybe soon. Aehr customers have good incomes and high credit scores.

Speaker 3

Our buildings are in good repair. Our teams are well paid and stable. 2017. Our balance sheet is not exposed to higher interest rates nor near term maturities. We have no buildings to finish.

Speaker 3

We have no lease ups to complete. So for us, a recession will be an opportunity to grow by accretive investment.

Speaker 1

The key

Speaker 3

In the Q2, Keith and his ops team delivered outstanding results. We're raising same store guidance based on expectations for this year. Plus their remarkable ability to manage costs through productivity suggests that next year will also be a very good year. John will report on sources and accretive uses and the faster growth we see in our portfolio of properties newly added to the Air platform. Paul will report on our balance sheet and why tax characteristics make the dividend on Aimco shares Especially attractive to individuals, C Corps, foreign investors and all who are interested to reduce income taxation.

Speaker 3

Patty Schwader has been called away by family duties of a happy nature. So Lisa will be her backup, Ready to report on our recently published targets based on the UN sustainability goals and our commitment to measurement and public reporting of our ESG undertaking. Lisa may also express our gratification that Aehr teammates' high engagement exceeds 23. The Kingsley Index rising when others are falling and perhaps one reason for another Kingsley report, Finally, I thank my teammates for your help, hard work and friendship.

Speaker 5

And

Speaker 3

I thank my colleagues on the Air Board. You are remarkable, engaged and committed to making Air excel. With that, I'd like to turn the call to Keith Kimmel to discuss our operating results. Keith? Thanks, Terry.

Speaker 5

The Q2 was outstanding. With over 80% of our leasing volume now complete for the year, I'd like to share a number of takeaways. 2019. First, rate performance is historically strong with leading indicators pointing towards elevated lease to lease performance in the second half of twenty twenty two and into 2023. In the Q2, signed new lease rates were up 18.4%, Renewals were up 10.6%, leading to a blended average increase of 14.1%.

Speaker 5

In July, rates strengthened further with new leases up 20.4% and the blended average up 16%. Looking forward, our loss to lease remains above 10% and indicates transacted rates will remain strong for the balance of 2022 and into next year. 2nd, demand is robust and occupancy is tracking on plan. Average daily occupancy in the 2nd quarter was 96.8%, up 160 basis points from last year. By design, we saw sequential declines in average daily occupancy associated with higher move out volumes during the summer leasing season, trend which peaked in July and will reverse in August.

Speaker 5

Our forward indicators of occupancy signal an acceleration as we move out of peak just like we saw in 2021. 3rd, Aehr is the most efficient multifamily operator. Our approach starts first with resident selection and world class customer service, which led to a record low trailing 12 month turnover of 38.4%. It is amplified by our decade plus of exceptional expense discipline and productivity gains. In the Q2, expenses were up 10 basis points year over year with controllable expenses up 2.7% due to timing of increased maintenance of communities offset by lower taxes and insurance.

Speaker 5

I have three thoughts on expenses as we navigate inflation. We focus first on avoidance of cost, using process design, investment and creating jobs in which they can maximize their skills through the elimination of administrative work, red tape and repetitive tasks. Last and most importantly, we do the right thing, solving not to managing expenses, but maximizing long term margin growth. We recently invested in additional compensation for our team members to recognize their importance to our success. All that said, which for the Q2 was 73.6%, up 310 basis points from 1 year ago.

Speaker 5

4th, the AirEdge, when applied to newly acquired communities, is a tremendous engine for growth. Our 5 2021 acquisitions are expected to have revenue growth 600 basis points above our stabilized portfolio in the 4th quarter, the first time period we have a year over year comparison. The Air Edge transforms the entire operation, strengthening the customer relationship, sharpening the team's approach, implementing our technology platform for efficiency and improving the physical community. As a result, we see improved resident satisfaction and increased value for both current and future residents. This leads directly to pricing power, with weighted average lease to lease increases of 26% in the 2nd quarter that further increased to 28% in July.

Speaker 5

Our 2022 acquisitions, Coconut Point in Astera, Florida Watermark in Miami Wheeler Towers in Chevy Chase, Maryland and now the District at Flagler and Fort Lauderdale are off and running with the implementation of the Air Edge well underway. And finally, the business activity happening today is not only securing a blockbuster 2022, by earning into strong performance in 2023. Eventually, the tailwinds that Aehr and the industry are experiencing will subside, But the signals we see indicate that time has not yet come. My thanks to all the Aehr team members, your dedication to serving our residents 2. And your drive to continuously improve our business have made this quarter a great success.

Speaker 5

And with that, I'll now turn the call over to John McGrath, The Chairman of our Investment Committee, John.

Speaker 6

Thank you, Keith. Since the separation with Aimco, the Air portfolio has been materially enhanced in terms of quality, risk and capital allocation. Our portfolio strategy is focused on profitable growth and reducing both systemic and idiosyncratic risk. Our transactions have supported this strategy. Over the past 18 months, 2.

Speaker 6

We completed $3,100,000,000 of transactions, dollars 1,700,000,000 of equity sources, dollars 1,400,000,000 of which which was used to acquire 9 properties located in South Florida and Washington, D. C. And we currently have another $500,000,000 of sources and $200,000,000 of uses under contract. Our sales supported the deleveraging efforts, which Paul reported on in the past, and reduce concentration risk and regulatory exposure. Through acquisitions, we invested in high quality properties, We will benefit from the Air Edge and we reallocated capital to submarkets that exhibit high growth due to durable demand factors and constraints on competitive supply.

Speaker 6

These acquisitions are expected to be highly accretive with IRR spreads 350 basis points or more over our cost of capital. While we measure by IRR, we test by reality. Take the class of 2021 acquisitions, for example. We purchased the properties last year at NOI cap rates in the mid-3s, but we now expect yields to be in the 5s later this year. In effect, our portfolio is bifurcated into a fast growing same store portfolio and an even higher growth AirEdge portfolio.

Speaker 6

Today, the Air Edge represents about 11% of the portfolio. Over time, we expect the allocation to increase to approximately 30%, provided we can find opportunities which produce an attractive spread over our cost of capital and are within leverage policy. This shift in mix will yield higher quality earnings, will help insulate us from macroeconomic pressures and will enable greater output generation. Before reporting on our Q2 transactions activity, allow me to offer a few thoughts. Macroeconomic factors are top of mind.

Speaker 6

Recession and inflation fears and interest rate volatility have sidelined many buyers. Having lived through the recessions of 2000 and 1, 2000 and eight-nine and 2020, Aehr's seasoned investment professionals have the real world experience to navigate choppy waters, which may lie ahead. Despite market uncertainty, we see the opportunity to make profitable trades and we remain focused on the continued systematic enhancement of our portfolio through disciplined accretive growth funded by paired traits. Air trades allow us to be relatively agnostic to changing market conditions by locking in our cost of equity capital. It is important to note that we are firmly committed to disciplined capital allocation and we have no fixed goal for further acquisitions.

Speaker 6

While we do expect future transactions to be highly accretive, we will only transact when we can earn an attractive spread over our cost of capital, During the quarter, we raised equity capital through a sale at fortuitous timing and pricing of

Speaker 5

4 of our

Speaker 6

lower ranked properties 2, located in California and Virginia for approximately $203,000,000 On top of these sales, We have another $500,000,000 under contract with non refundable deposits. Earnings to external growth, we invested 467,000,000 to inquire 3 properties located in the Washington DC Metro area and in South Florida. And as previously announced, 2. We entered into an agreement with Aimco for the cancellation of its master lease of 4 properties for 200,000,000 Additionally, earlier this week, we acquired 1 property located in South Florida for 173,000,000 In accordance with our investment policies, these acquisitions are expected to earn IRR spreads of at least 200 basis points over our cost of capital,

Speaker 7

call. Thank you, John. Today, I will discuss Air's strong and flexible balance sheet, 2nd quarter results, our expectations for the balance of the year and conclude with a brief comment on our dividend. We made significant improvements to the balance sheet during the quarter, details of which can be found in our earnings release. I'd like to focus my remarks on 3 key points.

Speaker 7

First, our deleveraging effort is complete. While we target a leverage to EBITDA ratio of 5.5:one, we expect that the actual ratio will vary from quarter to quarter based on the timing of transactions. As part of our pear trade discipline, we seek to keep our sources and uses in balance. Rarely does the timing of the transactions align such that our sources and uses are in perfect balance at a quarter end. For example, today, we are slightly out of balance due to the $125,000,000 of 2nd quarter share repurchases and the July acquisition of the District at Flagler.

Speaker 7

This imbalance will increase when we close on our agreement to cancel the 4 Aimco leases. We expect that the imbalance will be completely eliminated before year end by the closing of the $550,000,000 sale of properties, dollars 500,000,000 of which are under contract today. As such, our expectation of year end leverage to EBITDA at 5.5:one is unchanged. 2nd, our balance sheet is insulated from interest rate volatility and any potential economic slowdown. 98% of our leverage is fixed with rates and maturities fixed for about the next 7 years.

Speaker 2

In

Speaker 7

fact, only $205,000,000 or about 7% of our leverage subject to repricing in the next 30 months. 3rd, we have abundant liquidity with $840,000,000 available on our revolving credit facility, dollars 84,000,000 of cash and properties unencumbered by debt with an estimated value of almost $8,000,000,000 Now turning to Q2 results and our expectations for the balance of 2022. 2nd quarter FFO was $0.66 per share, be fully repaid in the Q2. Instead, approximately 30% of the payment was deferred into July. The effect was to shift $0.03 of the prepayment penalty from June to July.

Speaker 7

The aggregate prepayment penalty was approximately $0.035 below our expectations, a result of short term treasuries Increasing significantly more than forecast. This was offset in our 2nd quarter results by the sale of a small residual cost basis investment

Speaker 3

2nd quarter. With the

Speaker 7

payment of the AIMCo note, it was no longer necessary for Aehr to maintain this ownership position. Looking forward, we are narrowing our expectations for full year FFO to be between $2.38 $2.44 per share, maintaining the $2.41 midpoint. Similarly, our expectations for run rate FFO, which is pro form a FFO, excluding the earnings effect Relative to 1 quarter ago, we now expect $0.03 of incremental FFO from stronger NOI growth in our same store and acquisition portfolios, offset by $0.02 of lower contribution from the cancellation of the Forre and Co leases and a penny of other items. As Terry commented in his remarks, 1st 18 months of Aehr's existence has been a period of transition during which The vision and promise of the Air business model was implemented. With deleveraging complete and entanglements between Air and Aimco greatly reduced, Simplicity of the Aehr business model is clear.

Speaker 7

Best in class property operations, delivering strong operating results from our same store portfolio and even faster growth from our acquisitions as they benefit from being added to the Aehr operating platform and low G and A results in predictable, high quality income and faster earnings growth. Lastly, the Aehr Board of Directors declared a quarterly cash dividend of $0.45 per share. We believe the tax characteristics of our dividend makes our stock compared to our peers more attractive to taxable investors, such as foreign investors, taxable individuals and corporations. For example, in 2021, 2 thirds of Aehr's dividend was a tax free return of capital, while the remaining 1 third was taxable at capital gain rates.

Speaker 8

In the

Speaker 7

same year, approximately 60% of peer dividends were taxed at ordinary income rates, with the remaining 40% taxed at capital gains. With that, we will now open the call for questions. Please limit your questions to 2 for time in the queue. Matt, I'll turn over to you for the first question.

Operator

20. The first question is from the line of Nicholas Joseph with Citi. Your line is now open.

Speaker 2

All good. 20.

Speaker 4

Hey, it's Michael Bilerman here with Nick. Terry, good afternoon. If you step Obviously, you've articulated a lot of the go forward positives for the Air company as well as portfolio. Your stock is at the lowest multiple on 23 FFO or FFO, any which way you measure it. Where do you think the company should trade relative to peers?

Speaker 4

Do you think there are any impediments left to achieving that? And if it doesn't close, what do you and the Board plan to do about it?

Speaker 3

Michael, thank you very much for your questions.

Speaker 4

I think that

Speaker 3

I'm not going to compete with you in giving advice to people about which stocks to buy. But what I would say is That what we have set out to do and I think have accomplished is a business model which deserves a very favorable risk premium. A very low risk because we don't have the prevails of development today. We don't have lease ups and supply chain issues and

Speaker 7

so forth.

Speaker 3

We don't have the Issues implicit in a loan business where you have a runoff, we have a business of owning stabilized properties and operating them better. And the key to that is revenue and expense. And if you look at the last Many years, Keith and his team have excelled at doing just that. So that's what we're going to try to focus on. And I think that What we'll see is above average growth, and I think that the market will remark it.

Speaker 4

Right. But I guess if you stand back, you talk all about the things that you've been able to accomplish recently. To be fair, Terry, a number of these Should have been an issue for when Air was created. And I was surprised that you mentioned that this was an IPO because This was a spin. It did not have a shareholder vote, even though shareholders wanted to have their input.

Speaker 4

And so a lot of what you call entanglements, The loan, the fact that you were too highly leveraged coming out of the box, the fact that you didn't have an ATM and had to go issue direct equity at a big discount. And while the balance sheet is fixed today, let's not forget it wasn't and that was a risk that the company took. And so I'm not undermining, it's now we have to go forward, which is effectively my question, right? 2. We sit here today, you've now done all these things and you've cleaned it up.

Speaker 4

I need a little bit more from you in terms of The stocks at a big discount, reflective of the fact that you purchased stock in the quarter at 43, good execution, Fusion. Balance sheet fixed, you talked about the Air Edge and the operating platforms and everything that Keith is doing. So it doesn't 2. It's clear to be that there's any impediments left. And so I guess, how do you sort of see value of the company.

Speaker 4

You had historically, we've known each other decades, used to put out NAV. You have a very good sense of value. You compare yourself to peers and everything else 20. In that presentation. So can you give a little bit more detail about how you sort of see value?

Speaker 4

And if the stock doesn't achieve that, What are you going to do about it?

Speaker 3

Michael, I thank you for your prepared remarks. And what I would say is that you're entitled to your opinion, but the market has answered the question. If you look at whether the spin was a good idea or not, if you look at the TSRs for the 7 large apartment REITs, The 2 Sunbelt REITs have done the best, but the Air AID combo has outperformed handsomely the remainders. 20. So thanks very much and please call another time if you want to continue.

Operator

Thank you for your question. The next question is from the line of Rich Anderson with SMBC. Your line is now open.

Speaker 9

Man, I got to fall that up. So Keith, to Your question or your comment about earning, probably predictable. Can you give, triangulate what you're seeing in numbers And what assumptions might be in that in terms of where you think rents sort of peak out this year if they haven't already and sort of hazard an estimation about what we're what we have in front of us as a starting point for 2023.

Speaker 5

Rich, thanks for the question. What I'd say about sort of where we are at in the season is that July has between now and the balance of the year is some number that is similar to that or maybe in the high teens. So we think that we continue to maintain strong pricing As we go work our way through the balance of the year, what ultimately that will translate into is something That will be in the earning and call it the mid to high 4s when we get to 2023. And then I would couple that with what we believe to be a loss to lease of about 10% in January. So it gives you a couple of data points to know that we think that we're going to have a strong 2023, And we have more strength as we finish up the balance of this year.

Speaker 9

All right. So you started mid-4s and then you have this loss to lease, which could Go up or down depending on the market, but the starting point is 4 with some upside essentially is what you're saying.

Speaker 5

I think that's a good way to think about it, Rich.

Speaker 9

Okay. Second question is, you talk a lot about AirEdge and I appreciate The terminology and all that, but I think all of your peers have their own version of AirEdge. That's what makes you kind of separates from the pack. So, relative to the private market of ownership of multifamily. So with that in mind, now that You've cleared a lot of the entanglements.

Speaker 9

Why would AIRC Air Grow more than your peers, assuming you all kind of operate at a similar level of sophistication. What's the bold case for outperformance, keeping in mind that you have some tough competitors

Speaker 3

in the public world. Rich, we have very tough competitors and they They'll get better and we will too. What we have today is really 2 important advantages. With the highest margins, we retain more money out of every bit of increasing rent. And so it's one thing to say rents up 10%, but the question is how much of that gets to NOI.

Speaker 3

The second thing with an advantage also in G and A, more of that gets through to where it can be either distributed to or invested for the benefit of shareholders. Okay. Thanks very much.

Operator

Thank you for your question. The next question is from the line of Barry Lowe with Mizuho. Your line is now open.

Speaker 8

Thanks. I'm on the line for Haendel St. Just. I was wondering if you could talk through the expense. Impressively, your expenses stayed flat year over year, and you decreased your guidance.

Speaker 8

So I was hoping you could break out the line items, particularly for repair and maintenance and how we should think about property taxes for the back of this year and the Gulf War.

Speaker 7

Hey, Barry. This is Paul Belen. So nice to meet you and thank you for filling in for Haendel, but we miss him. So please wish Haendel well. In response to our

Speaker 4

expense expectations, we did

Speaker 7

2. Expense expectations, we did both narrow our range for expected growth and reduced the total growth at the midpoint by 25 basis points. 20. And that is a function of continued excellent work from Keith and his team on managing controllable operating expenses. I'll let Keith kind of fill in some of the details there.

Speaker 7

But also, it reflects the fact that we're now halfway through the year and we have greater visibility into the items that are outside of that bucket, Most notably, real estate tax expenses where we've had a good year to date where we're actually negative 2% on a year to date basis. And we expect that for the full year, real estate tax growth will be quite moderate, maybe in the 1% to 2% range.

Speaker 5

2. Barry, just some color around it is that really where we focus is the avoidance of costs through greater retention. 20. And that comes from the customer selection process on the front end and then having exceptional team members who are highly effective and highly efficient highly qualified team. We get this high-tech, high touch combination.

Speaker 5

And so through that, we get, as you point out, lower Repairs and maintenance costs, we also find our way to have lower marketing costs and seasonal staffing opportunities that we take advantage of. So those are some of the inputs.

Speaker 8

Got it. Thanks for that color. And so actually on turnover, so I noticed some really low turnover numbers as well. Some of your peers are trying to turn turnover to get push rents higher and taking a couple points of occupancy hit on that. Is that kind of a strategy you're thinking about or not as much?

Speaker 5

Barry, we don't think about it as individual single inputs. We think about the total contribution. So it's the combination of 1, having low turnover, but having high rents on both new and renewal rates And ultimately, avoidance of costs that find its way all the way down to margin and the cash that comes through. So we don't just focus on a single 2. We really look for the total optimization of return.

Speaker 2

Thank you.

Operator

Thank you for your question. The next question is from the line of Chen Lioufro with Goldman Sachs. Your line is now open.

Speaker 2

Hi. Thank you. Thank you for taking my question. You guys talked about these payer trades that you've been doing. Any sense of what's going on in the transaction market?

Speaker 2

How much have value come down? And has anything changed in that spread that you typically maintain? If you could give any color on that would be great.

Speaker 3

Hi, this is John.

Speaker 6

Thank you for your question. I'll first start by saying when we think about cap rates, first, comparing them to an imprecise science. But with that said, we've seen the cap rates across the board have expanded about 0 to 25 basis points on core assets and about 25 basis points to 50 basis points on non core assets. Valuations, we're seeing about 5% to 7% down. However, I should note that demand does remain strong and the prices continue to hold for our best assets for the best assets in the best locations.

Speaker 6

As far as the bid ask spread, what I'd say on that is if I use for an example, the dispositions we have in the market, including the $500,000,000 we have under contract today. We're not seeing a big bid ask 2. What we're seeing really that the spreads have tightened compared to maybe where they were a few months ago. And we're only seeing on our own deal A small spread of maybe a couple percent.

Speaker 2

Got it. And if I could please get a quick follow-up On bad debt, what are your expectations for the back half of this year?

Speaker 7

Yes. Johnny, it's nice to hear from you and thanks for joining the call. This is Paul. So for bad debt, as we've looked out 2. To the balance of the year, and there's been a lot of discussion of this in other calls, is around what can you expect around government assistance payments, Particularly for our portfolio in the State of California.

Speaker 7

And so as we look at our 2nd quarter bad debt, Our bad debt expense on a net basis was about 20 basis points of revenue, which is in line with our typical long term results, But important and to note within that is the benefit of having about $3,000,000 of government assistance payments. So if you look at bad debt as we do before those payments. That was about 1.9% of revenues. And as we are projecting to the balance of the year, we're not assuming that our bad debt Experience is going to get any better in order to make our guidance. We hope that it will improve.

Speaker 7

We're working hard with local jurisdictions to accelerate the eviction process, But we don't necessarily anticipate within our guided numbers to do much better than what we saw on a gross basis in the second quarter.

Speaker 1

Thank you for that.

Operator

Thank you for your question. There are currently no further questions registered.

Speaker 3

Well, thank you all on the call. Thank you, Matt, for managing this call. 20. If you have questions, please call Paul or Matt O'Grady or me, Terry Considine, and enjoy the summer. Be well.

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