BSR Real Estate Investment Trust (AVB) Earnings Call Transcript & Summary

Good morning. My name is Ludy, and I will be your conference coordinator today. At this time, I would like to welcome everyone to the BSR REIT conference call to discuss the transaction announced by the REIT this morning. [Operator Instructions] Thank you. I would now like to turn the conference over to Dan Oberste, President and Chief Executive Officer of BSR REIT. Please go ahead, sir.

Thank you, Ludy, and good morning, everyone. Welcome to BSR REIT's conference call to discuss the exciting transaction we announced this morning. We have a slide deck that accompanies this transaction, and you can access it on the Presentations & Events page in the Investors section of our website. I'll begin the call with an overview of the transaction. I'm sure you'll have some questions following my remarks, and Susie Rosenbaum, the REIT's COO and Interim Chief Financial Officer, will join me to answer your questions. To begin, I want to remind listeners that certain statements about future events made on this conference call are forward-looking in nature. Any such information is subject to risks, uncertainties and assumptions that could cause actual results to differ materially. Please refer to the cautionary statements regarding forward-looking information set out in the legal disclaimers to the slide deck and in this morning's news release for more information. During the call, we may also reference certain non-IFRS financial measures. Although we believe these measures provide useful supplemental information about our financial performance, they're not recognized measures and do not have standardized meanings under IFRS. Please see the legal disclaimers to the slide deck as well as our MD&A for additional information regarding our non-IFRS financial measures, including reconciliations to the nearest IFRS financial measures. Also, please note that all dollar amounts are denominated in U.S. currency. Turning to Slide 3. The REIT has agreed to sell a 9-property portfolio comprising of about 2,700 suites to AvalonBay Communities for gross consideration of $618.5 million. For those of you not familiar with AvalonBay, it is the largest publicly listed apartment REIT in the U.S. They own or hold an ownership interest in over 300 communities, comprising approximately 93,000 apartment homes in 12 states and the District of Columbia. In a stand-alone sale, the REIT will sell 3 properties in Austin, comprising 857 apartment units for $187 million. Under a separate contribution transaction, the REIT will sell 6 properties in Dallas, comprising 1,844 apartment units, for total consideration of $431.5 million. Total consideration for the Dallas contribution transaction will consist of approximately $193 million in cash, with the remainder consisting of the exchange and cancellation of up to 15 million BSR Class B units into a newly formed DownREIT partnership entity of AvalonBay. A critical element of this transaction for BSR is that as consideration to facilitate the contribution transaction, the contractual rights held by a subset of legacy holders of Class B units, pursuant to the investor rights agreement, including consent rights over certain fundamental sale transactions, will be eliminated. Why is this element of the transaction so important to BSR? I'll speak to this in a moment. The bottom of Slide 3 outlines the strategic rationale for the transaction. There are 4 key elements. First, the transaction validates the market value of our portfolio and substantiates our IFRS NAV. The sale of these assets at close to NAV reinforces the integrity of our property valuations, highlighting the public market mispricing of our stock. Second, the transaction strengthens our governance and reduces ownership and influence of certain legacy Class B unitholders that currently hold the majority of Class B units. With the removal of 15 million Class B units, Class B unit ownership will decline from 38% to 13% post transaction. Class B veto rights are eliminated, and Class B Board representation drops from 3 to 1. This simplifies our restrictive capital structure and is why this element of the transaction is so important. Third, the transaction provides an attractive foundation to recycle capital into new assets to drive enhanced growth, with continued focus on strategically investing proceeds into the core Texas Triangle investment markets. And fourth, it leverages management's unique competitive advantage, which is the proven ability to reposition our portfolio. As most of you witnessed yourselves during the 2020 and 2021 period, we identified and successfully executed on an opportunity to rotate the bulk of our Class B and C properties in secondary markets into higher growth, higher-quality properties in primary Sunbelt markets. This transaction enables the divestment of a cross-section of the portfolio and utilizes our expertise in maintaining high-quality, diversified multifamily strategy. Slide 4 highlights our strategy following the closing of this transaction. We anticipate redeploying approximately $190 million into acquisitions in the Houston and Dallas area markets. We will maintain our focus on high-quality, diversified multifamily communities in the core markets of the Texas Triangle. At the same time, we will continue to prove portfolio value by logically allocating capital and opportunistically divesting fully optimized assets at or near book value. We will ensure capital is secured from the most cost-effective sources and value is maximized to enhance investor returns. This is what the BSR platform was designed to do, and it is what we are good at. And I should add that the removal of the Class B unit veto rights will make us even more nimble and effective. Moving to Slide 5. This slide illustrates the 9 properties we are selling, which really represent a cross-section of our portfolio. As indicated, this transaction enables us to dispose of approximately 30% of the assets for approximately 40% of the market value of our total portfolio. 40% of the sale portfolio includes assets that are 10-plus-year old, enabling the REIT to redeploy proceeds into newer developments in our target markets. The sale price of this portfolio is $111 million value lift relative to the original acquisition price of these assets, which represents a profit of over $2 per REIT unit. This again underlines our competitive strength in successfully rotating portfolio assets. And finally, our remaining portfolio continues to be valued at a 5.2% cap for our IFRS NAV, again, highlighting that we have sold a true cross-section of our assets. Let's drill in a little deeper on Slide 6. This slide illustrates how our asset rotation strategy has transformed our portfolio and driven stronger performance, all without significant capital raises or riskier development investments. As I highlighted earlier, we have consistently invested upward in quality. The column on the left illustrates the portfolio after our 2008 IPO. We were in a lot of markets, most of them secondary markets with many older buildings, average monthly rent below $800 and 93% occupancy. Fast forward to the end of last year, the middle column, and you see us in 5 markets with a significantly younger portfolio, 93% higher average rent and 250 basis points higher occupancy. And we did it all without increasing our leverage. The column on the right represents our portfolio at year-end '24, adjusted for the impact of this transaction as well as the incremental dispositions of 2 properties in Little Rock and Oklahoma City. What you see here is a focused, high-quality portfolio without increased leverage and considerable dry powder for future acquisitions. We can add well over $150 million in acquisitions while maintaining our pretransaction debt-to-gross book value ratio of 46%. That represents a lot of potential AFFO when these new assets are stabilized. Moving to Slide 7. As I indicated earlier, we have a clearly defined investment strategy. We are targeting young assets in the Texas Triangle with high growth potential. These markets feature superior population, employment and median income growth compared to the U.S. overall growth statistics. The submarkets we favor are suburban focused with a positive absorption, rent and occupancy growth, multiple employment drivers and superior school districts. Whether a new property is a value-add candidate or a lease-up, the BSR platform has the people and the experience to optimize the asset. And the platform is built to support 50 properties, so we can more than double our assets without major cost additions. I've talked about our ability to optimize assets. Let me provide an example on Slide 8. In 2019, we acquired the Cielo Apartments in Austin, a 554-suite community built in 2015. There were 3 major elements underlining the underwriting. First, we saw a property with a great location in an affluent area, 20 minutes east of Downtown Austin and in a highly rated school zone. Second, we recognized that there was a significant NOI growth potential throughout the holding period. We saw this as an opportunity to showcase our track record of operational excellence and optimizing our portfolio. As indicated in the bar graphs on the bottom right, we were able to leverage the BSR platform to reposition the property and substantially increase our initial return. We increased occupancy by 185 basis points and average rent by 26%, resulting in a 50% increase in NOI. Now we're selling the property for 30% more than we invested. We expect to continue to create and unlock value going forward and expect that the market will recognize it and begin to pay for it. As I indicated earlier, that's one of the strategic rationales behind this transaction. We see an opportunity to rinse and repeat on a rotation. Moving to Slide 9. I'll put that in further context. As indicated here, this strategy of identifying value-enhancement opportunities has resulted in BSR consistently outperforming our peer group in both FFO and consensus NAV per unit growth over a sustained period. However, despite our superior historic returns, BSR presents a compelling discount valuation to peers as seen on Slide 10. BSR is traded at the lowest price to consensus FFO per unit multiple despite having the highest FFO per unit growth relative to our peers. And we're trading at an approximately 30% discount to our consensus NAV -- to consensus NAV estimates, well below our peers. This transaction further accentuates the discount given the realization of value in line with IFRS NAV per unit. We have put BSR back into a position to achieve what we do best, leveraging our dynamic platform to reposition the portfolio and aim to drive growth. That concludes our prepared remarks this morning. Susie and I will be pleased now to answer your questions that you may have. Ludy, please open the line for questions.

[Operator Instructions] And your first question comes from the line of Jonathan Kelcher with TD Cowen.

First question, just on the pricing on the 15 million Class B units. It looks -- if I calculated it right, it looks like it's about [ $15.86 ]. How is that determined?

That's a good question, Jonathan. So the 2 REITs' valued real estate portfolio, and then we took the B unitholders -- let's put it in their perspective. The B unitholders would have paid a cash amount in order to accept a paper into AvalonBay. So while this transaction is at or near our Q3 NAV, the -- I think it's your math on the read-through for the B unit shareholders. But from the B unit shareholders' perspective, they're settling up with cash to achieve that discount, if that makes any sense. So we started with a real estate transaction valued at real estate prices and then evolved into the B unit contribution as a portion of this transaction. And that's -- I think that's critical here.

Okay. And then the $193 million that you expect, that just assumes that all 15 million are subscribed, right?

That's correct -- no, no, no. The $193 million is an all-cash sale of assets in Austin, Texas. So that asset assumes no subscription for any B unitholders. Those 2 asset sales are moving through in an all-cash nature. And so the REIT expects to realize that cash and use those proceeds for immediate redeployment.

Okay. Secondly, just on the $190 million in assets for acquisitions that you talked about, have those all been identified? Are they under contract? What sort of time line and what sort of assets are they?

Yes, Jonathan, we've historically not announced deals until we close them. I think I've said before, we don't announce anything we don't close. It's our view that we're pretty confident in our ability to rotate or acquire $190 million of assets in Dallas and Houston in particularly. We don't have anything as of this morning under contract with nonrefundable deposits. Otherwise, we would, as a matter of course, disclose that. And we won't announce transactions until we are confirmed into them. But we're pretty confident, I would say, in acquisitions to occur in and around 90 days of closing. So between now and, we'll say, June.

[Operator Instructions] Your next question comes from the line of Matt Kornack with National Bank Financial.

Congrats on the transaction. We now know why we weren't down in Austin, I guess, not too long ago. But can you just give us a sense from an earnings standpoint and the timing of these transactions, how we should think about kind of the near-term use of proceeds? I know you've mentioned, I think, a $48 million repayment of the mortgage, but you also have your kind of line of credit. So presumably, should we assume that all the cash proceeds other than what goes to pay down the mortgage would be used to reduce leverage in the immediate term and then you'll kind of redraw on that as you acquire? Or will you sit with cash on the balance sheet for a period of time?

No, Matt, that's a good question. So we are reporting our earnings next week at a separate call, our year-end earnings. So I don't see that this transaction has impacted our year-end 2024 earnings. I don't anticipate that this transaction will materially impact our first quarter 2025 earnings. However, you're spot on. We're selling NOI-producing assets and using the proceeds to retire debt. I think the read-through cap on this that we provided is about a 5.1% cap in line with our IFRS NAV. And you can price debt. I mean we can all price what debt is, and we're using the proceeds in the short term to retire debt and then, in the medium term, to acquire, we'll say, at least $190 million of redeployment. We would -- we've talked about our acquisition criteria in the past, and we're not changing any standards whatsoever. So we would acquire when our spread between cap and spot debt creates positive accretion for our shareholders. So you can expect near-term disruption in Q2 to our earnings, paired with lower leverage, followed by redeployment of capital, consistent with our prior acquisition criteria.

Great. I mean it was a little lower for Austin, but a 5% cap is kind of where the market is at this point. And should we assume, I guess, on acquisitions, you'd be in that range? I guess it will depend if you buy assets that are in lease-up, but I'm not sure if that's on the table at this point.

Yes, we'll see. We'll see. I do think that this is a superior counterparty in the United States. AvalonBay is with a very low cost of capital. And I do not think the rest of the buy side in the private market, the people that we buy assets from, have a similar cost of capital. And I'm not going to talk about forward cap rates for acquisitions today other than to say we -- once again, as I said, this is a rinse and repeat, a BSR special, if you will. We're selling assets that we view have matured in our portfolio, and we see an opportunity in the near term in a buyer's market to pick up assets that we can apply to our portfolio to drive kind of outsized NOI growth, not unlike what we've done in the past 5 years.

Okay. And then last one for me. Those B class units, as restrictive as they were, also provided a bit of a control block on your shares. Now you're kind of out there without that protection. Do you think this increases the likelihood that the portfolio gets acquired in hold by somebody? Or how should we think about that prospect going forward?

Matt, I don't want to speculate on whether this increases the likelihood, but what I can confirm is that as the shareholder rights agreement is amended, these consent rights are eliminated, it certainly prohibits an irrational blocking right of a minority shareholder on something like a privatization.

[Operator Instructions] And I'm showing no further questions at this time. I would like to turn it back to Dan Oberste for closing remarks.

That concludes our call today. Thank you all for joining us. We look forward to speaking with you again on March 6 following the release of our 2024 year-end results.

Thank you so much.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.