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

good afternoon. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the BSR REIT Q3 2020 Financial Results Conference Call. Note that all lines have been placed on mute to prevent any background noise. [Operator Instructions] Thank you. Mr. Bailey, you may now begin the conference.

Thank you, Sylvie, and good morning, everyone. And also with us today are Dan Oberste, President and Chief Investment Officer; and Blake Brazeal, our Co-President and Chief Operating Officer, who will both be available to answer questions following our prepared remarks. I'll start this call by providing an overview of our Q3 performance and other corporate developments. Susie will then review the financials, and I'll conclude with some comments on our outlook and strategy. After that, we will hold a Q&A session. Before we begin, I need 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 on forward-looking information in our news release and MD&A dated November 10, 2020, for more information. During the call, we will 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 our MD&A for additional information regarding our non-IFRS financial measures, including for reconciliations to the nearest IRFS measures. Also, please note that all dollar amounts are denominated in U.S. currency. We continue to operate our business with relatively minimal disruptions created by the COVID-19 pandemic. Our highest priority is the health and safety of our residents and BSR team members. Management will continue to monitor all of our markets and properties to adjust policies and procedures as necessary to providing safe environment to live and work. Our rent collections remain within the pre-COVID historical levels, specifically during Q3 2020, we collected 98% of the total monthly revenue compared to our historical average of 99%. We continue to advance our capital recycling program. On July 30, we acquired Broadstone Park West, constructed in 2014, a high-quality property in Houston market with 370 suites for $51 million or $137,838 per apartment unit. On September 24, we acquired Aura Castle Hills, constructed in 2019, a 276-suit garden-style residential community in the Dallas, Fort Worth market, for $51.8 million or $187,681 per apartment unit. Subsequent to quarter end, earlier this week, we continued the recycling program with the sale of 6 noncore properties comprising of 1,483 apartment units, 4 in Little Rock, Arkansas and 2 in Houston, Texas, generating gross proceeds of $130 million. We are very pleased with the progress of the capital recycling program. Since our IPO in Q2 2018, we have acquired 12 properties comprising of 3,511 apartment units, while selling 26 properties, comprising of 5,149 apartment units. Net operating income from properties located in our primary markets now comprises 88% of total NOI compared to 52% at the time of the IPO. Moreover, our asset quality has improved substantially, and our portfolio's weighted age -- average age has decreased from 29 years to 18 years old, reducing our CapEx requirements going forward. We are very excited to see our portfolio improve as we continue to recycle capital to take advantage of the compression in cap rate spreads between primary and secondary markets. The REIT's debt to gross book value is currently at 48.1%, providing the flexibility to add approximately $200 million of assets without further equity. We also remain confident we will sell an additional $120 million to $140 million in assets before year-end. Our ongoing transformation of our portfolio was evident in our Q3 results. Weighted average rent at September 30 was $1,011 per apartment unit, representing a substantial year-over-year increase of 12.3%. We expect our financial performance to strengthen further as we continue to redeploy capital into primary Sun Belt market MSAs with some of the strongest long-term economic fundamentals in the country. Economic uncertainty, obviously, remains heightened in the near-term due to COVID-19. But with our current liquidity position of approximately $103 million, we are well positioned to manage our business, while also executing on our capital recycling program and growth strategy. Now I'll turn it over to Susie to review our third quarter results in more detail. Susie?

Thank you, John. Same community revenue increased 3.1% in the third quarter over the prior year to $20.3 million, reflecting an increase in average rental rates from $900 per apartment unit as of September 2019 to $909 per apartment unit as of September 2020 as well as $0.4 million increase in utility reimbursements. This was partially offset by the absence of late rental fees of $0.1 million related to the COVID-19 pandemic. We resumed charging late fees in mid August of 2020. Total portfolio revenue for Q3 2020 increased 7.2% from $27.8 million in Q3 2019 to $29.8 million this year. The increase was primarily the result of property acquisitions, which contributed $7.4 million in revenue as well as higher rental rates across the portfolio and an increase in utility reimbursement, partially offset by dispositions that reduced revenue by $6 million. NOI for the same community properties totaled $10.6 million, an increase of 4.9% compared to $10.1 million in Q3 last year. This was primarily due to the revenue increase, partially offset by $0.1 million in additional to COVID-19 pandemic expenses. NOI for the full portfolio increased by 4.8% to $15.2 million compared to $14.5 million in Q3 last year. This increase was primarily attributable to acquisitions contributing $3.6 million as well as the increase in NOI from same community properties, partially offset by property dispositions reducing NOI by $3.4 million. As we continue to redeploy the recycled capital from secondary markets into primary markets, we expect the accretive impact of long-term growth to be reflected in our financial performance. FFO for the third quarter was $7.4 million or $0.16 per unit compared to $7.1 million or $0.18 per unit last year. The increase of $0.3 million was mainly the result of higher NOI, partially offset by an increase in the amortization of deferred financing costs of $0.2 million and an increase in interest expense of $0.1 million as well as higher general and administrative expenses of $0.1 million related to share-based compensation. Q3 2020 AFFO of $6.5 million was flat compared to last year equal to $0.14 versus $0.16 on a per unit basis. The increase of $0.3 million in FFO was primarily offset by an increase in maintenance capital expenditures of $0.2 million related to emergency only maintenance performed during the previous quarter. Hence, we had lower spending on maintenance CapEx in Q2, which shifted these costs to Q3. The REIT paid pay quarterly cash distribution 12.5% per unit in Q3 of both years, representing an AFFO payout ratio of 87.5% in Q3 2020 compared to 80.3% last year. Turning to our balance sheet. On September 3, the REIT issued $40 million of 5% convertible debentures maturing September 30, 2025 with a conversion price of $14.40 per unit. Subsequent to quarter end, on October 5, the underwriters of the offering exercised their option to acquire a further $2.5 million. Our debt to gross book value ratio at September 30, 2020, was 50.8%. As John indicated earlier, following the subsequent dispositions of the 6 noncore properties and the partial exercise of the over-allotment option, our debt to GBV now stands at 48.1%. As previously mentioned, our current total liquidity following the sales and the offering is $103 million. This includes cash and cash equivalents of $6.8 million, $61 million of borrowing capacity under our credit facility and $35 million available under our revolving line of credit. As of September 30, we had total mortgage notes payable of $396.9 million, excluding the credit facility and the line of credit with a weighted average contractual interest rate of 3.9% with a weighted average term to maturity of 9 years. Total loans and borrowings at quarter end were $595 million, excluding the debentures, and 77% of the REIT's debt was fixed or economically hedged to fixed rate. Total loans and borrowings are $474 million after the sale of the 6 properties this week, excluding the debentures. I will now turn it back over to John for some closing comments. John?

Thanks, Susie. Last week, we announced a change to the REIT's senior management structure. Dan Oberste has been appointed President and Chief Investor Officer (sic) [ Chief Investment Officer ], having previously served as Executive Vice President and Chief Investment Officer. In his new role, Dan will retain oversight over the REIT's investment strategy while also assuming responsibility for our capital markets program. Blake Brazeal continues as the REIT's Chief Operating Officer, while also assuming the role of Co-President. Blake's primary focus will continue to be the oversight of the REIT's property operations and the management platform. Dan and Blake will both report to me and work alongside me in determining the REIT's strategic direction. Dan's appointment as President reflects his contribution to the growth and success of the REIT, and his promotion is reflective of the REIT's long-term succession planning. The year 2020 has been a challenging one, but we have continued to deliver solid operating performance, while also successfully executing on our capital recycling program. This high-level performance is attributable to the platforms added value to the REIT. We operate in a highly liquid market. And as you have seen, our pace of both acquisitions and dispositions has remained consistent during the pandemic. Once again, we feel confident we will complete our targeted range of $120 million to $140 million in dispositions before year-end. We have a robust acquisition pipeline, and we are looking forward to continuing growth in our primary markets. We are monitoring the spread of the COVID-19 closely. We are comfortable that we have made all the appropriate adjustments to our daily operations. But if we determine further changes are necessary, we stand prepared to implement them rapidly across our portfolio. COVID withstanding -- notwithstanding, we believe the REIT is advantageously positioning itself to continue our strategic transformation in our primary markets. The economic performance of our markets has historically outpaced the country as a whole, and we expect that trend to continue. Our portfolio has improved significantly in terms of location, asset quality and age. And we have a strong liquidity position and an excellent pipeline of opportunities for the portfolio growth. That concludes our remarks this morning. Susie, Dan, Blake and I, would now be pleased to answer any questions you may have. So operator, if you would please open the line for questions.

[Operator Instructions] And your first question will be from Fred Blondeau at IA Securities.

And obviously, big congrats to Daniel. John, just on your current asset for sale in the pipeline. Where would that put your NOI generated by noncore assets at year-end in 2020?

I believe it was around 12%, Fred. If we were to continue executing the way that we've been saying and are confident the way that we have in our pipeline of noncore assets that we're looking at queue to sell.

Yes. I saw the 12% in the MD&A, but I thought that you had more sales in the pipe until the end of the year.

In the queue for sale beyond the 12%?

Sorry. I'm seeing in your MD&A that you are currently 12% noncore of NOI provided by your noncore assets today. So I was just wondering what are your expectations in terms of asset sales...

That's right.

Between now and the end of the year? And where would that put you at the end of 2020 in terms of your NOI generated by noncore assets, if that make sense?

Fred, it should go down to about half that amount and that we ought to have around 6% the noncore. We had noted that we would be selling Pascagoula, the rest of the properties that we had in Beaumont, Texas, we have in Houston and Little Rock property. That leaves just a few of the properties that are outside. So I'm going to say about 6%.

Okay. No, that's great. And so just a segue to my next question. Susie, how would you feel today about your current debt ratio at 48%?

Yes. Quite low. We're still in the middle of recycling, and we just sold 6 assets. We're still holding true to that we'd like to be no higher than 55% as we finish the capital recycling program.

That's great. And maybe last, last 1 for me. It looks like the portfolio continued to perform well in October. What would be your base scenario in terms of occupancy for Q4 and Q1? And where do you see greater challenges across the portfolio today?

This is Blake. I would expect -- I would not expect an increase in occupancy of any substantial amount. I think it will be along the historical lines. The main things that we will be looking at that could pop up is, obviously, the pandemic. We're keeping our eye on that. We feel like we handled the first wave of the pandemic in a very effective manner, which did not affect our daily operations to any great degree. And that will be one of the main things that we'll be keeping our eye on as the next wave of the pandemic.

And do you feel like part of the portfolio is more at risk than others today, geographically speaking?

Well, the reason -- one of the main things that I think is an advantage in our portfolio, frankly, as we're in an area that are -- as you've seen through the last almost year, pro business and -- have continued to operate during the most -- I guess, at the time, the most affected and percentage-wise pandemic growth. So we feel good about that. And we're also in areas that continue to grow with people that are moving in at the highest rates anywhere in America. So we're obviously not immune to worrying about that. It is something that we're keeping our eye on, but we feel like we're in one of the best areas in America. Our portfolio is in order to handle an outbreak.

Next question will be from Brad Sturges at Raymond James.

Just to follow-on to Fred's question on the cap rate or the capital recycling discussion. But just more in the general context about pricing. I guess, a few quarters ago, you were guiding towards a spread between primary, secondary markets of, call it, 100 basis points. Has that changed in any way? Because it does seem like there is some cap rate compression happening within some of your core markets?

This is Dan. That's a good question. So I mean, I think if we look at the historic spread between major and nonmajor markets, it's set around 110 basis points recently. The current spreads compressed down to about 90 basis points. So yes, we're seeing further compression between major and nonmajor markets. I think when you yank out of some of that data, you're defining your major markets is really the urban population centers that have probably been hit more fundamentally than our Sun Belt markets. And what I'm referring to is New York, that has negative absorption and leads the nation in deliveries, San Francisco, Seattle, Chicago. When you think about the cap rates for those markets, yes, they've creeped up a tad, maybe. But you compare that to the markets that we're in, in Dallas and Houston and in Austin. As Blake mentioned, the ramp-up in COVID cases in Texas occurred more recently than March relative to those cities we just talked about. And so you continue to see good performance. You continue to see great net migration going into those markets, right? And I would say the cap rates are compressing. The risk is compressing specifically for Austin, where we're really seeing cap rate compression.

So for going in cap rates now, what would be the kind of the range you're seeing in some of your core markets like Austin or Dallas?

Going in [indiscernible], yes. That's a good question. You can run the game. And I mean, I would say, Austin, right now, today, in that market, you're seeing a whole lot of high 3s. That's not to say, well, that's what we acquired, the $212 million of assets we bought in Austin the last year. We didn't have a 3 handle on our cap rates, but that's what we're seeing right now for those assets. We're happy to compete with those individuals, just not at those prices. Where we're seeing in Dallas and Houston sit is probably between 4 and 5, nominally, call it, a 450 cap for our style of asset. I think what continues to be interesting is that the value add, I'll say, a little bit older assets in these markets, we're seeing transaction volume continue to outpace kind of the core and core plus assets, and we're seeing cap rates for those value-add assets remain low, which is impressive.

Next question will be from Kyle Stanley at Desjardins.

Just looking at the occupancy, I'm wondering, could you provide a bit of color on the sequential decline in the same property portfolio?

Sure. Kyle, this is Blake. We're -- when you really look at it the way I'm looking at it, we're talking about 75 units. And if you really go granular on it, they're basically made up in 3 different properties or 4 different properties. One of them is Heritage in Austin, we were down 10 units. At this current moment, we've made up that difference and are right along where we were. We just had a dip and it was a timing issue. Beaumont was another area which has always been kind of an up and down area. And if you look at the last quarter, it was at 98%, which was very high for Beaumont, which now, both of those assets are back at the range, it's not at 98%, a tad above what is showing in the MD&A right now. Dallas stayed relatively flat. Houston was down about 23 units. Of those units, that was 2 properties that made up the whole amount. Those have come back. I want to add also that the 6 properties we disposed off yesterday, those were -- their combined effect were below higher averages. And the assets that we -- that John alluded to earlier, that we'll be selling in the different MSAs, those are also below our averages. So where does that leave us? The core assets that we expect to be in our portfolio are performing as we would want them to perform. Now the next question that I would assume you would ask is over the year-over-year. That is a hard one from each year to compare because the nonsame-store properties are a different mix of properties each year. Last year, for instance, we had the Tulsa portfolio, which was running at 98%. That was in that number. And also, this year, we've added 2 properties our late -- one of our latest properties that we bought, the Broadstone that is running at -- when we bought it, that we're running at 82%, and now it's at 88%. And we've had another 1 that we bought that was a 91% story that is leasing up, and we had put it in there, and it's actually has leased at 93% and stabilized. So that creates that gap in the nonsame-store comparing year-over-year.

Okay. Great. That's really good color.

So does that answer the question?

Yes. Definitely answers the question. I guess this is probably a question more for Susie. So the NOI margin impacted a bit by some of that acquired vacancy that Blake was just talking about. Just wondering where you see the NOI margin kind of trending into the back or the end of the year and into 2021 as maybe the lease-up progresses a bit further?

Yes. I'm sticking with the 54%, but I've said on the last few calls. This quarter, yes, we did see margins go down a bit for the reasons you just mentioned, but also because we had some expenses that were little bit higher due to timing. Some additional health care costs that were all booked this quarter as well as the shift in turnover costs. We didn't have as many last quarter because we went to emergency only maintenance. And therefore, we picked up some of those costs in Q3.

I wanted to add 1 more thing, and I'm sorry, I didn't add it when we were talking. But I think it is germane to the conversation is that October was our highest move-in, move-out ratio of units, which was 97 units that we've had by far since before the pandemic. So we netted up 97 units in our portfolio, and those are were basically based in the core unit. So that's obviously something that's a really good sign also. There was some pent-up demand and our leads and tours and everything, which I talked about later, are all up.

Okay. Maybe just 1 last one for me here. Can you just provide an update with regards to the in-suite rental program on these turnover? Just maybe have you continued to do those year-to-date? Are you still seeing pretty healthy demand for that kind of product and maybe the spreads that you've seen?

Yes. We've continued to do those. But obviously, with the pandemic, we weren't -- we have not been able to do as many as we were thinking we would do this year. We've really picked up the pace over the last quarter in dealing -- in doing more and more of these. Through the year, we've done 157 partial upgrades and 120 signature upgrades. Wimberly in Dallas is performing at a 20% return. And we've got 76 unit upgrades at that property, in particular. We've really got 3 areas -- 3 properties that show a real affinity for producing the returns. And those are Wimberly, River Hill and Auberry. So we've been pretty strategical during this time. But even with that, we've completed 15 more than we budgeted. We just really thought we would produce more during the year. That was my original plan advance too when we started, but the pandemic kind of threw us for a loop for a 6-month period there.

Next question will be from Matt Logan at RBC.

Blake, I appreciate all the commentary on your leasing. Certainly, it sounds like things are trending positively in Q4. Can you give us a sense for what you're seeing in terms of like relocations from major markets? Or if you're seeing a shift from the downtown to the suburbs? Just any commentary you can provide on what is driving demand would be appreciated.

Do you mean aside from CBRE's recent decision to relocate their corporate headquarters from L.A. to Dallas? Or Tesla's construction of its $2 billion factory about 10 miles from our properties? Yes. I guess we can go into that. So I think what's interesting is when we look at the net absorption in the second and third quarters, you're seeing Houston lead the pack. And we saw that -- we talked about this in the last few quarters. Houston had a 2018-'19 year where they had really low deliveries with sustained net migration and the majority of that was coming for job growth and with some international migration in Houston. So we talked about it last year, particularly when we acquired a couple of assets in Houston about how we saw this year, probably in Houston, outperforming the expectations and it has. Most of that is driven just, I would say, the same type of organic net migration that you've seen in Houston in the last 10 years, making it one of the second fastest-growing population center in the country at that time. Dallas, it's the same story. I mean you're seeing PGA of America relocate the corporate headquarters, CBRE, Toyota. A lot of jobs moving in a lot of U-Haul and other moving trucks kind of sucking residents out of, call it, northeastern employment centers into the vast open, beautiful spaces in Dallas, Texas. Austin is somewhat of a different story. We're seeing a net migration from Austin come in from all over the world. But it really predominantly has to suck from, I'll call it, the West Coast. You're seeing tech salary growth and tech jobs be created in and around Austin. I want to say that WalletHub named Austin the Best College Town in America for the third consecutive year. Wall Street Journal just came out for the second consecutive year, named Austin is the hottest U.S. job market. U.S. News last year for the third year in a row named Austin as the best city to live in, in the United States. Austin has kind of got it all going on, and they're sucking from all over the country. But we are seeing a higher percentage of net migration from the West Coast, particularly California going into Austin relative to Dallas and Houston. And I don't think that's -- there's no sign of that stopping. I would say it's quite the alternative. We see that accelerating on a look forward.

So I guess, in short, it just continued job growth and net migration as opposed to people living in the downtown cores moving more towards the suburbs?

Yes. That's -- thank you for hitting on that. Yes. The -- we are seeing a little bit of weakness in the urban, call it, high-rise areas of these markets and all markets. BSR is pretty well situated and always has been in the suburban areas around these MSAs. I think it comes down. I mean you can just naturally place yourself into that environment where your job no longer requires you to work downtown. You can see a rent discount by moving out into the suburbs. And I mean that just makes total logical sense. This last 6 months, you've got a lot of white collar employees that haven't had to commute to work and are deciding perhaps to get a nicer apartment unit or a bigger apartment unit just outside of the urban center and the suburban areas, kind of like the Aura Castle Hills property we bought 1.5 months ago. You save $700 on rent, you're in a brand-new property. You're across the street from a lake in the middle of the city that has 9 million people, and you're a 5-minute drive -- as Blake's telling me, you're 5-minute drive to everything you need to do in Dallas, including the airport.

BSR having acquired more newer assets over the past 12 to 24 months. Is there any signs of new supply on the horizon that you see potentially impacting any of those newer assets?

A little bit. I would say that Dallas and Austin continue to kind of lead the country in net absorptions and New York, I think I mentioned earlier. The difference between New York, Dallas and Austin or Dallas and Houston right now is Dallas and Houston actually have net positive absorption. What we really focus on is, I would say, I'll pick up on Austin. We want to look at completions as a percentage of total inventory. And when I'm looking at the trailing 12 months completions in Austin, it's about 4.5%, 4.4% of total inventory, that's a little high. Houston, Dallas always have great deliveries, but they're always sitting anywhere between 1.8% and 3%. And I think if you look in the last year, they're at about 2.5% to 3%. Austin at about 4.4%, a little high. If you zoom into the Austin area, we see a lot of those deliveries kind of occurring up in the northern corridors. They're Class A product. There's a lot of urban delivery in Austin that's coming online. We don't think those deliveries really compete with our properties, and we feel pretty confident in our business strategy. And I would say, I'm happy that we spent the last 12 months deploying capital in Austin and not the next 12 months, deploying capital in Austin.

Did you have any further questions, Matt?

I did. Sorry. I was on mute there guys. My apologies. Just in terms of the dispositions that were completed post quarter, is it possible for you guys to provide a broad range for the cap rate on those?

Yes. We -- this is Dan again. We don't like to talk about cap rates. I would say, historically, we've talked about how -- let's say, the buy cap rate on this one the going-in probably looks like a 5. And I think historically, we've said our exit cap rates are about 75 to 125 basis points north of the going-in cap rate. And based on this transaction, we don't see anything surprising on our exit that could cause us to deviate from that comment.

Good color. That's really all we need. And maybe just 1 last one for me in terms of rolling up some of the prior commentary. When we think about the leasing demand and the outlook for Q4 and potentially into 2021, would it be fair to say that we should look for a modest same-property lift in revenue and NOI?

I could get the last part of the question.

Just would it be fair to say that the run rate NOI and revenue might tick up slightly going into Q4, given some of the leasing demand and higher NOI margins?

Higher than 4.9% year-over-year?

On a sequential basis?

On a sequential basis, I don't -- I wouldn't want to say that it would be flat if there is any. Most people have been predicting, not large increases. And at this point, with everything that's going on in the world, I would hate to predict anything substantial.