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

Good morning. My name is Onus, and I'll be your conference operator today. At this time, I would like to welcome everyone to the BSR REIT Q2 2021 Financial Results Conference Call. [Operator Instructions] Thank you. Mr. Bailey, you may begin your conference.

Thank you, Onus, and good morning, everyone. Welcome to BSR REIT's conference call to discuss our financial results for the second quarter ended June 30, 2021. I'm joined by Susie Koehn, our Chief Financial Officer. Also with us are Dan Oberste, President and Chief Investment Officer; and Blake Brazeal, Co-President and Chief Operating Officer, who will be available to answer questions following our prepared remarks. I'll begin the call by providing an overview of the second quarter performance and other corporate developments. Susie will then review the financials, and I'll conclude by discussing our outlook and strategy. After that, we will hold a Q&A session. Before we 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 on the forward-looking information in our news release and MD&A dated August 10, 2021, 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 IFRS measures. Also, please note that all dollar amounts are denominated in U.S. currency. Our strong second quarter financial results demonstrated the benefits of our strong management team and capital recycling strategy, which is substantially complete. By reorienting our portfolio to high modernized quality properties in primary Texas markets, on a per unit basis, we generated 26.7% year-over-year growth in AFFO and 21.9% year-over-year growth in net asset value. AFFO will continue to increase as we stabilize the portfolio using our $200 million in acquisition capacity. Our weighted average rent at the end of Q2 was $1,206, a 21.8% increase from $990 at the end of Q2 last year. This increase reflects the impact of the capital recycling program, which has been transformational. To put this point in perspective, at the time of our IPO, in 2018, primary markets represented 22% of our NOI. Following the Hangar 19 acquisition announced July 29, that figure has increased to 97% and the weighted average of our properties in our portfolio has decreased from 29 years to 13 years. At quarter end, weighted average occupancy was 96.2%, an improvement from 94.9% at the end of Q2 last year. This, too, is a significant accomplishment and not just because it was achieved during the pandemic. Our 3 core Texas markets: Dallas, Houston and Austin are among the best in the country, and were generating simultaneous growth there at both average monthly rent and occupancy. This is the primary driver of our significant year-over-year and quarter-over-quarter growth in NAV. And we expect this strong NAV growth to continue. Susie will take you through the financials in more detail shortly. I will note for now that we generated same-community revenue growth of 5.4% and same-community NOI growth of 5.2%. We also generated positive growth in total revenue and NOI, even though we divested far more properties than we acquired over the past year. Those results highlight the underlying strength of the Austin, Dallas and Houston MSAs. Subsequent to quarter end in July 21, we were excited to see our same-community rental rates for new leases increase 16.3%, so you'll understand our confidence in AFFO and NAV growth going forward. During the second quarter, we completed sales of noncore assets in our portfolio. We are now focused on deploying our acquisition capacity in our target primary markets while also exploring accretive opportunities to more fully exploit the platform. As I indicated, subsequent to quarter end, we acquired Hangar 19 apartments in the Dallas-Fort Worth market for $82.75 million. Hangar 19 is a newly constructed garden-style community with 351 high-quality apartment units. It is a new property that was constructed just last year and is equipped with many of the amenities that our residents like. As you might have guessed, the name, it is located close to the Dallas Fort Worth International Airport as well as major highways. With Hangar 19 included, we now have 3,014 apartment units in Dallas-Fort Worth. We are excited to realize the benefits of this new scale in one of our core primary markets. Following the Hangar 19 transaction, we have debt to GBV of 44.9% and approximately $200 million of acquisition capacity. We expect to complete, however, approximately $167 million of additional acquisitions before the year-end of 2021. We expect these transactions will increase AFFO by approximately $4 million or $0.08 per unit on an annual basis, assuming similar economics to the Hangar 19 deal. At that point, our portfolio will be stabilized. Therefore, before I turn it over to Susie, I would like to provide a brief update related to COVID-19. We collected 99% of expected monthly rent in the second quarter and again in July 21, which is in line with our historic norms. So the pandemic is not impacting our collections. I also want to note that as of July 31, we have collected $0.6 million in rental assistance through the federal government's emergency rental assistance program, which assists households that are unable to pay rent and utilities due to COVID-19. The money was collected through eligible residents at our properties. We are continuing to monitor the spread of COVID-19 and its variants. We will take the necessary measures to help keep our residents and employees healthy and safe. I'll now invite Susie to review our second quarter financial results in more detail. Susie?

Thank you, John. Same community revenue increased 5.4% in the second quarter to $13.9 million from $13.2 million last year. The improvement reflects an increase in average rental rates for the same-community property from $1,044 per apartment unit as of June 30, 2020, to $1,079 per apartment unit as of June 30 of this year as well as increases in late rental payments, fees associated with moving in and out of a community and utility reimbursement revenue. Total portfolio revenue for Q2 2021 increased 2.8% to $28 million compared to $27.3 million in Q2 last year. This reflected organic rental growth as well as the contribution from property acquisitions and nonstabilized properties, which added $8.3 million and $0.8 million of revenue, respectively. Property dispositions reduced revenue by $8.9 million compared to Q2 2020. To clarify, nonstabilized refers to properties that were undergoing lease-up or renovation during at least part of the comparative period. NOI for the same community properties was $7.4 million, an increase of $5.2 million from $7 million in Q2 last year. This increase was attributable to higher same community revenue, reflecting the strong rental market dynamics that John referenced and a decline in real estate taxes, partially offset by increased utility costs, higher costs associated with preparing apartment units for new residents and higher property insurance costs. NOI for the total portfolio increased 1.1% to $14.4 million from $14.2 million in Q2 2020. FFO for Q2 2021 was $7 million or $0.13 per unit compared to $6.6 million or $0.15 per unit last year. The increase in FFO reflects higher NOI plus reduction in finance costs, excluding the law on extinguishment of debt. The decline in FFO per unit reflects the temporary dilutive impact of $69 million bulk deal offering completed in February of this year. AFFO increased to $7.9 million in Q2 2021 or $0.15 per unit from $6.2 million or $0.14 per unit last year. The increase reflects the higher FFO as well as a $1.5 million escrowed rent guarantee that was realized in the quarter. This was partially offset by additional severance and retention costs related to the capital recycling program that were added back to AFFO in Q2 2020 and less straight-line rent. As John noted, we expect that AFFO will significantly benefit in the second half of 2021 and throughout 2022 from property acquisitions using our acquisition capacity. Net asset value increased 42.1% year-over-year to $769 million from $541 million in Q2 last year. On a per unit basis, NAV rose 21.9% to $14.77 in Q2 2021 compared to $12.12 last year. The REIT paid quarterly cash distributions of $0.12 per unit in Q2 of both years, representing an AFFO payout ratio of 79.2% in Q2 2021 compared with 90% last year. All distributions were classified as a return of capital. We expect the AFFO payout ratio to continue to decline as we deployed our acquisition capacity. Turning to our balance sheet. Debt to gross book value ratio at June 30, 2021, was 41.5%, and we had total liquidity of $96.9 million, including cash and cash equivalents of $8.2 million, $53.4 million available on our credit facility and $35 million available on the line of credit. Following the Hangar 19 acquisition, which was completed subsequent to quarter end, our debt to GBV is 44.9%. Acquisition capacity is approximately $200 million without the need for additional equity. As of June 30, we had total mortgage notes payable of $403 million, excluding the credit facility and the line of credit with a weighted average contractual interest rate of 3.3% and a weighted average term to maturity of 6.1 years. Total loans and borrowings were $524 million, excluding the debentures and 78% of the REIT that was fixed or economically hedged to fixed rates. In July 2021, the refinancing of debt, 84% of the REIT's debt was fixed or economically hedged to fixed rates. In addition, as of June 30, we had $42.5 million of convertible debentures outstanding at a contractual interest rate of 5%. The debentures mature on September 30, 2025, with a conversion price of $14.40 per unit. I will now turn it back over to John for some closing comments. John?

All right. Thank you, Susie. The upcoming weeks and months are going to be a very busy period for BSR team. We have set an ambitious goal of completing about $167 million of further accretive acquisitions by year-end. We are extremely confident in our ability to achieve this outcome. The multifamily real estate markets in Austin, Texas and Houston are highly liquid and quite robust. Our corporate investment team is always busy reviewing opportunities. But we will also be disciplined and are committed to maintaining our strong liquid position. It has served us very well throughout this pandemic. We also expect to continue achieving solid organic growth. The economic recoveries in our primary markets have been impressive since the start of the pandemic. That has supported strong growth in rental rates at our properties and continuing high levels of occupancy. We fully expect these trends to continue. The second quarter of 2021 was an important period for us and it demonstrates how the reorientation of our portfolio to high-growth primary markets generates stronger financial performance and expansion of our NAV. This is what we have been talking about since we initiated the capital recycling program in 2019. We expect our financial results to continue strengthening in the months ahead as we deploy our acquisition capacity in our target markets and continue benefiting from our exposure to these high-growth regions. Obviously, COVID-19 remains an issue. While the pandemic could create additional challenges for us in the months ahead, we have proven over the last 1.5 years that we can operate successfully through even the most difficult conditions. We have learned a great deal about how to operate during the pandemic, and we will apply those lessons learned as needed going forward. Please allow me to take this opportunity to thank all of our BSR team members for their commitment and hard work. Also announced yesterday, effective December 31 this year, I will assume the role of Executive Vice Chairman of the Board of Trustees, and Dan Oberste will transition to the role of Chief Executive Officer. In this new role, I will assist the team as the need arises. Dan's leadership qualities are a perfect fit for taking BSR to the next level, and I am blessed to work for such a fine and professional team. That concludes our remarks this morning. Susie, Dan, Blake and I would now be pleased to answer any questions you may have. So operator, please open the lines for questions.

[Operator Instructions] The first question comes from Kyle Stanley with Desjardins.

Just wanted to quickly say congratulations to both John and Dan on the upcoming changes. I think things are looking fantastic here.

Thank you, Kyle. We're excited.

So just taking a look at the healthy leasing velocity in spreads achieved in June and July, I'm just looking for general market commentary. Is this activity being experienced portfolio-wide or maybe more specific to certain submarkets? And in your opinion, what is the primary driver of this market rent growth?

Kyle, this is Blake. I want to start out by saying that as many of you know, I'm a Texan, you probably can tell by listening to me. And I've grown up in the Dallas area. I was a banker for 20 years. I'm going to rehash this because I think it's really important. And I've been on this side of the desk for another 20 years. And I've seen different dynamics and different cycles in the real estate market in Dallas, Houston and Austin during my years. And although this is not unprecedented, this is one of the best stretches and when it comes to occupancy growth and rental growth that I've seen in my time. And I expect this to continue. And the question that you brought up, I'm going to answer in a couple of different ways. You asked what's causing it. Well, we've been talking over the last 2 quarters and I think the numbers now are bearing this out about the migration into Texas. And you can look it up. There's articles everywhere. It's probably not as well known or the gravity of it in Canada as it is in the United States, but people are moving into these markets at unprecedented rates. Also, I think it would be interesting for everybody to look at the companies that have moved into Texas over the last 2 to 3 years. Why are they doing that and continue to do that? Well, as I've stated before, Dan stated before, it's a business-friendly stage. There's no personal income taxes. It has tremendous public schools. Add all that up, and it's a pretty good place to move to when you look at some of the bigger cities on the coast and what they've gone through during this pandemic. Well, that has all helped us with the strategy that we laid out to you 3 years ago. And our strategy really has 3 main components to it. It's the product that we buy, the quality of it; it's the location, location, location in this particular instance; and it's our people. And we talk about our people all the time, but it's really important to go over again the fact that our turnover rate with our people is half the national average and continues to be that way. And that is driving out all of these things that have contributed to the numbers that you're looking at. So I think it's really important to put that in perspective for everybody to realize what is happening in these locations and continues to happen, and I see it happening well into 2022, if not further. Now to answer your question, Kyle, as far as is there a region or something that's carrying this, no. All of our main MSAs are in double digits in new leases. And just to give you an idea, Oklahoma City, which is our smaller MSA, it had a 12.3% increase in new leases for July. And for the quarter, year-over-year, it's in a like growth of 7.4%. I know we've had some of our competitors trumping in their OKC growth. And I think you can check and look at our growth in -- all over MSA, but -- and we've done better than they have. One thing that I do think is very interesting in looking at this is that -- how do I think or what am I facing some of this that is going to continue out? Well, when I look at our leads which I bring this to you guys every quarter, that it's important. Our leads sequentially, first quarter and second quarter are up 21%. That's really important to look at. That's the people that are on the international or they're coming in and coming into our properties. I mean where are they coming from? Well, it ties back into migration comments that we discussed -- that I discussed earlier. And I always bring it up to you guys, the virtual tours, the self-guided tours and the in-person tours. This is really important because this is another stat that is showing that there's no let up inside. Those are up 25% sequentially, and our closing rate on those went from 40% -- went to 40% from 31% in the first quarter. So I can go over a lot of these things, I'm sure will later on lease-ups and things. But to answer your question, I hope I did it because there's a lot going into this. And the numbers are starting to reflect that. I hope that answered everything, Kyle.

Yes. Very helpful. Maybe just one last one for me. OpEx inflation looks to be a bit of an issue across your U.S. Sunbelt peer group. Could you just talk about a bit of a few of the factors that are contributing to that? And maybe thoughts on how that trends in the second half of the year?

Yes. Be happy to. When you look at our buffers, I think it's really important to -- as most of you know, the age of our portfolio has decreased dramatically over the last year to 1.5 years, which you look at the last 6 to 7 purchases, which Dan made in his group and look at the age of the properties. This has contributed to the fact that we're not as susceptible to cost and the cost inflation. Is there some cost inflation? Yes. But when you look at our numbers year-to-date, we're sitting at total expenses of about 2.8% year-over-year. And our renting expenses and turnover expenses are very minimal compared to the uptick in rents that we received. Another thing that I think is important that goes into that figure that's not discussed a lot is the employee wages and that's something that I had concerns about going in because tech is such a dynamic state. It's very competitive, and there's a lot of construction going on. It's competitive for employees. But year-to-date, if you look at our employee costs, we're down 0.55. So we've done a really good job of controlling that. I would say that a lot of that has to do with the fact of our scalability and the ability to move people from locations where we have divested ourselves. And that has helped us not have to go out and hire in some bigger cost to our categories, new people. So we've kept that in control. And to answer the question for the end of the year, I do not think that, that's going to affect our numbers on a scale that would be anywhere near the rent increases that we're seeing.

Your next question comes from Brad Sturges with Raymond James.

Maybe just a follow-up on Kyle's question there on cost inflation, but maybe zero-in on property taxes. Can you just walk through the accounting treatment so far in terms of the accruals? And then what would be -- I think the funnel builds come in near the end of the year. So what would be your expectation for property taxes given the recent changes in valuation that's happening in markets like Texas?

Yes, sure. So first of all, for the accounting, it is a little bit confusing if you look at the base of our income statement. You're going to see a credit sitting in real estate taxes, and that's because we recognize tax expense under IFRS when the tax is actually assessed. The credit relates to refunds received during the year and then true up based on assessments as well. You have to combine that IFRS 21 adjustment that's also on the income statement to get a true accrual basis accounting look at what our real estate tax liability would be as of June 30. Right now, we're on track with our real estate taxes as we budgeted, maybe even a little bit better based on some of the refunds that we've received. And at this point, we underwrite when we've got new properties for increases in real estate taxes. So we don't expect to be surprised.

What are you underwriting in terms of increase in taxes for this year? The average increase, I guess.

This is Dan. I think on average, we see our taxes increase about 4% year-over-year. I want to remind the group that I believe Texas passed a statute capping property ad valorem tax increases in any commercial asset, I think at 3.5% a couple of years ago. That created some tailwinds for those of us that underwrite taxes into NOI and cash flow, helped us become a little bit more aggressive in our future tax expectations and took some beta out of ownership in the state of Texas.

All right. That's helpful. In terms of Hangar 19, the guidance on accretion of $0.04 a unit, what type of rent growth would you be baking into that assumption?

Yes, Brad, that's a great question. So that submarket in south of the airport and DFW is looking at about an 8% to an 8.5% organic rent growth from the date of acquisition. Now being -- I wish being a landlord was as easy as charging an 8% rent to 10% rent growth and collecting 100% of that revenue over a 12-month period but it's not. So we'll probably blend that year 1 number. We'll probably offset that 8.5% rate growth by about 5% and loss to lease as we, say, otherwise, stabilize the year 1 pro forma.

Your next question comes from Matt Logan with RBC Capital Markets.

Susie, in terms of the fair value gains this quarter, can you tell us how much was driven by higher NOI versus cap rate compression?

Yes, Matt, sure. So -- and also you want to take out the dispositions we had as well because that can skew it. And the answer is it's exactly half and half, 50% of it, of the growth comes from increases in NOI and the other half is compression in cap rates.

So it would be about 15 and 15 basis points if we kind of split it evenly?

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Perfect. And in terms of what you're seeing for the real-time transaction market, things that perhaps aren't factored into the appraisal rent rolls, would that indicate to you that there could be further cap rate compression in the back half of the year?

Matt, this is Dan O. Yes, we're seeing July bids. I want to remind everybody, this is Q2 end reporting, and I know everybody knows the date today. So just to evidence the velocity that we're seeing in trade outs in this market, we're seeing July bids for properties at 10% to 20% outside of the money relative to valuations we're seeing trade at today. A lot of that cap rate compression is built into what Susan just talked about, which is NOI increases. Any time an acquirer can underwrite to 10% to 20% organic rent growth on a going-in pro forma, it's going to increase that purchase price and lower that going-in cap just a little bit, but that's a healthy cap rate reduction. You know you're going to collect that revenue. You're going to collect the NOI that drives the cap rate reduction. I would contrast that with a market where you're seeing pancake growth opportunities and low interest rates. That's just a straight line going in cap with not a lot of hope of expansion. The market that we're looking at looks to produce some tailwinds through the end of -- into '22 and perhaps ongoing. That helps us, I'll say, underwrite to a lower day 1 cap rate and NOI expansion over a period of 2 to 3 years in the horizon. Now unfortunately, it helps our competitors underwrite to those low cap rates as well and kind of use leverage to push property prices up a little bit further. And that's a little bit of what we've seen go on in the months of June and July and August is probably some higher leveraged offers, taking advantage of more debt on the trade and driving cap rates down. But with all that to be said, anytime you can underwrite the higher rent growth, it's a healthy cap rate compression environment.

And in terms of your acquisition cap rate for Hangar 19, could you give us a sense for where that would be just in the general ballpark?

Yes, sure. 50 basis point spread, we could say between 3.75% and 4.25%. Somewhere around there at a cap rate. I mean cap rates, everybody on the phone, think about a dog, and we're all thinking about different dogs. Cap rates are no different. Economic nominal before CapEx. These are all things that all of us use to establish a cap rate. I think a 50 basis point spread between 3.75% and 4.25% is a good evidence of where the market sits for a property like Hangar 19 right now.

And last one for me. In terms of the NOI margin for 2022, Susie, how should we be thinking about that on a stabilized basis after the repositioning program is complete?

Yes. Obviously, it's going to increase. Everybody knows that right now, we have properties in lease-up, and we're not including the rent guarantees in NOI. So that's producing some lower overall margins. Going forward, we're looking at 54% to 56%.

Your next question comes from Frank Lee with BMO.