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

Good afternoon. My name is Joanna, and I will be your conference operator for today. At this time, I would like to welcome everyone to the BSR REIT Q1 2024 Financial Results Conference call. [Operator Instructions] Thank you. Mr. Oberste, you may begin your conference.

Thank you, Joanna, and good day, everyone. Welcome to BSR REIT's conference call to discuss our financial results for the first quarter ended March 31, 2024. I'm joined on the call by Susie Rosenbaum, the REIT COO and Interim Chief Financial Officer. I'll begin the call with an overview of our Q1 performance and highlights. And Susie will then review the financials in detail and I'll conclude by discussing our business outlook. After that, we will be pleased to take 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 on forward-looking information in our news release and MD&A dated May 8, 2024 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 reconciliations to the nearest IFRS measures. Also, please note that all dollar amounts are denominated in U.S. currency. We generated continued growth in all of our key financial metrics in the first quarter. This performance was supported by higher average monthly rent and relatively stable occupancy compared to Q1 last year. Despite the short-term increase in apartment deliveries in our core Texas markets. For the quarter, same community revenues increased 1%, same community NOI rose 4.4%, FFO per unit was $0.25 compared to $0.23 last year, and AFFO per unit was $0.24 compared to $0.22 last year. The results reflect the continued solid demand for rental housing in our markets, which continue to have very strong underlying fundamentals. They also reflect the tremendous efforts of our community management teams and the strength of our operating platform. Weighted average rent at quarter end was $1,502 a month, an increase of 0.9% from $1,489 a month a year earlier. Weighted average occupancy was 95.3% compared to 95.9% at the end of Q1 2023. Blended rental rates in the first quarter declined less than 1% compared to the prior quarter, excluding short-term leases. Suburban Class A apartment rental rates, as evidenced by our portfolio, have been slightly impacted by new apartment deliveries, an expected phenomenon that we discussed in our last conference call. We still firmly believe that this impact is temporary. One benefit of a higher rate environment is fewer construction starts and a future strong rent growth trajectory. I will speak more about this later on in the call. In addition to our solid financial performance, we were delighted to have recently been ranked second in online reputation score among U.S. multifamily REITs for 2023. The ORA score, which is published by Jay Turner Research, measures online review sentiment across major websites and is the industry standard measurement of resident satisfaction. We also rank first overall in the subcategories of customer service, communication, cleanliness and security. This is a very strong endorsement of our team, our product and our operating platform. We take the questions and concerns of our residents very seriously and move quickly to address them. Our strong online reputation is an important tool to help us maintain strong occupancy and drive rent growth over time. We continue to be in a strong financial position with good liquidity, a conservative payout ratio and 100% of our interest rate exposure effectively hedged. We will continue to focus on prudent capital allocation as we pursue growth. I will now invite Susie to review our first quarter financials in more detail. Susie?

Thank you, Dan. To begin, I want to note that I will reference same community performance only as all properties were owned in Q1 of both periods. Same community revenue increased 1% in Q1 2024 to $42 million compared to $41.6 million in Q1 last year. This improvement reflects a 0.9% increase in average rental rates from $1,489 per apartment unit as of March 31, 2023 to $1,502 as of March 31, 2024, as well as year-over-year increases in other rental income and utility reimbursements. Same community NOI increased 4.4% to $23.8 million compared to $22.8 million in Q1 last year, reflecting a higher revenue and a reduction of $1 million in real estate taxes, primarily due to tax refunds received during Q1 of 2024 and the change in Texas tax legislation during Q4 of 2023. This was partially offset by a $0.4 million increase in property operating expenses due to higher insurance costs. FFO for Q1 2024 was $13.6 million or $0.25 per unit, an increase of 4.6% compared to $13 million or $0.23 per unit last year. The increase reflected higher NOI, partially offset by higher interest costs. The repurchase of approximately 3.5 million units during 2023 also positively impacted FFO per unit this year. AFFO for Q1 2024 increased 3% to $12.9 million or $0.24 per unit compared to $12.5 million or $0.22 per unit in Q1 last year. The improvement was primarily due to the higher FFO partially offset by higher maintenance capital expenditures due to the timing of projects in the first quarter. The REIT paid quarterly cash distributions of $0.13 per unit in Q1 of both years, representing an AFFO payout ratio of 53.9% in Q1 2024 and 59.1% in Q1 of 2023. All distributions were classified as a return of capital. Turning to our balance sheet. The REIT's debt-to-growth book value as of March 31, 2024 was 46.5% or 44.3% excluding the convertible debentures. Total liquidity was $107.4 million, including cash and cash equivalents of $7.7 million and $99.7 million available under our revolving credit facility. We have the ability to obtain additional liquidity by adding properties to the current borrowing base of the facility. As of March 31, we had total mortgage notes payable of $458.8 million with a weighted average contractual interest rate of 3.5% and a weighted average term to maturity of 4.1 years. Those figures exclude the credit facility and a construction loan for an investment property under development. In total, the mortgage notes payable and revolving credit facility totaled $779.9 million at quarter end with a weighted average contractual interest rate of 3.4% excluding the debentures and the construction loan and 100% of our debt was fixed or economically hedged to fixed rates at a weighted average contractual interest rate of 3.5% excluding the construction loan. The outstanding convertible debentures were valued at $39.8 million as of March 31 at a contractual interest rate of 5% maturing on September 30, 2025 with a conversion price of $14.40 per unit. The major increase in the fixed component of our debt reflects the impact of the 8 interest rate swaps we have entered into since July 2022 as well as other debt management activities. The last of those swaps took effect in February of this year. I'll now turn it back over to Dan for closing comments. Dan?

Thanks, Susie. Our business outlook remains very robust. While we recognize the impact of short-term increase in apartment supply in our markets, it is important to recall that this is a natural response to a surge in housing demand. And that demand reflects the extremely strong fundamentals of our core Texas Triangle markets. Those fundamentals have not changed in the least. We continue to see very strong population and economic growth in our markets. And despite that growth, rental rates as a percentage of household income remain below the national level and far below the major gateway markets. As I noted last quarter, we fully expect that 2024 will be the peak year for apartment deliveries. The pace of development slowed sharply last year due to the impact of rising interest rates on developers. The pipeline of new supply is very thin beyond this year and with migration into our markets continuing, we expect new supply to be absorbed by early 2025. We therefore believe that '25, '26, '27 and beyond will be significantly stronger years for our rental markets. I would now like to review our guidance for 2024 which we updated yesterday. We currently expect growth in same community revenue of 3%, growth in same community NOI of 1% to 3%, growth in property operating expenses and real estate taxes of 0% to 2%, FFO per unit of $0.91 to $0.97 compared to $0.93 in '23, AFFO per unit of $0.84 to $0.90 compared to $0.85 in 2023. While our revenue forecast was slightly lower compared to our previous guidance in March, we also reduced the forecasted growth in property operating expenses and real estate taxes due to lower insurance costs. As a result, there were no changes to our forecasts for NOI, FFO per unit and AFFO per unit. We expect to continue generating solid financial performance despite the more challenging near term environment. We continue to patiently surveil our markets for investment opportunities. However, we have no interest in nation building. As we have discussed previously, we will only look to capitalize on our opportunities for accretive growth on a per unit basis. We have seen positive momentum in acquisition spreads year-to-date and we are poised to quickly pounce when we see an opportunity. But for now, the most accretive investment is our stock price. So long as the price of our equity remains vastly different from the actual cost of our real estate, we will continue to explore opportunities to repurchase shares on behalf of our investors when able. Overall, we are pleased with our current competitive position. We are generating solid financial performance and maintaining strong liquidity and a conservative balance sheet. We look forward to even stronger performance as the temporary impact of new apartment supply in our markets dissipates. That concludes our prepared remarks this morning. Susie and I would now be pleased to answer your questions. We'd like to respect everybody's time and complete our call within an hour, giving all of our analysts the opportunity to ask a question. So please limit your questions to one and then rejoin the queue if you have additional items to discuss. If we don't have the time to address everything, we can respond to additional questions by phone or email afterwards. Joanna, please open the line.

[Operator Instructions] Our first question comes from Jonathan Kelcher at TD Cowen.

Just on the cadence of revenue growth, I guess we're kind of at or just past peak deliveries for both assets, obviously, are still in lease up. When would you expect your blended rents to turn back positive? And then do you see that sort of accelerating as we go through the end of this year and into 2025?

Yes. Jonathan. So April looks a little bit, it's trending positive right now. So it looks a little bit better than Q1, though we're not quite out of this period of stabilization yet. With that being said, I would say, just like I said last quarter, right now Q1 was pretty much in line with Q4. Right now, it looks positive, but I still wouldn't expect things to turn up to where we're seeing a trend that lasts longer, that's more positive towards the latter half of the year in 2025.

Next question comes from Brad Sturges at Raymond James.

Just on the guidance range, I guess the lower end of the range was adjusted a little bit, but the midpoint's roughly the same. Just wondering if you could elaborate a little bit more in terms of what might be driving the lower end of the range?

Yes. So what we did with the guidance is we reduced the midpoint for revenue from 2% to 1.5%. As I just alluded to, because I don't think we're going to be out of this period of stabilization right as quickly as we initially thought. But then that was offset by a very favorable insurance renewal that happened in April. So the impact of the insurance renewal, which is actually was a 15% decrease over the prior year, has basically outweighed or is right in line with the revenue decrease projection that we already had, which is why NOI became more FFO or AFFO.

Okay. It's just the moving parts on those 2 sort of moving -- those 2 main assumption changes, but overall, it's just a slight adjustment.

That's right.

Next question comes from Kyle Stanley at Desjardins.

It looks like the -- just sticking with the new leasing side of things. It looks like the new leasing spread in Austin actually improved versus the fourth quarter. Just wondering, was there seasonality there, or is this now we're starting to see the stabilization of the kind of elevated supply, and this is kind of how we expect can expect things to trend in the other markets as we move forward?

We're still bouncing around in Austin. It's still pretty close, right? And the blended rates in Austin, in April at this point, are around like a negative 3%, so that's obviously the toughest market right now when it comes to product coming online. However, but keep in mind, too, right, that's just Austin. We've got, that's only 25% of our portfolio.

Kyle, this is Dan. I mean, in particular to Austin, Susie hit the nail on the head. That's about 20% to 25% of our portfolio. And within Austin, I really think of 2 markets that we are somewhat paying attention and defending against some supply, and that would be up in North Austin and Buda and Georgetown. I think what we're seeing, we're a little bit hesitant in Austin to call peak deliveries. We've seen peaks in Q4 of '23 and Q1 of '24. We do see some early peaks in April on deliveries in Austin, but it generally takes about 3 to 6 months for a market to pick up the slack generated by peak deliveries. So I'll contrast that with the other 75% of our company. In Houston and Dallas, Dallas where we have 50% of our company, we saw peak deliveries really in Q4 to Q1 of '24. So we're coming out of the back end of Dallas sooner than we're coming out of Austin. Now, moving back to Austin, let's take Georgetown. Georgetown looks to be one of the, I'd say the highest culprits of deliveries in 2023 and moving into '24. So last year, that Georgetown sub-market where we have one property, that market delivered 28% of its overall inventory. Now, an average that you want to see for a healthy market is about 6% to 5% in the United States. So 28%, I think we can all agree, is a pretty high number of deliveries. What's fascinating about that market is it's also the fastest growing county in the United States and has been for 2 years. So last year, that market absorbed 17% of its overall inventory, right? So it's not -- I mean, we're seeing those same absorption ratios throughout the country. In a small market with no supply to speak of, we're seeing no net absorption to speak of. And in markets where we're seeing a lot of supply being delivered, I would say about 9 out of 10 of those markets, including all of ours, we're seeing more absorption than we've ever seen in that sub-market. And that just goes back to your real estate thesis. Do you want to be in the population growth game, which I think is the long-term bet? BSR wants to be in that population growth game. Or do you want to be in a declining -- in a degrading operating environment? And I'll tell you what, 1 out of 10 years, that latter market looks good, man. The other 9, it favors population growth.

The next question comes from Mike Markidis at BMO.

Just with respect to, I guess, you got the favorable impact on the insurance. I think you booked a tax refund that's fairly significant this quarter as well. And I know, Dan, you've -- I think characterized your appeals process as being a little bit of a contact sport. But with all that being said, is there an element of additional refunds that you expect that would be significant for the rest of this year embedded in your guidance or no?

Okay. So let's be very clear about this. In our original guidance, it included having those tax refunds. They just happened faster than we anticipated. So we received $1.1 million in tax refunds in Q1. And of all of that for our 2024 guidance, we had predicted all but about $100,000 of it that's extra. So, you can't extrapolate that to future quarters.

Got it. Okay. So, and if you do benefit from any others, then that would be upside, potential upside to you guys. Not saying you're expecting it, but if it were to happen.

Yes. There is some -- for the other. I think as in past years, we will kind of, we'll have a closer bead. We'll be able to hunt with a rifle and not a shotgun on our tax assessment for the year, closer to August and September. So look for any adjustment to guidance related to tax appeals to occur in that second quarter review in August. As it stands right now, we had 31 active prior year lawsuits. 13 were settled and we have 18 remaining. Now, at any given time, those 18 could settle. We're not in control of that. What we are assuming in our guidance is a typical year where a certain percentage of those active, that contact support is addressed. If we see an accelerant in one year, we would expect to see a decelerant in the following year. So it's a balancing act of -- it's still good quality NOI because it occurs every year. To the extent we see something happen faster in a year, that's blended into our guidance. And if we expected 20 lawsuits to be settled this year and we got 22, we would -- we'd probably account for that and communicate that to the market that next year we might see 18, not 20.

I'd be interested in your guys' thoughts. We can -- you've done a great job holding the line on your revenue and we can all argue about whether we're there in peak supply or not, or if it's Q2 or Q3 when we start to get leasing spreads to improve again. But I'd be more interested in your thoughts, Dan, just with respect to knowing that you've got strong population growth in the markets that you've chosen, knowing that it'll take a while for the supply to come back online. But what I'm really more interested in is just like where you think all else equal rents on new supply have to be to make development economic? And sort of what's the limiter in terms of market rent growth where, or what's the threshold where you start to see developers get back in the game? Not saying that, that supply comes on and limits your growth, but just trying to get a sense of what the potential runway for future rent growth is in the next up cycle?

Well, yes, that's a great question. And forgive me, I'm going to throw a dart at a dartboard in the dark here on rent. I just -- I don't have my calculator in front of me, but I'd ballpark it right now. It's something that competes with us in a 7% developer interest environment with debt and equity needing somewhere similar of a return. You need to build something that makes about $2,900 a month in effective rent. You need to lease it up in 14 months. Before you can generate the kind of returns that we're seeing at $1,500 a month. So with that's impossible in Dallas and Austin and Houston. And what that means is there's no development. So you're seeing year-over-year, new permits, new deliveries, I mean, new starts just fall off a cliff, right?

So you're saying versus the $1,500, that's rents for your product. So where would rents today in the market be for new product and knowing there's incentives to get it done, where would the rents be?

Yes. New product just generally in Texas or in a growth market in the U.S.

Where would the market rents be today versus that $2,900 for new product?

Yes. So I think market ask right now on a development lease up is probably sitting at $2,200 to $2,400 a month concessed by 1 to 2 months, so call it 15%. So that puts effective asking rates on a lease up at about $1,800 -- $1,750 to $1,850 a month. And balanced against our effective rates in those markets still puts us at a competitive advantage. And I do want to -- it'd be one thing if we had older properties that $300 a month rent spread, we'd probably be in a different position, but right now, the product that's delivering in our markets and our submarkets that we own is borderline the same, if not slightly inferior in quality and amenities to the products that BSR owns. So we have a better product and a lower price, which is why we would expect retention rates to increase throughout the rest of this year to continue to see positive renewal momentum. If you've got the fundamental advantage on product and price, and then you happen to place the best team in America as the operator, I'll take those odds.