Centerspace (CSR) Earnings Call Transcript & Summary

Good afternoon or good evening. Welcome to Citi's 2025 Global Property CEO Conference. I'm Eric Wolfe with Citi Research, and we are pleased to have with us Centerspace and CEO, Anne Olson. This session is for Citi clients only and disclosures have been made available at the corporate access desk. To ask a question, you can raise your hand or go to liveqa.com and enter code GPC25 to submit questions. Anne, I'll turn it over to you to introduce your company and team, provide some opening remarks, tell the audience the top reasons an investor should buy your stock today, and then we'll go into Q&A.

Yes. Great. Thanks so much for having us. We're happy to be here. As you said, I'm Anne Olson, CEO, I am joined by Josh Klaetsch, who's our Director of IR, formerly used to sit in all of your chairs. So been a helpful addition to our team as we've navigated since my transition to CEO in 2023. The company is multifamily, and we own across the Midwest and into the Mountain West, a portfolio of about 14,000 units and really had strong results in 2024, and we're looking forward to being here and what 2025 has in store.

Great. So maybe I'll start with how you're looking at your cost of capital today. It was clear from looking at the presentation and your earnings call that you'd like to grow. So maybe talk about the opportunity set you see in your market versus your cost of capital and whether that cost of capital is supportive of that growth today.

Yes. I mean we've really tried hard to be very disciplined about allocating capital over the -- since we transitioned to multifamily in 2018. It's really important to us to maintain a really flexible balance sheet and then get the best return we can on the dollars that we have to spend. We've mostly been looking at acquisitions and growth through the lens of capital recycling. And then this past year, in 2024, we were able to issue both equity to bring down some of our leverage, but also which was accretive for us on a cash flow basis and then also OP units to acquire to really facilitate some external growth. And that is -- we've done about $500 million of OP unit deals in the past 5 years. So using that as a way to -- we can issue those at a premium to our stock price in agreement with the party who's accepting of that currency. And we really are looking this year to take the stability of our portfolio and the strong growth that we've had and find ways to leverage a little bit creative ways to be accretive and continue to scale the company. But cost of capital is certainly top of mind. And I think one of the things that we were able to demonstrate in 2024 was being nimble with that when we had some tailwinds at our back and the price was at consensus NAV, we were able to issue and take advantage of what turned out to be a pretty small window. And so we were happy with that. We did some of that on a forward basis. So we're trying to pull every lever we can to reduce that cost of capital and then make accretive decisions to scale the company.

Got it. And so when you say accretive decisions, are you talking about accretive to core FFO, accretive to NAV? And I guess to what extent would you be willing to incur some dilution if you felt like strategically, it positioned you in, say, markets that were growing faster, so sort of short-term dilution versus long-term accretion?

Yes. I think when I think about accretion, there are, as you mentioned, many ways to think about that, FFO, AFFO, NAV. And for me, I really think it could be a combination of those things or just one of them. When we think about capital recycling, we try to stay neutral or accretive to AFFO. So what does it look like on an after capital basis. When we think about share issuance and for example, when we use the proceeds to pay down debt, we're really thinking about enhancing that core FFO, the core earnings growth. So as a team, we're committed to making sure that earnings are growing, but that we could dilute some of it, right? So let's say we might organically have $0.09 of earnings. I'm making up numbers, dangerous thing to do as a CEO. We could have $0.09 of earnings. But maybe we do a transaction that gives us external growth that helps us scale the company, and we only end up with $0.04 that year. So while we're committed to growing the earnings year-over-year, it might come in a combination of things that are a little bit dilutive to core, mixed with organic growth and potentially some transactions that help on the cash flow basis, but from a core earnings perspective, look dilutive.

And you said that in some circumstances, you're able to issue OP units at a premium to your stock price. I guess why does the seller accept something that, I guess, is very visibly sort of above that price? Like what is the discussion around that? Is there something, I guess, that you're giving them? Obviously, you're giving them tax protection. But is there anything else that they're getting in return for accepting stock that is below where -- or I guess, above where the stock is trading?

Yes. So I think there are several factors that we find sellers are willing to contemplate, the largest being tax protection. They're almost always tax motivated when they find their way to us or we find our way to them. But they're also looking for diversification. If they maybe own a single asset or a small portfolio that's concentrated, they're looking for diversification. And also very frequently, they're looking for professional management with a good track record. So it may be something that they've managed themselves or that they found themselves owning through different methods, private investment, otherwise. And so really, it's tax protection, professional management and diversification of that. And most of them really do understand that we want to make an NAV to NAV transaction. So that if they want -- if they have an expectation that their asset should trade at a 5 cap that they have to look at our portfolio, the actual asset buildup through that exact same lens. And that's really where we can come together and say, okay, if yours is worth that, then ours is obviously worth that, too, and you're getting the benefits of tax protection, that diversity across the portfolio. And we can prove to a track record with great transparency in the public markets on how it will perform.

Got it. And I guess where are you sourcing? So you mentioned that there's an institutional investor, they want diversification, makes sense. They want tax protection. I guess how are you sourcing these deals? And if we think about sort of maybe the percentage of deals that you look at versus what you end up transacting on, I know there's no exact percentage, but just curious sort of how much volume of deals you're looking at like that versus what you end up doing?

Yes. I'd say if I look back historically over the 5 years, we're probably hitting on one in 15 or 20 opportunities. These opportunities are a little bit harder to find. We both target individuals who have portfolios or assets that we want to own, concentrated ownership in markets that we think is interesting. We might slice that a little bit by tenure, age of the founder. Some of it is sourced through word of mouth, right? People who we have transacted with, who are happy with how the stock has performed long term, the dividends that they're getting and the information that they're able to obtain on how things are performing, they might be recommending it to other developers or owners. But it's a combination of we need -- we have to want what they have. They have to want what we have, and then you have to agree on price. And so they are difficult to identify. And I'd say, as we look at those opportunities, we take a broader market view. So we're a little less market focused when we think about OP unit transactions because we can use -- we do have a currency and a cost of capital that's better than using cash or capital recycling in that. But we are still trying to maintain a differentiated portfolio that really has produced that stable growth. So our eye stays kind of in that Midwest and along that Mountain West corridor as we look for these potential owners who are ready to transact but still want the tax protection.

Got it. And I guess, generally, I know it's hard to generalize, I said generally, but it's hard to generalize. Like what sort of cap rates are sellers looking for today? And maybe if you could, I don't know if you have sort of an estimate of sort of where the stock is trading from an implied cap rate perspective. I guess I'm just trying to get a feel for sort of where you'd potentially be issuing equity or OP units versus the yield that you're getting on the acquisition. And I know it can vary based on whether you're using nominal or sort of post CapEx. So however you think about it internally in terms of the cash flow accretion or AFFO accretion?

Yes. There's a lot in there, Eric. Generally, sellers are still -- have very high expectations of pricing. So I'd say in core markets like Denver, which is where we did the last transaction, seller expectations are between 4.75% and 5.25%, depending on quality of the product. But it's still very expensive to transact, and they want market pricing. And that's where that NAV to NAV relative value conversation does come into play. I'd say our stock today is trading in the high 6s. When we think about issuing near consensus NAV, so around $75 in the transaction last year, we issued at about $76.5. That does bring that cap rate down a little bit. And so we are able to make those deals work, right? So we might pay a 5 -- why don't you give the real numbers. Josh? I know Josh was writing them down right next to me.

Yes. So when we think -- to go back to this point, when we think about a transaction from last year, it's an asset that's primarily multifamily, a small component of commercial. When we look at that, it's a deal where we think that we can add value by bringing our operations onto it and leasing it to market. So a stabilized cap rate there, we think, is a mid-5 number. When we look at, again, as Anne mentioned, our stock, we think right now, it's roughly a high 6. So a logical question for you is bridge that gap, right? Deal like we did last year, we make that gap work because we're also able to acquire it with low rate debt. So that asset also came with debt that had a 3% coupon on it. And so when we roll those together, we can make the numbers work better.

And if you're using -- I don't know to what extent you're using dispositions, but I guess it seems like you're maybe thinking about selling some of your older assets, maybe higher CapEx assets, lower growth assets. If you had to put that sort of in the pool of sort of total potential sale candidates, what would that look like?

From an aggregate dollar amount of...

Yes, percentage of the company, however you think about it? I mean it's sort of like you look at your portfolio, there's a certain probably percentage that you're willing to part with, a certain percentage that you really would like to keep and there's everything else in between.

Yes. I mean what we would really like is to grow on top of what we have. The portfolio that we have today has produced sector-leading same-store NOI growth 2 years in a row. We have good tailwinds coming out of Denver. We have 24% -- or 20% exposure to our NOI there. So ideally, we would have external growth opportunities that would diminish the relevance of some of those tertiary markets just by sheer getting bigger. And -- but if I look and I say over the next 5 years, I'd say maybe 30% of the NOI is either markets where we're watching very closely to see what the future growth profile is or the age of the asset is getting to a place where the CapEx is not sustainable. And we should be, from a capital allocation perspective, recycling that into higher growth profile, lower CapEx assets.

Got it, had an audience question, effectively asking for your outlook, rent growth outlook for some of your major markets this year. And I guess maybe I'd just add on sort of maybe walk us through what's driving that in terms of demand versus supply.

Yes. So the rent growth outlook, I think, looks pretty good. We think it's going to look similar to '24, but we expect a little more tailwinds out of Minneapolis, where it was a high supply market and past peak supply last year and the absorption rate has been really strong. And then also 50% of our NOI exposure had really no supply to speak of. And so that would be markets like North Dakota, South Dakota, Montana, Omaha. North Dakota, we saw rental -- new rent growth in the high 5s, 5.8% for 2024. And even in Denver, our blended rate came in positive. So we have a great stable portfolio. We are running at a great occupancy level just ahead of 95%. So we feel really well positioned this year to take advantage of both the continued lack of supply across the smaller markets, no real single-family home development, no multifamily home development to speak of. And then in Minneapolis and Denver, where the supply is diminishing very quickly and absorption has been particularly strong. And so we think that the back half of the year will have some tailwinds out of those markets.

And I guess, could you help us -- I think -- I haven't looked specifically for your markets, but obviously, nationally, we're seeing development starts come down certainly versus peak, but also just versus sort of more normalized periods over the last 15 years. Maybe help us understand where starts are today in your markets as a percentage of inventory and sort of what that suggests supply might look like for the next couple of years?

Yes. I mean at a high level, we would characterize ourselves as past peak supply. And market by market, Minneapolis, we passed that peak roughly a year ago. Denver, I would look towards the back half of last year. Then to the next question of where starts are, starts -- I don't want to use the phrase falling off a cliff necessarily, but it wouldn't be unfair to characterize them that way. Rationale behind that could be just lack of funding, could be lack of available space to even do a development. There was a series of permitting delays for many people where things that had been in process have just dried up. When you roll all that together, new starts right now are minimal. So when we look towards the next several years, we don't see anything that causes us to say, "Oh, this is going to pick back up and change the dynamic" that we're seeing right now where we think we have a favorable supply-demand balance.

I would just add that I think there's 2 catalysts that are going to need to come together, and one is going to be lower interest rate and the other is going to be we're going to need to see stronger rent growth out of markets where people are looking to develop. So while we're seeing very strong rent growth across the smaller markets in the Midwest, there isn't a demand for development there. There's not institutional capital or merchant builders that are coming in and saying, wow, these rents make sense. Also the cost of capital just across the board for new development is higher than it has been in the past. So we think the catalyst for new development for starts to pick up is really going to be lowering interest rates and strong rent growth.

Got you. I guess how much do you think rents need to grow before you'd see new development pick up?

Well, I think the real catalyst is probably going to be what you see on a national basis. So when people look at those kind of blended national numbers, I'd say they're going to need to be 3% or higher.

Then you look at one of your peers, they did a little bit of an asset sale equity raise last year. They've lowered leverage. Specifically, I'm talking about IRT. I don't know I just said one of your peers is IRT. It lowered leverage to sub-6x. Maybe just talk about sort of how comfortable you are with your leverage level, if you want to be lower? And then to the extent that you want to be lower, how much it could sort of improve your debt cost of capital?

Yes. This is a great question and one that we're thinking about constantly about how to maintain flexibility in the balance sheet and what the long-term goals are with respect to leverage. So last year, we were able to raise about $110 million of equity off the ATM. We used that to redeem entirely our preferred, which brought our leverage down almost a turn, almost a full turn. So we're sitting right at 7x right now, which long term is higher than we would like, but we really have to balance that with the need to scale the business. So it's very difficult to get external growth and scale and deleverage. We have a very well-laddered maturity schedule. So in 2026, we don't have a lot of opportunity of about $26 million of mortgages maturing or maturing debt and a minimal line -- a minimal balance on our line of credit. So I think we're going to continue to do what we can to take -- to use the capital that we have access to the most accretively. And with our average cost of debt right now that paying off additional debt wouldn't be kind of our first priority. So when we retired the preferred, that was a high 6% rate. We also, last year, really managed down our line of credit balance, which was also in the 6s. But overall, our cost of debt on an average basis is pretty low. So we're really balancing that need to grow externally with what's the best use of capital. But we definitely want to try to maintain the most flexibility. And as I've shared with all the investors, we've met this week is our goal would be to be able to access capital, grow the company to $5 billion, at which case, we'd like to be in 5 institutional markets that have differentiated exposure and leverage in the 5s.

And so really, I mean, yes, the deleveraging is coming through growth because there's limited opportunity to pay down near-term debt without probably breakage.

Yes, that's right.

And then I guess you mentioned institutional markets. I guess, which institutional markets are you looking at to the extent that you enter a new market, maybe talk about how you build a team there, how you sort of scale there. Yes, I'll start there and I have maybe a follow-up after that one.

Yes, sure. So I'll take the first part of that first. And I think one of the questions that goes unsaid one time is what is an institutional market, right? So we would consider Minneapolis and Denver, both institutional markets based on the fact -- just based on the liquidity profile and that large institutions, insurance companies and/or other large publicly traded companies own and trade in those markets. Specific to Minneapolis, there's a lot of insurance company ownership, a lot of large fund ownership there. So when we think about maintaining a differentiated exposure from other public companies, we -- our eye really stays focused on that, the Midwest, kind of the place where no one else owns, and I'd say not Chicago and then down the Mountain West corridor. So for us, those markets might include places from Columbus and Indianapolis, Milwaukee, Kansas City, Salt Lake City, Fort Collins, Colorado Springs, good extensions of where we already have portfolios. With new capital on a single asset community basis, we're really focused more on the Mountain West than we are the Midwest. When we enter a new market, it is really important to have the operating efficiencies that come with scaling in that market. So scale is twofold for our business. One, just the overall size of the company and what that means for things like float and liquidity and debt, but also on a regional basis, how the team operates, where we can get efficiencies, can we have centralized services for our residents in those. And when we have a new asset, sometimes we use third-party management to get our feet on the ground, really get a sense of how it's operating and then scale up our own team and with our second and third assets. I think what we found is 4 assets starts really to be ideal. I've had the privilege of watching our Denver team go from our very first asset acquisition in 2017 to now a team of over 60 people across a 2,500-unit plus portfolio there. So you really do start to see the velocity of being able to share services when a maintenance person is out or on vacation, someone can cover those things. When you don't have significant scale in the market, it does weigh heavier on the just operating cost of those. So we do it carefully. We're obviously looking to -- I mean, if we could enter a market with scale, that would really be ideal. And I think also a really attractive way for us with the public market backdrop to really be able to access capital in a bigger way to say we have a deal, we're going to go in this market. This is what the company is going to look like. But the portfolio deals, like all transactions have been limited in the past couple of years. So we're looking forward to a time when there's a little bit more transaction velocity and we start seeing some of those portfolio trades.

So like a smaller portfolio would be ideal in a certain market?

Yes. And I think with respect to the Midwest markets I mentioned like Columbus or Indianapolis, Kansas City, I think because we're not targeting there with just single asset acquisitions, those would come to us in portfolio transactions or some sort of M&A, maybe acquiring a private company. And we're open to all the avenues to grow, and we're trying to be as creative and scrappy as possible.

What's wrong with Chicago? I'm just kidding. So I guess if you were to buy sort of like a private company, as you've mentioned, like a smaller private company or go enter in one of these markets, I guess maybe just help us understand like is the best way to do that through -- so like you have this mezz book, right? So there's a certain way to may you could take on risk there by being a financier to either companies that are building assets there, you could come in and buy an existing company. Like what do you think the sort of optimum way to enter a market is? Because ideally, what you'd like to do is do it in a way that the sort of the basis is very attractive. So what do you think the best way to do it would be?

Yes. I mean I think the best way to do that entering a market with scale is to find a solid long-term owner who has maybe good operations, but not enough scale to have great operations or best-in-class. So not -- they own it, they manage it really well. They're probably getting great cash flow from it. But they don't have that excess capital to really invest in the properties with respect to technology or with -- on their own platform with respect to technology and leverage that to enhance margins. Those portfolios also usually have single asset owners that maybe have a couple of partners. They have their -- but not single asset owners, but single entities. So they have individual debt, which means many times the CapEx might have some deferred needs. And we -- because we run off the balance sheet, these are opportunities for us to come in, really take a look at the portfolio, do things like value add, which maybe they didn't have the capital to do and put it on our operating platform. So when I think about that, it's maybe someone who, over time, ended up with 6 to 8 assets, maybe they developed them themselves or bought them. And now they're at the end of their career and looking for things like diversity and might be interested in the OP units or cash if it's really scalable. So I'd look for something that has some meat on the bone. And that also could come to your point, with respect to new development, a few new developments that maybe aren't all the way to lease up where there's some advantage for us to get a good risk-adjusted return on that portfolio acquisition.

And I guess you have one mezz deal now. Is that right? I guess how would you look to grow that sort of book of business? What would be the conditions under which you would do that? And I guess, how do you get sort of comfortable with whatever risks you're taking on, whether that's construction risk or other types of risks?

Yes. The answer to how we look at it is very carefully. So this is a great return that we have just one small mezzanine financing out. It's a rate of 10%. So this is a really good use of our capital. But we need to be very careful about what -- when it rolls off and what that does to earnings and really building what we want as a pipeline of potentially smaller deals. And because of our scale, we also don't have a huge appetite for mezzanine financing. We really try to target opportunities that we want to own long term and then make part of our transaction an option to purchase it. So for example, the current project that we have, $15 million out in financing is now complete. It's leasing up. It delivered at an absolute great time in a really good submarket of Minneapolis with strong schools. It's on time, it's on budget. And that stabilization, we have the right to purchase that for a 7% discount. So we're really targeting not only the great return you can get on mezzanine financing, but also projects that we feel like we want to own long term.

And you mentioned that sometimes you're looking at properties with deferred maintenance or deferred CapEx, there's sort of a value-add component to it. Maybe just talk about some of the things you look for. Is that really just sort of like dated kitchens and bath where you get a 15% bump on the rental rate by putting in capital. And then for your own value-add program that you have now, it does look like the guidance came down, not familiar enough with the company to know why. So I was just curious why it came down year-over-year.

Yes. I think those deferred opportunities are really what you want is good bones and good long-term maintenance that the roof is in good shape and the mechanicals all are in good working order. But it might be things like the landscaping hasn't been refreshed or kitchens and bath. It could be easy things, relaying the asphalt parking lot or making package locker rooms so that it's easier for the current status of the residents, adding an amenity like dog parks or grilling with now 40% of residents having a pet, these things become important in the outdoor spaces. When we think about that, we really are looking at it from kind of all aspects, like how can we position the asset? And then also, is there a pipeline of those unit renovations that we can do when the premium makes sense in the market to position it the right way. In our own portfolio this year, we did move -- in 2024, we had about $24 million of value add. And this year, we're guiding to about $17 million. That's really a factor of our cost of capital. So our return on value add is tied. We want a premium over our cost of capital. So that's gone up slightly as we look to underwrite projects. And then also, it is just more difficult in this environment to find things that pencil out, particularly the renovations because of the supply has come online. So it's -- with concessions in a brand-new product, having something that's maybe 12 years old that's new renovated and trying to push the rents right up to it, we just don't think we'll get the returns there. So we're being very cautious and disciplined about that. The majority of the $17 million that you're going to see us deploy this year is in a couple of assets. One is a complete reposition of an asset in Woodbury, Minnesota. We actually moved it to non-same-store. We are replumbing the building and adding washers and dryers. So that's a pretty significant renovation. Everyone will have to move out of the unit. There will be no one way for anyone to kind of transfer or stay and a pretty significant premium. We have a lot of confidence in that project. And the other thing is finishing out our SmartRent rollout, so our technology rollout, which includes keyless door locks, also thermostats controlled from outside and importantly, to us, leak detection in the units, which has really helped us reduce our nonreimbursable insurance losses and some of our maintenance costs over time.

And I guess putting aside your cost of capital, if you were to scale the value-add program, I guess, what type of returns would you be looking for?

Yes. I think on the -- well, on common areas, so things that have a longer useful life, we're probably at 8.5% to 11% is where we're targeting depending on the market and just the dynamics of how long we think our ownership horizon is in particular markets. And then on unit renovations, we're looking for a 15% plus return on those based on today's cost of capital, I think, 15.5%.

Maybe just looking at your guidance and looking at your presentation a bit earlier, it looks like sort of the shape of the new renewal and blended lease rate growth is pretty similar to last year thus far. Maybe just help us think what's embedded in your guidance in terms of typical seasonality and how strong sort of blended rate growth should be this year versus what you saw last year?

Yes. I think this year, we should expect to see a similar seasonal leasing curve, meaning that in Q2 and Q3 of the year, our leasing spreads are higher than they are in Q1 and Q4. Importantly, that's also when we have a higher velocity of leasing. So if you think about Q1 and Q4, a reasonable bogey is 15-ish percent of our lease expirations happen in each of those quarters with the remainder happening roughly evenly split between Q2 and Q3. So normal seasonality. The one other thing I would add, though, is that markets like Denver, where we saw a higher supply last year, we do expect to see more of a ramping as the year goes on to leasing spreads. So that should continue to progressively improve as the year goes on.

And retention for you and your peers has been stronger the last couple of years. I assume in your markets, it's similar to others markets and that it's just -- there's not many options and especially on the for-sale housing side, which is very, very expensive. I guess what are you projecting this year in terms of retention? And I guess, do you have a view on whether this is sort of a new normal in terms of retention and turnover in your markets?

Yes. So the high-level answer, we're expecting roughly 51.5% retention on the year. That's what we assume in our guidance. To the new normal question. Historically, multifamily had been ballpark 50% is where you could expect that retention level to shake out. We've been in the mid- to high 50s in the last few years. I think part of what's driving that higher than historical number is where people have been able to buy or not buy new housing. Right now, we're not seeing a big change to that. But where things have been, we still want to be anchored to that to a certain extent and keep in mind that, that has been the historical reality. So we don't want to get aggressive and say, yes, 57% is where we will shake out again. If you pull the string on that, though, if we do continue to see better than historical numbers like that should inure to our benefit.

It looks like we have about a minute left. I think I missed it during the opening remarks. I guess maybe just the top reason as you think for shareholders, a top reason to buy the stock. I guess what do you offer that other multifamily and apartment REITs don't offer?

Yes. I think really what we offer is differentiated exposure to stable growing markets that have, over the last couple of years, led to sector-leading same-store NOI growth. And we really have some good tailwinds coming in Denver, where we have 20% of our NOI.

Rapid fire question. What will same-store NOI growth be for the apartment sector in 2026?

2.6 -- in 2026?

2026.

3.7%.

Great. I guess you're going to say 2.6% this year, 3.7%, 110 basis point increase, okay. Will there be the same more or less apartment REIT at this time next year, publicly traded?

Less.

Great. Thank you.