Centerspace (CSR) Earnings Call Transcript & Summary

Good morning, ladies and gentlemen. Welcome to the Independence Realty Trust and Centerspace joint conference call to discuss the announced merger of the 2 companies. During today's call, management will make prepared remarks, after which we will open the line for questions. [Operator Instructions] As a reminder, this conference is being recorded. Your host for today's call is Stephanie Krewson Kelly, Senior Vice President of Investor Relations and Capital Markets at IRT. You may begin.

Good morning, and thank you for joining us on short notice. On the call today are Scott Schaeffer, Chairman and Chief Executive Officer of Independence Realty Trust; Anne Olson, President and Chief Executive Officer of Centerspace; Jim Sebra, President and CFO of Independence Realty Trust; and Jason Lynch, Senior Vice President of Investments at Independence Realty Trust. Earlier this morning, IRT and Centerspace issued a joint press release announcing that the 2 companies have entered into a definitive merger agreement. That release and an investor presentation filed with the SEC are available in the Investors section of IRT's website, irtliving.com and on Centerspace's website at centerspacehomes.com. A replay of this call will be available on both websites shortly after we conclude. Before we begin, I would like to remind everyone that statements made on this call may constitute forward-looking statements within the meaning of the federal securities laws and are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based on the current beliefs, expectations and assumptions of IRT's and Centerspace's management and are subject to business, economic, competitive risks and uncertainties, many of which are difficult to predict and outside of either company's control. Either IRT or Centerspace undertakes any obligation to update or supplement any forward-looking statements, except as required by law. Today's discussion also includes non-GAAP financial measures, including FFO, core FFO, EBITDA, adjusted EBITDA and net operating income. Definitions of these measures are included in the appendix to today's presentation and the press release, and reconciliations to the most directly comparable GAAP measures are available on each company's SEC filings. With that, I'll turn the call over to Scott Schaeffer.

Thank you, Stephanie, and good morning, everyone. This morning, Independence Realty Trust and Centerspace announced the definitive agreement to combine in an all-stock merger creating a leading middle-market multifamily REIT with a total enterprise value of approximately $8.1 billion and more than 44,000 apartment homes across 17 states. Before I discuss the strategic logic, let me say how pleased I am to be joined this morning by Anne Olson. Anne and her team have built an excellent portfolio with center space. And just as importantly, they have built a culture and operating philosophy, much like our own. The conversations that wrote us here were direct and constructive and they were grounded in a shared view of where value gets created in this business. Let me frame why we are doing this and why now in 5 points. First, scale matters in multifamily, and it matters more every year. The combined company will own 163 communities and over 44,000 units in predominantly non-gateway markets across 17 states. Scale improves our access to the capital markets, and over time, our cost of capital. Just as importantly, it lets us spread our institutional operating platform across a much larger base of units. This is how a bigger company becomes a better company rather than simply a larger one. Second, we achieved better growth without changing who we are. I want to be clear on this point because I expect it to be the first question we got. IRT is and will remain a Sunbelt weighted company. The Sunbelt represents 58% of pro forma NOI and remains our largest exposure and our primary growth engine. Centerspace's portfolio increases IRT's concentrations in the Midwest and Mountain West regions to 27% and 15% pro forma NOI, respectively. The Midwest and Mountain West markets have historically delivered NOI growth above the U.S. average with less volatility. Over the period from 2017 through 2025, IRT and Centerspace together delivered weighted average same-store NOI growth of 5.7% a year above both our non-gateway peers at 4.2% and gateway peers at 2.3%, and it did so with a narrower band of outcomes through the cycle. This is the case for a better risk-adjusted portfolio, a high-growth Sunbelt core compared with lower volatility Midwest and Mountain West markets. Roughly 80% of our pro forma NOI comes from markets that rank in the top quartile for projected population growth, and no single market accounts for more than 11% of our pro forma NOI. Third, the supply picture is turning in our favor. Across the combined footprint, new deliveries are set to decline through 2029, while population growth continues to outpace the national average. In the Greater Denver MSA, CoStar projects rent growth turning positive this year. Deliveries in the Denver Front Range are expected to fall from 6.7% of inventory in 2024 to approximately 2.8% by 2027 against population growth that is projected to be twice the national average over the next 5 years. Minneapolis has 1 of the lowest supply pipelines of any market we track with deliveries expected to fall from 3.8% in 2024 to 1.3% in 2027. Much like Denver, Minneapolis population growth is expected to be almost twice the national average over the next 5 years. We are not underwriting a recovery that has to be imagined. We are seeing it in the data today. Fourth, we gain a bigger opportunity set for our proven platform. The near-term synergies from this merger are tangible. The reason this combination improves our long-term growth rate rather than just their size is because it provides a longer, broader runway for the 2 internal growth engines we have built, mainly our value-add renovation program and our other income initiatives, including our community WiFi program that we began implementing this year. Both drivers are scalable, are funded with free cash flow and now have several thousand additional units to work with. Jim will take you through the economic shortly. Fifth, we have done this before. In 2015, we acquired Trade Street Residential in a cash and stock transaction that added scale across our regional Sunbelt markets. Then, in 2021, we more than doubled the size of this company through the Steadfast Apartment REIT merger. We integrated into a single operating platform within months of closing, and we exceeded the synergy and accretion targets that we have set at announcement. This is the same management team running the same playbook, and this transaction is roughly 1/4 of our current size rather than doubling it. Our track record of successfully integrating companies does not eliminate execution risk, but it does mean we know the cadence of how and what to do. Upon closing, I will continue as Chairman and Chief Executive Officer; and Jim Sebra will serve as President and Chief Financial Officer. Our Board will expand to 11 directors, 9 from IRT and 2 from Centerspace. The combined company will retain independents realty trust name, and we'll continue to trade on the New York Stock Exchange under the ticker IRT. We will have more to say on organizational structure as we work through the integration plan between now and closing. And with that, I'll turn the call over to Anne.

Thank you, Scott, and good morning, everyone. Our Board and management team are pleased to be working with IRT on this transformative transaction that is in the best interest of all of our stakeholders. At Centerspace, we've worked to scale our business in strong growing markets while seeking enhancement to our balance sheet. This merger significantly advances that strategy. The company will now have scale and benefits -- the benefits to operating platform and the cost of capital will further diversify the market exposure, and we'll have an improved leverage profile. I'm confident that IRT's commitment to residents and stakeholders reflects our own. I want to give a special thanks to the Centerspace team. I'm very proud of what our team has accomplished, and I'm confident that IRT's leadership will further our commitment to providing great homes for our residents, opportunities for our team members and returns for our shareholders. With that, Jim is ready to walk through the financial impacts.

Thank you, Anne, and good morning, everyone. I'm going to go over the structure and consideration of this transaction, the earnings impact and synergies and the balance sheet; and lastly, the growth upside beyond the near-term synergies. Centerspace will combine with IRT in a 100% stock-for-stock merger. Each Centerspace's common share and limited operating partnership unit will convert into 3.8 shares or units of IRT, resulting in the issuance of approximately 67.6 million IRT shares in OP units. . On a fully diluted basis, IRT shareholders will own approximately 78% of the combined company and Centerspace shareholders will own approximately 22%. The transaction is expected to qualify as a tax-free reorganization for U.S. federal income tax purposes. Pro forma, the combined company will have an equity market capitalization of approximately $5 billion and a total enterprise value of approximately $8.1 billion. On earnings and synergies, we expect the transaction to be approximately 5% accretive to 2027 core FFO per share on a leverage-neutral basis. Supporting our accretion is approximately $24 million of identified annualized synergies, roughly $19 million of that comes from corporate, general and administrative overlap. The remaining synergies come from property level and platform efficiencies, as we move on to a single operating system and near-term incremental revenue opportunities. The vast majority of these synergies will be achieved within the first 12 months of closing. One data point that frames the efficiency gain. On a pro forma basis, G&A load as a percentage of assets falls to 37 basis points for the combined company. That is a 24% reduction versus IRT stand-alone and a 57% reduction versus Centerspace standalone. It places the combined company well below the REIT sector average of 61 basis points and in line with some of our larger multifamily peers. When we merge Steadfast back in 2021 and its trade Street in 2015, we established synergy targets at announcement and ultimately exceeded them both of those transactions. We have used the same ground-up approach here. And as always, we will work to capture additional synergies and efficiencies beyond those announced as the integration process develops. Regarding our balance sheet, we expect the combined company to maintain our current BBB investment-grade rating from both Fitch and S&P with a well-laddered maturity profile and minimal near-term maturities. In connection with closing, we plan to repay Centerspace's outstanding unsecured notes and to assume secured debt of approximately $500 million. The average interest rate on this debt is 3.5%. Centerspace does have 1 mortgage material in January 1, 2027, and we are not anticipating it will be assumed and instead expected to be repaid on or before closing. The average remaining term of the planned assumptions is 10 years. To delever the combined balance sheet and have the transaction be leverage neutral, we are planning to sell approximately $140 million of assets and have modeled the dispositions at a 5.75% economic cap rate. IRT expects to maintain its quarterly dividend of $0.18 per share following closing. Centerspace will continue to pay its regular quarterly dividend of $0.77 per share, except in the quarter, which the closing occurs in which Centerspace will declare and pay a stock cash dividend of $0.09 per share per unit for the number of days elapsed in the quarter prior to closing. Before handing the call back to Scott, let me discuss the growth upside beyond the immediate synergies. The $24 million of synergies is the near-term highly visible piece of the story. It is not the whole story. The reason we can say that this transaction improves our growth profile is what the larger platform does for 2 internal growth engines that we can fund out of free cash flow. First is the value. We have renovated approximately 12,500 units to date at IRT generating a return on investment of 16%. Coming into this transaction, our remaining identified pipeline within IRT is approximately 10,000 units. Centerspace brings approximately 3,200 more units, taking the combined run rate to roughly 13,200 units. Those Centerspace assets are predominantly in undersupplied markets, where rent growth is inflecting, which is precisely the environment in which renovation capital is most productive. This incremental volume adds additional years to the existing value-add runway at IRT. The second is our community WiFi program. We launched our community WiFi program this year, covering approximately 18,000 apartment units, which are on track to generate approximately $11 million of incremental annualized revenue in 2027. This recurring high-margin other property revenue is also better for residents, manage bulk delivered Internet at a lower cost make individually. Looking ahead to future WiFi rollout, the additional runway is now approximately 25,000 units, roughly 15,000 units from the legacy IRT portfolio and now approximately 10,000 units from Centerspace. Both the value-added WiFi opportunity will build over the next few years, and we expect it to enhance our returns over the longer term. Both are high-return, low-risk sources of growth, and they're funded entirely of off also retained cash flow. Both boards have unanimously approved the transaction. We expect to close as early as the end of the fourth quarter of 2026, subject to shareholder approval, timing of some lender consent and other customary closing conditions. With that, Scott, I'll hand it back to you.

Thank you, Jim. This merger significantly enhances our scale and diversification and delivers immediate earnings accretion on a leverage-neutral basis while preserving balance sheet strength. Since our IPO, IRT's total shareholder return has outperformed our non-gateway peers. We did not get here by growing for growth's sake. We've got here by owning the right assets in the right submarkets and running them well. This transaction is consistent with our core strategy, and I believe it puts us in a stronger position to continue generating attractive risk-adjusted returns for our shareholders. I want to thank Anne and the Centerspace team for their professionalism. They have brought to this process, and I want to thank our team for their continued hard work and dedication to our residents and shareholders. With that, operator, we are ready to take questions.

[Operator Instructions] Your first question comes from the line of Eric Wolfe with Citi.

It's Nick Josee for Eric. So, talk on my star matters. Do you have a sense for how much of the portfolio you could ultimately end up selling? I think you'll have 22% of your NOI across 15 markets around 30 markets in total. So what do you think that looks like in 2 to 3 years? And you touched on this, why does it make sense for or your submarket exposure at a time when these markets have started to recover?

Nick, I think it's -- you're right. Your voice is a little muffled, but if I can restate the question. You're basically asking us how much of the Centerspace's portfolio do you think will sell over the next few years because, again, the view of the Sunbelt re-inflecting versus the Midwest. Is that right?

Yes, how much total you may sell. And then on the strategic rationale of why lower the exposure to the Sunbelt right now as we started and track more positively.

Again, Nick, it's really hard to hear you. But ultimately, here's what I say. As Scott had mentioned in his prepared remarks regarding the strategic rationale. And Scott, maybe you want to kind of chime in again on that. Obviously, the portfolio of Centerspace is located primarily in Minneapolis and Denver. Those markets, especially in Minneapolis has been very kind of stable and low volatility in rent growth. And if you look at kind of the data sources, there's actually a fairly robust rent growth trajectory over the next few years, all at lower volatility. And as we also mentioned in my prepared remarks, just that incremental growth in both value add and Wifi continues to provide that earnings growth trajectory down the future and only enhances the overall growth that's going to be flowing off the Sunbelt portfolio in the next few years. Scott, feel free to chime in.

No, I think you covered it, Jim.

Great. This is Eric, just a follow-up on Nick's question. I guess, how much of the -- are you assuming this sold to get to the 5% accretion estimate? I know you mentioned $140 million in your prepared remarks, and then, also in the presentation. But I guess if you end up selling more than that, and I think Centerspace was planning on selling more than that based on the sort of most recent presentations. I guess, could that eat into that 5% accretion estimate? Are you confident that you're only going to sell, say, around $140 million or something around there?

Yes. We're very confident that we'll only be -- we will only sell the $140 million. Obviously, we've had a very robust and consistent capital recycling program at IRT for years, and we've always done it on an earnings neutral/earnings accretive situation. And if we do decide to sell other assets down the road, which currently are not planned for, we think it will only be beneficial to the combined portfolio down the road.

Your next question comes from the line of Jamie Feldman with Wells Fargo. Jamie.

Great. Can you talk a little bit more about your experience with Steadfast and Trade Street. I think some of the incoming commentary from the Street is just concerns about integration risk and execution risk on this transaction. maybe talk more about what does give you the confidence that you'll be able to stick the landing and things will go smoothly?

Sure. Thanks for the question. This is Scott Schaeffer. First of all, the steadfast merger integration was with a much larger company that also had tremendous overlap of the portfolio geography. That caused a little bit of friction at times because we were working through which employees and which markets we're going to continue with the combined portfolio. The situation here is much different. First of all, Centerspace is much smaller. It's about 1/4 of our size rather than more than doubling it. And the markets are completely independent other than some small overlap in Colorado. So the integration here will be more of back office systems rather than people, and the integration of the people is where you end up having most friction.

Okay. And then you'll have a lot of markets that are kind of 3%, 4% or less. I think it's almost like 2/3 of the portfolio spread pretty widely across the country. I mean just in terms of like operations post transaction, how do you plan to manage that? Do you think you're going to want to beef up any of your markets to have more scale? Or are you happy with like this 3% to 4% in a lot of market type portfolio and just you said it's a people business, but that's a lot of people in a lot of places. Can you just talk more about that?

Sure. We're happy with 3% to 4%. We -- as we talked about this and we had in our prepared remarks that no market is more than 11%, which is good diversification. But even at 3% or 4%, there's enough concentration that we can keep good teams in place and manage the property as well. We are always looking to recycle when appropriate. So that's something that we've done in the past, and we will continue to look at that going forward. But at this point, we're happy with the markets and we're happy with the communities. And we think that post integration, the accretion targets are well within reach.

Your next question comes from the line of John Pawlowski with Green Street.

Jim, are you able to put some brackets around the upfront transaction costs we should expect you guys to incur?

Yes, right now, it's modeled to be about 3.5% of the transaction value, which is just over $2 billion.

Okay. And then just curious for high-level thoughts how you guys got comfortable with some of these, I guess, more secondary or tertiary markets in Montana, North Dakota, even some assets well outside of Denver. Are you concerned that these markets will just run at a little bit of a lower long-term growth rate that's going to dilute the long-term organic growth profile of IRT's portfolio?

No. Actually -- and it's a great question because it was something that we looked at very, very, very early on in this process. And the way we got comfortable was is that all of these markets are very, very low supply. There's just nothing being built, there's nothing being added. While there is some population growth, which is what's going to drive good, stable occupancy and ultimately rent growth. So while they not -- they may not be as dynamic as some other markets in the country, there's low volatility and really no addition to the supply. So these communities have performed well and will continue to perform well. And please feel free to jump in. You've managed this for a year, so you may have some more color.

Yes, sure. I think some of these markets are small, North Dakota billings. But even we are public, you could look at the history there. In those markets, we have seen steady growth and particularly through these times where there have been significant supply influxes across the Sunbelt and in markets like Denver and even on the coast, markets like North Dakota have been consistently growing 5% to 7%. So -- and we see that in the good times, but we also see that hold. So I do think that the combination of this portfolio, which will have the very strong growth narrative in the fundamentals with the Sunbelt markets and Denver turning the corner coupled with this really steady pace of these lower volatility and lower supply markets, it's a very strong combination and should produce very good results for the shareholders.

Your next question comes from the line of Rich Anderson with Cantor Fitzgerald.

So when I started reading the press release, I saw synergies, and it started to read a little bit like a merger of equals. I know it's not. But see Centerspace has been through its process and landed on the asset sales in June, and now, we're here. I'm wondering if I were to write the proxy for you, did EQR, Avalon Bay give you any cues into how to make this combination work? And how did it come to fruition after CSR went through its process now this merger happens? I'm just curious if the Chapter 2 of the conversation came with a few hints from EQR, Avalon Bay.

Yes. Rich, this is Jim Sebra. Obviously nice to meet you, and we appreciate your time. And certainly, Anne or Scott, feel free to chime in. But when it comes to like the background of the merger, we will be filing an S-4 proxy most likely later this month, and that will detail all those points that will provide a lot more color in terms of the background of the transaction and kind of where it came from.

Okay. Fair enough. And then on the asset sales, are there any exit markets? You might have said if you did, I apologize. Is there any exit markets in that $140 million. And as a subset to that question, what do you mean by complementary markets when you say we're Sunbelt, their Midwest, Mountain West, what defines complementary to you just the fact that you don't have overlap. Is that what you mean by that?

Yes, generally. And that the Midwest is much more stable and less volatility while the Sunbelt seems to be higher growth, but also a little more volatile. So that's why the complementary. It brings growth with additional stability to the existing IRT portfolio.

Yes, the exit markets, we haven't announced anything specific on the actual assets to be sold, but we'll be working on that over the next few months as we kind of get ready for closing. .

Your next question comes from the line of Ami Probandt Provant with UBS.

Do you still expect to be paying a special dividend to distribute proceeds from the Centerspace strategic review?

Thanks, Ami. Great to chat with you. And feel free to kind of chime in. But I think what I would say is that the Centerspace process around kind of identifying retaxable income estimating it for the year, looking at the impact of this transaction on it. All of that is still kind of ongoing, and we'll be revisiting that as we get ready to closing, we'll be able to kind of announce the share with shareholders on the third quarter call, the expectation. But Anne, please feel free to chime in.

No, I think that covers it, Ami. We had some expectations of the requirement. And gave some estimates around that and held that cash on hand. But those estimates are still under review, what would be required or may not be required, and this merger and the impact of that certainly may impact us. So as Jim said, we'll be reviewing that, and we'll obviously update as we have more information.

Got it. And maybe I'll ask...

Ami, you cut out.

Ami has cut out. We will move up to the next question from the line of Alexander Goldfarb with Piper Sandler.

Two questions. The first 1 is, you guys give a lot of praise to the Midwest. And for those of us who have covered Centerspace for a while, it's been pretty clear that their markets were underappreciated, but you guys are hyping them in a way that's good to hear, and yet you're still saying that your focus is going to be more Sunbelt, which has been prone to a lot of supply and a lot more volatility. Why wouldn't you look to increase some of the Midwest or certainly look at other Midwestern markets that have low supply, good economic growth, more stability? Why wouldn't increasing some of that? I'm not saying overweighted, but why not increasing it? Why wouldn't that be a good thing?

Well, we are increasing our Midwest exposure with this transaction. When you look at the results over an extended period of time, the Sunbelt has consistently outperformed, and we expect it to outperform again in the future or going forward, I should say. We've come through a significant supply wave, and that has come to an end. And now, the Sunbelt will be -- we'll have much better supply-demand dynamics, strong population job growth with limited additions to the supply over the next 3 to 4 years. That's a great runway for above-market growth. We're hyping the Midwest because the Midwest, first of all, we already have an exposure to the Midwest. It has performed very, very well with low volatility, and we expect it to continue to perform well with low volatility, but it will not be that happen as the Sunbelt going forward.

Okay. And then the second question is on the 5% earnings accretion to core '27, you mentioned center space, which has really low cost of debt, 3.6%. Is that 5% adjusted for GAAP mark-to-market of debt and everything else? Or is that sort of a cash 5%, whereas the GAAP number would be different?