Independence Realty Trust, Inc. (IRT) Earnings Call Transcript & Summary

Great. Thank you, and good morning. Welcome to Citi's 2021 Virtual Global Property CEO Conference. I'm Nick Joseph with Citi Research. We're pleased to have with us IRT and CEO, Scott Schaeffer. The session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast. For those joining us here today to ask management any questions, simply type them into the question box on the screen. They will come directly to me, and I will do my best to ask them during the session. Scott, I'll turn it over to you to introduce the company and any members of the management team that are with you today, and then we can get into Q&A.

Thank you, Nick. With me this morning, I have Jim Sebra, our CFO. And I want to thank you all for joining us this early Tuesday morning. I have to say these virtual meetings are easier at 7:30 in the morning, but Jim and I both look forward to being together with all of you in the future in person. So IRT has a middle market portfolio of 56 properties and over 15,600 units, all in desirable locations. And we have a differentiated strategy that was with us from the very beginning. We own and operate B-Class assets, primarily communities in non-gateway markets, with over 60% of our communities in the Southeast or Sun Belt regions, markets with strong population and job growth. Our occupancy is above 95%, which is an increase of over 2.5% over the last 1.5 years, since the beginning of 2020, actually. And we've had positive rent growth in every quarter of 2020, and it's now accelerating. That rent [ growth ] is accelerating into 2021. In this hypercompetitive environment, we have 2 strategies that we've been focused on: value add, where we're renovating older communities and competing more with Class A assets; and recycling of capital, where we're selling out of assets in markets where we don't see long-term growth and redeploying that capital into better positioning markets for the future. Our value add initiative has been a real driver of our growth. It creates an apartment product that competes directly with the newer Class A assets but at much better price point. We have 19 properties currently underway with about 3,800 units completed, generating over an 18% rent premium and a 16% return on investment in those value add dollars. It's a significant value add creator -- value creator and with the opportunity to continue into the future as we have many more properties within our portfolio that will be right for this type of investment. We also have a strong management team that has experience through multiple economic cycles. We moved early and decisively in response to the pandemic, resulting in a 2.5% growth in occupancy, as I mentioned, during 2020 and positive rent growth throughout the year. We had low employee infection rates and 0 spread of the virus within our communities. We provided flexibility to all impacted residents while maintaining significant liquidity and reducing leverage throughout 2020. We manage all of our properties ourselves with over 450 employees with a regional manager strategy, where our regional managers have in excess of 20 years average experience. Before I turn the call over to Q&A, I want to discuss capital allocation. In our last earnings call, we announced an initiative to explore JV and preferred equity investments for IRT. As cap rates have continued to compress and the competition for assets from the private sector increases, we believe targeted investments into new communities being developed is a way to generate more attractive returns while all within acceptable level of managed risk. There's currently a dislocation in construction financing, which has generated this opportunity. And again, we can make these preferred equity and JV investments, we think, without increasing our risk level, but generating higher returns than you can get just by going in and acquiring and competing with the private sector. So Nick, at this point, I think we can turn it over to questions.

Great. We start every session off with the same question. Coming out of the pandemic, if an investor were to choose only one real estate stock to own, what are the 3 reasons why they should invest in IRT?

Well, I think, first and foremost, is our strategy of investing in somewhat older communities, 10 to 20 years average age in non-gateway markets. And again, this is a strategy that's been with us from day one. We're not just into doing this because it seems to be a benefit today. But we're in markets where you have continuously strong demographics, job growth, population growth, where people are moving away from the high-tax and high-regulation states into the Sun Belt region. So I think our markets and the type of properties we invest in will continue to outperform in the long run. I think also the value creation from our value add strategy. And again, we have generated over 18% rent premiums over a 16% return on invested dollars through this program. We've completed over 3,800 units. So clearly, we have a track record. And we have a long runway of additional properties to continue to invest in, without having to go out and buy new communities to keep this initiative going. And I think the third reason is the management team that I mentioned. We've all been around a long time. I've been in multifamily real estate for over 35 years. We have lots of experience. We understand how to run a multifamily community. And it starts at the top and goes all the way down through, again, our regional managers, where we have in excess of 20 years average experience, operating, managing multi-family communities. So I think those are the 3 reasons. We're in very strong markets that will continue to see good demographics. We have good value-creating strategies in place, and we have a strong management team to execute on all 3 -- or all 2, I should say.

Great. Well, thanks for that. Why don't we start with operations. And you put out an updated operating update last night, so maybe we can start with that. It looks like occupancies continue to remain strong, if anything, accelerate, and blended leasing as well, particularly on the new lease side. Are there any markets or types of product that have surprised, one way or the other, quarter-to-date in the first quarter?

Our whole portfolio has really performed well. We've had wonderful growth in Atlanta and Tampa and Charleston. We were facing some competition in the recent past in Charleston. But clearly, the pandemic has slowed down some of the new deliveries, so we're seeing good growth and stable occupancy there. I will say the one area that had been a little bit soft is Louisville. We have 5 communities there. We've owned them for some time. I think today it would be considered a very, very attractive basis. But the social unrest last summer caused some traffic interruptions at those communities. But so far now here in 2021, we're seeing a strong recovery there. So all in all, I think I really can't point to one area that's really significantly better than the other. All of our communities are performing in all their different [ lines ].

And how about at the different price points? You mentioned predominantly older product, but you do have some newer Class A product as well. Are there different trends within the markets?

The occupancy of the Class A is a little bit stronger in our markets. And I think in the past, it might have been a little bit -- it might have been different where the Class B was a little bit stronger because of new deliveries. Remember, people are always concerned about new deliveries in multifamily with all the construction permits and COs being delivered. But the Class B assets don't compete with that. So it really has not affected our Class B portfolio, which is probably 75% of the company. The Class A while having been impacted a little bit in the past, really, that impact has waned. And we're seeing now that the Class A is a little bit of the stronger occupancy. I think it's 96%, where the Class B on average is about 95%. But the rent growth at the Class B will always outpace the Class A because of the value add initiative.

So as you think about that value add initiative, it has weighed on same-store occupancy because some of those value add properties are in same store. But now you're back up above 95%, whereas last first quarter, I guess, it was lower than 93%. As you continue to redevelop and do the value add, should we expect occupancy to tick back down? Or is 95% kind of a good run rate going forward?

I think the 95% on average is a good run rate. The value add will always have a little bit of a lower occupancy just because you're taking units off-line for 30 days. And if you think about it, that's over 8% of the year. But it's averaging in the Class B portfolio at around 95% because the properties that are not in the value add program are at 96%, 97%, in some instances 98%, 99% occupied.

And then just on rent collections. And obviously, they're still very high, right? So January and February, over 97%. But if we look back to third quarter, it was nearly 100%. Is that just a timing issue in terms of collections of delayed rent? Or is there anything -- it's a small trend, but a trend from the third quarter to fourth quarter to 1Q of slightly lower collections. .

Jim, do you want to take this?

Yes. It's actually -- exactly, that's right. We are certainly noticing it's taking folks a little longer to pay, but they are certainly paying. And we'll see Q4 and Q1 2021 continue to kind of pick up as time elapses.

And I will say, Nick, let me just add to that, that if we go back and look at January and February, at the 8th of the month, so far in March, we're ahead of where we were on collections in those 2 [ problems ].

That's more of a timing issue right now.

Yes. And then the number of weekends. People get paid on Friday, and they pay the rent.

Right. We've certainly seen that in the NMHC data. How do you think about just tenant health overall for your resident base? Do they need additional stimulus? Has the eviction moratorium impacted yet? How do you think about their ability to pay rent going forward?

Well, I think our collection rate where for 2020, we were at about 99%, and we think we'll be there again in 2021. And I think that says or shows us that our resident health -- financial health is intact. When the pandemic started, we went out to all of our residents, and we offered them payment plans if they were suffering from financial hardship. And only out of more than 15,000 units, only 150 asked for that payment flexibility. And I will say that the ones that we provided that flexibility to are actually -- we allowed them to defer their rent and pay it back over a new 12-month lease. The vast majority of them are actually paying on those payment plans, and we're very, very pleased that we were able to provide that benefit to the residents. So only 150 people took advantage of it back in April and May of 2020. And now with the CDC eviction moratorium, it's a very similar number. We have about 150 people that have given us affidavits and said that they're not going to pay the rent, and they're just going to wait until the moratorium is lifted. So again, it's a very small percentage of our tenant base.

What do you see on the ancillary revenue opportunities? I think in the past, you've talked about cable and valet trash. How can that be additive to revenue growth over the next few years?

Jim? .

Yes. No. We're continuing to roll those initiatives out. We're also, later this year, going to start some smart home-type investments to drive additional ancillary revenue growth. But I can't give you a specific growth number for next year in terms of how much ancillary revenue growth will grow, but we do continue to take advantage of every opportunity where it makes sense in each geographic market.

Do you roll that across properties? Or is it opt-in from a resident perspective?

We're evaluating that right now. I mean, we're probably going to start it in some of our value add communities as a kind of additional amenity package and then see how it continues to transition and make progress into the tenant base.

Jim, what are you seeing on the expense side, particularly on the property tax, but even insurance and some of the other line items?

Yes. On the insurance side, we continue to hear noise about additional property insurance increases of the 20%, 30%, 40% ranges for this year. We're in the process right now of marketing ourselves. Our renewal is up in the end of May. So we'll have some further guidance for our folks, once the second quarter rolls around or maybe even the first quarter earnings call. On the property tax side, generally speaking across our portfolio, we're 4%, 5% increases. We do have a few properties in, say, Memphis that goes through a 4-year -- they renew every 4 years. So year 4 is this year. So we're expecting a sizable increase there as well as a few properties in Atlanta. And that as well as our kind of thought around what we think is going to happen to insurance is leading to our outsized noncontrollable expense guidance that we've given.

And as you think about kind of property taxes in the out years, right? Obviously, there's been disruption from COVID, maybe a little less so in your markets, but do you think we see a more normalized level? Or do you think they continue to grow at this outsized pace that we've seen more recently? .

It's a good question. I mean, I would think it's going to be more realistic, probably still above inflationary-type growth, but I think you'll definitely begin to see a little more calming down as the real estate markets and values stabilize.

Scott, one big topic, obviously, across the space has just been demographic shifts and population movement. It seems like it's certainly benefited your portfolio. How much of that, at least more recently has, do you think, been a pull forward versus a sustainable trend that will persist past COVID?

I truly believe it will continue, Nick, and persist past COVID. I think that we saw it even before COVID. I mean a number of larger companies had announced that they were leaving New York and moving down into the Carolinas or into Georgia or Florida. I think COVID accelerated that somewhat. But I believe it really is -- the big driver is the tax policies and regulation in the northeastern states. And it's just -- I have to say, I spend a lot of time down in the Sun Belt region with our communities. It's a happier area. And I think it's going to be here and will continue for the foreseeable future.

So does that open up additional markets that maybe look attractive for expansion, either continued in the Sun Belt or even zagging maybe some of the markets that maybe have been impacted a little more that you see an opportunity in bounce back?

It does. We're always looking at new markets in the region, the Sun Belt region and the Southeast specifically. We want to make sure that we can make an impactful investment. We don't win by one community because it just is not efficient to operate only one. So we're looking at markets where we think we can go in and buy 2, 3 or even more. Tampa is a perfect example of that. It's a community or a market, I should say that we identified about 4 years ago as an area that we wanted to invest and grow. And today, we now have 4 communities in Tampa. Two of them are now going to our value add initiative. And we expect to add more. So we're always looking for new markets, but we want to stay and will stay focused on the regions where we -- the region of the country where we are currently invested.

What's the best capital allocation decision for IRT today?

It has to be the value add? I mean, if you look at cap rates at 4% or in many instances, sub-4%, we can invest $10,000 in a unit upgrading the -- not only the common areas, but also the kitchens, the baths and in addition to common areas, putting in the amenities that you see in many of the newer developed communities today. And while still being $300 or $400 a month below new construction rent pricing, we're generating, again, 16% returns on those investment dollars unlevered. So when you compare 16% unlevered to a 4% cap rate, it's a very easy decision.

And what does it do to the exit cap rate of an asset, do you think? Maybe you can talk about what it would be, kind of pre-renovation and then post-renovation?

It's funny that you asked because I am always hesitant to talk about exit cap rates, and Jim is smiling because when my team comes to me and they start saying how -- if we make this investment, we'll get this IRR. And I say, "Well, what are your exit assumptions 5 years, 7 years out?" I mean I say, "How do you know?" So cap rates, who knows? If we had -- 4 years ago had known that cap rates were going to be so poor, we would have bought anything in everything that we could have. So I really try to stay away from what I think cap rates are going to do.

I'll ask you about the 10-year yield later, for that question.

Okay.

How do you think about identifying opportunities for value add, I guess, within the existing portfolio?

It's a very simple process. We look at a community within our portfolio, and we compare it to Class A new construction communities that are directly competitive in the submarket. And if we can -- for a reasonable investment and it's usually, give or take, $10,000 a unit, if we can improve our community so that it competes on a product basis with that new construction, and at the same time generate those 18% to 20% rent premiums; and b, below that Class A, that is an opportunity that's right for us. So we're competing -- again, we're competing with brand-new construction from a product amenity point of view, but at a much better price point and still generating high-teens returns on our investment dollars.

So new supply from a redevelopment perspective is actually helpful? Obviously, it's competition, but it almost creates an opportunity as well for a certain portfolio or certain assets?

It does. It does. When you look at, again, these communities that are, let's say, I think our portfolio on average is 18 years old. They're all different. So they all have their advantages and disadvantages. But one of the real benefits of that vintage community, especially in the Southeast and Sun Belt region, is that you're in better locations. The newer developments are now being built further out of the city centers, further away from the employment centers because that's where the land is available. So again, if we can through our improvement program, renovation program, if we can build a product that competes with that new community and being in a better location, closer to the employment centers, we're just in much better shape.

What's the constraint to do an additional value add?

Just that we want to manage the process. It does put some pressure on the portfolio, as we mentioned. It reduces our occupancy. It does have a short-term, through that process, an impact on cash flow, obviously, if you have units sitting vacant. So we're just managing it where we're generating these healthy returns. We'll have a long runway of opportunities within the existing portfolio. And at the same time, it doesn't really impact our current operations.

So you touched on, I think in your opening remarks and there's obviously a big conversation on the call a few weeks ago, looking at these JV developments in preferred equity. So what's attractive about that opportunity given where IRT is today?

Well, it's always about capital allocation. And where do you want to invest your dollars? And a few years ago, when we could buy a property at a 6.5% cap or 7% cap and invest it and generate an 11% or 12% -- finance it, I should say, and generate 11% or 12% return from day one, that was attractive. Today, pricing has gotten a little, in my opinion, a little out of whack. I think that people are not recognizing that there are risks associated with owning and operating apartments. You have to be able to do it. I'm not sure that a 4% return or sub-4% return is appropriate for that risk. And you put that together with the fact now, as I mentioned, that a number of the construction lenders, that there seems to be dislocation in that market, so that there's less construction money available to the developers. And we feel that we can fill that gap without taking undue risk and generate much higher returns than that 4% unlevered cap rate. So to me, it's that simple. It's investing in the markets that we're in. It's building a pipeline for future acquisitions because in every instance, we're going to have a purchase option. So we'll be able to buy the community outright at the end if we want it. If someone wants to pay a crazy price more than we think it's worth, then we'll let it go, and we'll take our return on investment at that point and move on. But we expect that in many instances, we'll be building a pipeline for future acquisitions in the markets we want to grow at equivalent cap rates because we're going in predevelopment through these JVs or preferred equity strategies at equivalent cap rates that would be north of 6%. So you compare that again to 4%, sub-4% pricing, and it's attractive.

When do the purchase options typically strike? Is it on completion? Or is it that lease-up?

It's going to vary with developers. Some want it to be at lease-up because they want to sell it for a little bit of a higher price. Some want it at CO, so they can get their money out and do the next deal. So it will be either at CO or at some stage of lease-up. And I would guess that it will be, at sub-stage would be about 50%.

And are you doing the lease-up?

We are -- we're going to manage these communities when they get to that stage.

And is that -- is there an additional fee there that you're achieving that we should expect?

There will be. But remember, management fees are not high-margin income. So it really is not going to be meaningful.

Would you ever do third-party management across the states that you're currently in?

I would never say never. But again, it's not a high-margin business, and I want our team to focus on our assets. So it's not something that we're doing at the moment or that we're contemplating.

And from a geography perspective, where are you seeing the most disruption and opportunities for these preferred investments?

It's everywhere. We're seeing it in our Midwest markets, but we're also seeing it in the southeast and even in Texas, where we have some communities in Dallas. So it really is everywhere. And we think we'll be able to take advantage of it.

I think you had talked about on the call that you were going to put a cap of $100 million of exposure to this. How many projects is that roughly?

They're going to be $15 million to $20 million a pop. So it will be 5 to 6 communities.

And then what's the preferred rate typically?

It will be low double digits, 11, 12 in that region.

You mentioned kind of trading as well in assets, right, which you've done more recently. Where are you seeing the best opportunities for acquisitions?

It's tough for acquisitions right now everywhere. So I'm not sure I would identify any of them as opportunities. We're growing strategically. We just purchased a community for -- it's really 2 communities being operated as one in Huntsville, Alabama. Great little market, off most people's radar, highly educated workforce, lots of job creation. So we invested $95 million there at a cap rate that was about 5%, if I'm remembering it correctly. And that was a recycling of capital. We sold out of a community in Baton Rouge -- and Jim, forgive me, what was the other when we sold?

I think that was it.

No, there were 2 that we sold. It was Baton Rouge. There was Little Rock, Arkansas that we exited -- oh, Chattanooga. There were 2 small, older communities in Chattanooga. So the Chattanooga and the Baton Rouge assets we sold, and we redeployed that money in Huntsville, Alabama, which I think was a very good swap for the long run. .

You expect any additional market exits over the next year or 2?

We do. We will continue to hone the portfolio. And I think if you look at our map, you'll see that there's one asset outside of St. Louis in the precore submarket, very nice submarket, but we have not, for any number of reasons, have not been able to acquire additional assets there. So that's probably one that we will recycle out of, just because it's inefficient to run one asset in a market like that. And there's some older assets that we think that we could do better. We have 5 in Oklahoma City that we -- 4 together, 1 is off on its own. I've talked for a long time about potentially reducing our exposure there. So we will continue to hone the portfolio and make sure that we believe it's in the best position for future growth.

Maybe turning to the balance sheet. Leverage has been ticking down, but still a little above 8 on a net debt-to-EBITDA basis and above peers. How do you get to that mid-7 goal?

Jim?

Yes. I mean I think the continuing NOI growth just organically in terms of just pushing rents and managing expenses will help to further that kind of EBITDA margin, as well as all the additional NOI that will come from all the value add investments. As you know, we have excess capital from after paying the dividend, that will be going right into the value add program. And that will not be ticking up the debt balance. So kind of -- any of that kind of ROI, as Scott mentioned, that 18% will go straight to kind of helping that EBITDA, driving that EBITDA and furthering that kind of -- further reducing the net debt-to-EBITDA through time.

So by the end of 2021, just given that EBITDA growth, where do you expect to be?

Yes. When we kind of gave guidance a few years back, we talked about kind of gains at the kind of mid-7s by the end of 2021. Obviously, the pandemic has delayed that a bit. So now we think that we'll be -- by the end of 2022, we'll be in that kind of low to mid-7 range. Our guidance, as we've kind of given you for 2021, would kind of get our net debt to EBITDA to be about 7.9 -- 7.8, 7.9 at the end of 2021.

Do you need any external capital for the redevelopment spend or any other capital spend this year? Because you're rightsizing the dividend, so is that all covered with free cash flow at this point? Or does it contemplate any additional capital?

It does not contemplate any additional capital. It's all covered by free cash flow.

I wanted to ask on ESG. What are the -- what are your top 3 priorities to improve your ESG score next year?

Well, I think like many of our peers, we want to improve sustainability and also our reporting. It's been a focus point for many investors, appropriately so. And I think we're all trying to navigate through what is the appropriate reporting on ESG. So that's a focus for us. We want to make sure that we are at the forefront of that. Obviously, continued diversity amongst our employee base. We've done a good job with our Board. We have 6 independent directors, and 50% of them are women and minorities. We are always looking at our employee ranks and making sure that we have appropriate diversity throughout. If you think about the type of community that we own and operate, our resident base is very diverse. And accordingly, we think that it would be very helpful and is helpful to have a -- and make sure that we have diverse employees throughout the ranks. And I think to continue promoting culture within our company, it's important. We've added last year -- we added a diversity and inclusion committee that's made up of all employees. I sit in, but I'm not a voting member. We have a women's group that's very active within our team, and we expect that to grow and there to be different and additional groups that -- I think culture is important and needs to be a focal point.

Great. We have our rapid-fire questions to end the session.

Okay.

When we're sitting physically together in Florida a year from today, what will be the one thing that will surprise people the most about your business over the prior 12 months?

I think the growth in NOI relative to our peers. And maybe it won't be a surprise, but it's going to be strong. We are well positioned to take advantage of the shift in demographics, and this is going to be a very good year for us.

What do you think your corporate travel budget will be in 2022 as a rough percentage of what you spent in 2019?

Jim?

Good question. We've been actually talking about it for a little bit. We think it will be down probably about 25% as life returns.

Hopefully, we'll be in person next year at the conference, so that can be part of it. What will same-store NOI growth be for the apartment sector overall? So not IRT, but the sector overall in 2022.

2.5%.

Then finally, what will the 10-year treasury yield be a year from today? It's roughly 1.5 today.

It was 1.6 yesterday. So which way is it going, I think it's going to be 2.25. The government is printing too much money.

All right. Well, thank you, both. Really appreciate it. I hope the conference goes well, and we'll talk soon.

Thanks, Nick. Thank you, everyone.

Thank you.