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

Welcome to the 9:45 a.m. session at Citi's 2022 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 and at the AV desk. For those joining us here today in person to ask management any questions, please step to one of the mics we have located in the center aisle of the room. If you're joining us remotely, simply type them into the question box on the screen, and they will come directly to me. And I'll do my best to ask them during the session. Scott, I'll turn it over to you to introduce the company and the management team, and then we can get into Q&A.

Thanks, Nick. Thanks, everyone, for joining us here today. We're delighted to be back in person. With me today, I have Jim Sebra, our CFO; and Ella Neyland, who joined us from the Steadfast Apartment REIT, who is our Chief Operating Officer. So IRT today has 119 communities, over 35,000 units. We're a Sunbelt-focused apartment REIT. 70% of our NOI is generated in Sunbelt. We have consistently delivered a total shareholder return. Over the last year, it was 97%; for 3 years, 222%. And for 5 years, 284%. I think they're all leading indicators for apartment REITs. The STAR merger positions IRT for continued growth through the benefits of scale, additional value-add units and a stronger operating platform and ultimately lower leverage. The merger integration, which was a big focus of ours, we wanted to get it done before leasing season, is now complete. We combined the people of both companies, 75 IRT corporate office people and 75 STAR employees with -- focusing on culture and engagement so that we can deliver a good resident experience. Technology was the other big focus as part of the integration. We've integrated the STAR properties onto IRT's operating platform for both property and revenue management. We expect up to $23 million in G&A synergies and about $8 million operating synergies. So the company is well positioned for future growth.

Great. We start off every session with the same question. What are the top 3 reasons that investors should buy your stock instead of any other listed property company?

Well, I think apartment REITs are generally better investments than others. But even when you then look at us relative to the other apartment REITs, our portfolio is Sunbelt-focused. That's where people are migrating to. Strong demographics, majority of Class B assets that don't compete with new supply. And that's what's allowed us to grow as much as we have over the last few years and it will continue. And the other is our pipeline now of 20,000 value-add units that we already own. These are assets that are -- units within our communities. We do not have to go out and buy new properties at 3% cap rates in order to continue to do the value-add program. Last year, our value-add initiative generated between a 20% and a 30% return on investment, and we expect that to continue. With these 20,000 units, we have a 5-year runway of value-add work within our portfolio. And lastly, I think the scale from the STAR merger and our investments in technology will bring additional efficiency to the operating platform. So we will continue to be able to generate better margins.

Great. Why don't we start with merger integration? It sounds like a lot of it is already done. What's left to complete from here?

Yes. Great question, Nick. The -- pretty much everything is done. As Scott mentioned, we saw the opportunity during the December 15 and January 15 period, which is the slowest period from a lease velocity of leasing aspects to really kind of cultivate and move from their property management system, their revenue management system onto the Entrata and the LRO revenue management system that we run. The stuff that's left is fairly small and insignificant items, kind of combining the 2 payroll systems. But the vast majority of the integration effort is done.

And so from an operating standpoint, I think we saw occupancy. I mean, it's still very high, but just ticked down a bit. From an operating perspective, though, it seems like everything from here should be at least smooth from an integration perspective?

That's right. I mean, we certainly expected some amount of friction as part of the merger and the migration of one system to the other. But for the vast majority, that risk is behind us, and we specifically wanted all this to be done. So we had all the properties, all the team members operating on one system well ahead of the upcoming leasing season.

And how do you think about pricing and training of the people that did move over to the new operating system, right? So half the portfolio has been moved to a new operating system.

That was pretty seamless. One of the questions we've been getting at the conference is why is that so seamless? Why did that work so well, that integration process? And I think there's 2 reasons that it did. One is that as we were going through our due diligence -- and again, remember, I was with Steadfast Apartment REIT for 10 years. But as we were going through our due diligence, we looked at the IRT company and their assets, and it was actually a mirror image, I think, of what STAR had. When we looked at the properties, we looked at the people on the properties. And toward those, it was like looking at STAR properties, the same sort of approach, same markets, the people on site had the same knowledge and care for the resident customer experience and pretty much the same markets and the same culture for the 2 companies, too. So the integration of people that you were just mentioning, that was very easy to do because we really had the same sort of approach to how we took care of our associates. But the second thing that made the integration so successful, as Jim was mentioning, when we announced this on July 26, we actually created an integration committee. And it had members from the STAR team and the IRT team. And we had this very extensive list we went over every week for hours and included everything from merging the 401(k) plans, benefit plans, leasing commissions, technology so that when we actually closed the merger on December 16, it was a smooth -- very smooth, seamless transition over. And I think part of that was because, again, the LRO system and the Entrata were new to us but not to IRT. So the ability to have -- we had super users that were there for any questions that the STAR people had associated with any of those systems. And we also had a very strong training team that took all of our on-site associates to go through that. So it's really a well strategic planned out transition for the integration.

As you think about kind of pricing strategy from your previous company versus IRT, what were you doing differently and kind of -- either what best practices are you bringing to your old portfolio or what are you bringing over to IRT?

Well, again, interestingly enough, and when I talk about the similarity of the portfolios, we really did a lot of the same things. I think the LRO system is easier to use in some of the STAR system that we had. But as far as looking at the track record of the 2 companies', occupancies were pretty similar. The ability to increase rents was pretty similar. We did not have the value-add initiative that IRT had, which clearly promotes it and creates more generous returns than we were able to do. But as far as just sort of the ability to raise rents, they were pretty similar in the portfolio. So again, that is the commonality of being able to bring 2 portfolios together but then also benefit from the best practices of the systems that we have.

And how about from an expense or staffing perspective, right, property management, how efficiently were you running those properties versus when you look at IRT?

At the property level, we were pretty similar. And it's, again, all of the property on-site people stayed. So from a resident experience, if they came in on December 15, and they talked to Jane, who was the community manager, and then they came on December 16, they talk to Jane, who was the community manager. So you didn't see any disruption on the on-site. I will say that STAR, as a result of the merger of 3 previous nonlisted REITs and some of the internalization we did, we knew we were overstaffed at the corporate level. We were staffed for a much larger portfolio. So as part of this integration process we went through focusing on people. There was an intensive sort of review of the departments and the people in the STAR organization and the department and the people in the IRT organization, and we balanced it to where, at the end of the day, there were about 75 of IRT corporate staff that stayed with the combined company and about 75 of the STAR staff so very well balanced as far as where we ended up. We were rightsizing the organization for the size of the portfolio.

Great. Why don't we turn to the operating update that you provided, I think, in -- I guess it came out yesterday morning, right? So what are you seeing in terms of kind of year-to-date results? Obviously, occupancy came down a bit, but we've touched on that. But still very strong blended lease rate growth. So what are you seeing across the portfolio?

Yes. I mean from a portfolio standpoint, the operating update we published yesterday, clearly, the rent growth trends that we saw in the fourth quarter continue. Obviously, there is a little bit of seasonality in the fourth quarter. We have a very low level of equities expirations. Generally speaking, in the first quarter and fourth quarter, our expiration is about 15% of our total portfolio. So we're relatively low compared to the leasing season. New lease growth was 15.9%. Renewals were 10.1% and blended, 12.4%.

And how about from a market perspective, which are leading the pack and which have you seen, I guess, relative weakness?

Yes. I mean the markets -- in the entire combined same-store portfolio, the markets that continue to lead the pack are ones where we have value-add happening. You've got Tampa, Atlanta, Raleigh continue to lead the pack and certainly others as well. Some of the ones that with a little bit of weakness would be like Birmingham, for example, or some of our assets in some of our store assets in Indiana.

And if you kind of take out the value-add component and just think about kind of from a market rent growth perspective...

Sure, you continue to see Tampa, Atlanta, even from just a normal rent growth standpoint, continue to lead the pack.

We do have a question, live QA that's tied to it, and it's really kind of inflation and affordability-driven. And so as you see kind of rises in consumer prices, how do you think about that as the ability to reprice rents, just kind of capturing a percentage of the consumer's wallet, given other strains that they may be facing.

So our average rent to income ratio for our residents is 20%. So we feel that there's room with what our residents can afford, but we are very cognizant of the fact that there are fuel costs and food costs and all the other costs are going up. The good thing is that our typical resident is within the employment area where they've seen the most wage growth. So the wages are going up, probably not as fast, frankly, as inflation. However, we have at that 20%, we feel that we have room that we can continue to grow rents and be competitive in the marketplace without putting undue pressure on the residents' ability to pay.

And if I could add to that, I think as we do that and are cognizant of the inflation even though wages rose 5% on average, inflation clearly is outpacing that. It puts an increased focus on customer experience because we want to -- like any consumer, if you feel like you're getting value for your money, it's easier to go through this inflationary period that we have. So we want to make sure that we give them a great living experience at our apartments so that when they come home, the communities are clean, they're well taken care of, parking lots are easy to see at night when you're getting out of your car, going into your home. Maintenance request, that when somebody puts in a maintenance request in the morning, it's responded to. We want to show that we understand that these are their homes and that we understand that, and we appreciate that. And I think that will help sort of offset some of those experiences we're going to see. Plus, with the cost of single-family housing, the value of living in an apartment community that's well located, well maintained. And with the kind of amenity package, it increasingly puts value on that residential living and apartment communities.

What rent to income levels would start to concern you? So you're at 20% today. What's kind of the pressure point?

I think the high 20s to 30. I mean that's typically when someone applies for a mortgage, how the agencies look at it that they don't want them to be above 30% income to total cost of a mortgage, principal and interest. So we feel we have some room at 20%.

And so how does that play into the pricing strategy, particularly on the renewal side?

Well, we're continuing to manage renewals up. We also are aware of tenant turnover. But my mandate has been, let's continue to grow rents, let's continue to lead the pack, but it's okay to leave a little bit in the tank for next year and the year after. So we might be a little bit behind the market. But at the same time, we look at total rent growth as well as occupancy in an effort to maximize revenue.

You mentioned move out to buy homes. And obviously, we've seen pretty material home price appreciation, particularly in some of your markets. Has that metric moved at all? Are tenants starting to either look to buy homes? Or are they starting to look even on the single-family rental side? What trends are you seeing in the data you collect?

We haven't seen the trends and -- or change yet, I should say. It's always been about 20% for us, although with the appreciation in home costs, I would expect that trend to go down. But...

As there was a study that came out recently that talked about, again, the entry level for a single-family home is increasingly high. And that because of the down payment and income requirements to get into a single-family home and those price increases, it's put 1 million extra people into the renter pool. So those kinds of things are clearly driving people into rental housing as opposed to single family.

And when you look at your kind of new move-in surveys, what are you seeing from a population shift perspective? Where are these new residents coming from? Is it existing markets? Are they moving into some of these markets?

Well, I can tell you, I live in California. And every day, I look around, there are less and less people in California. So they're definitely moving out of California, moving out of Illinois. And I always track the U-Haul index. I love that because that's sort of like what does it take to as far as in-migration. And they're showing that Texas is the major state that people are moving into. Florida after that and Tennessee after that, and those are 3 of our big markets.

And as you think about the operating platform, I think a big topic across all of these meetings have been the future operating initiatives and deploying technology to expand operating margins. How are you thinking about the platform today versus when we're sitting here in a year or 2 years? Kind of what should we expect both in terms of operating efficiencies and then also bottom line margin expansion.

Yes. I mean I think we've continued to be focused on PropTech, property technology, to help increase automation and just drive more efficiencies at the on-site levels. And we -- that was the primary driver why we switched from Yardi into Entrata and certainly why we were so high on the horse to bring STAR's properties into Entrata so quickly. I think from longer term, you'll continue to see us and the whole industry continue to centralize certain operational functions as well as continue to kind of expand margin possibilities from incremental revenue or amenity charges to just continue to just kind of keep a very close watch eye on expense trends and how expenses grow through time. But I think over the next, call it, 18 to 24 months, you could see certainly a plus or minus, a 200 basis point improvement in operating margin.

And that's from initiatives or just kind of rent growth outpacing...

just from initiatives.

And so maybe we can break that up on revenue and expenses, right? So you've talked a bit on the expense side. What are the revenue opportunities that maybe you aren't capturing today?

Yes. So from an IoT portfolio, we've done certainly a lot of it, the one big additional rental opportunity or income opportunity we have on the STAR portfolio is simply renters' insurance and providing that to our tenants and receiving a commission for doing so as well as a variety of other amenity charges, parking fees, et cetera, to further improve the kind of revenue profile.

For your product type, are parking fees -- that's been a big driver for some others. Does your product type kind of support that? Do you see a lot of the competition doing that?

We see some, certainly, but it's very specific to each property, which ones can drive, which ones don't benefit from it. But we do certainly look to do it everywhere we can.

And then you mentioned being from California or living in California, how are you thinking about kind of the regulatory overlay across your portfolio? Obviously, not coastal, so you're not dealing with a lot of kind of more burdensome regulations. But certainly it feels like more of a national issue today.

And clearly, when companies move to different areas, jobs follow. So you're seeing, particularly in California, you're seeing a lot of companies move out of California into these kind of markets that IRT are in that have, for example, a much more favorable personal income tax. I mean Texas and Florida, no state income tax, that tend to be very business-friendly, encourage businesses to come in, regulatory-friendly, right-to-work state. So those kinds of states are attracting businesses because it's too expensive to operate in some of the markets that they're in right now. So as those companies move into our markets, people move into our market. So you see that sort of inbound migration into the markets for that.

Does that come with regulatory risk as electorate changes, right? So if you have people moving from California or other areas, right? Well, is there a risk of rent control or other kind of government intervention?

I always make it a policy not to talk about sort of recent regulatory issues. I think that clearly, you're starting to see in some places, not necessarily the IRT markets, but particularly, as you mentioned, in California, you're starting to see concerns about some of the rent control. But back to your point about sort of rent to income levels, that's because some of those apartments, those people were paying close to 45% to 55% of their income. So it's a little different in our markets.

Maybe on supply, right? So as you've seen this excess demand, how quickly can supply catch up? Or are we at more capacity today?

We get that question a lot during this conference, too. And it's not just the markets we're in, but it really is sort of the supply and demand issues associated with it. So last year, according to CoStar, we had almost record deliveries. You think historically in this industry, it's sort of 300,000 a year on average. Last year, it was almost 400,000 apartment homes delivered, but the absorption was 705,000 apartment homes. So will that delta stay that large? Probably not. But again, last year, there were 1.5 million households created. When households created, they need a place to live. But you're also seeing again on the demographic trends that are going to drive people to apartments, 75 million millennials who are, in some cases, living in their parents' basements. I've seen numbers in 25% to 30% sort of pent-up demand from those millennials that want to get out and have an apartment. That's a demand driver for our industry. But the interesting thing that we've seen in the last, say, 5 to 10 years is the number of baby boomers who are getting equally large demographics that are increasingly becoming renters by choice. They're either working longer. Some of them are getting apartments near grandchildren, gray divorces, but also because of the on-demand services that you can get, people can age in place in apartments longer so that they don't need to necessarily go to an independent living facility because they can call an Uber to go somewhere. They can do Instacart, they can do Wag!. So we're starting to see the average age of a resident and apartment community to increase again because when you got 75 million millennials, you got 75 million baby boomers, that's almost half the population that are increasingly becoming apartment renters.

Scott, how do you think about growing the company from here, right? So it sounds like integration is basically complete. Is there appetite for more growth today?

There's always an appetite. However, we've operated IRT and grown IRT when we could do it, I say, intelligently, when we could do it accretively to income, when we could do it accretive to NAV. I never want to grow just for the sake of growth. there's always benefit in this business from additional scale. There are markets that are attractive that we're not in. But we're not going to go out and just acquire new properties at these crazy low cap rate values just because we want to be bigger. We're going to do it when we can, again, do it accretively and when it enhances the portfolio for the long-term continued growth.

Which markets are attractive today that you're not in?

Well, there's some markets in the Southwest that are very similar -- with similar demographics to the southeast that we're not in. So as part of the STAR merger, we entered into Austin and San Antonio and Houston in Texas as well as Denver. So you can see where our portfolio is pushing westward a little bit. So as you go beyond that, there are some additional markets that I think fit our profile. But everything is so expensive right now, Nick, that I would say it's unlikely that you see us just acquire something for growth in the near term.

How about the flip side of that? You've exited a handful of markets over the past few years. As you look at the portfolio today, particularly after integration, any more market exits?

There'll be some more recycling of capital. We exited markets as part of the STAR merger with an eye towards deleveraging. That was very successful. When we announced the merger, we had -- we said we were going to exit 9 assets. We had targeted $340 million as the price that we felt we would achieve. We were being aggressive. They actually sold it for over $400 million just because the market is so frothy right now. But as we look at the portfolio, there are some additional properties that are expensive to run from a CapEx point of view and some in markets where we just think that there will be better long-term fundamentals in other markets. So you can look at our -- the map of our portfolio, and you'll see some one-offs and markets we're probably not going to add, Chicago, Coastal Virginia, just to name a couple. So there will be continued recycling.

How much scale do you need in the individual market to make it efficient?

I saw someone today say that they needed 10 or 15 properties, but we do just fine with 3 or more. So that's really what we look at. If we have 3 properties in a market, then we're comfortable just continuing with that or more, obviously, but not less.

Why don't we touch on the value-add redevelopment program? Obviously, that's been a big driver. I think you mentioned, obviously, on the same store, but also part of the attractiveness of the STAR portfolio. So how do you think about kind of the growth from here and what the annual run rate could be?

So this year, we're forecasting 2,000 units to go through the value-add process, 1,500 legacy IRT, 500 from STAR and then that ramps up to 4,000 units a year for 2023 and beyond. That's where we get the 4- to 5-year runway within our existing 20,000-unit pipeline. The way we do it, it just takes a little bit of time. There's a lot of preplanning that goes on serving every unit, making sure that we have supply and supply chains worked out. And then obviously, we have designers on staff that are then picking the materials, the flooring, the countertops, the cabinetry that are going in. So all that prework is done prior to the actual physical work of the renovation starting. So it takes some time, and we don't want to do that during leasing season or right before leasing season starts. So that's why we're going to be at 2,000 units this year because we, again, 1,500 of them were legacy IRT. That process had already been done, and we can get it done for a couple of the STAR communities. But then next year, with the proper amount of time to plan, that will ramp up to 4,000 and stay at that level for the next few years.

And how are you thinking about inflationary pressures? Obviously, again, the benefit on the rent level, but I imagine it's hitting you on the cost of these renovations.

It is, but it's very manageable. We built out a procurement department within our value-add team a couple of years ago really to control the costs of -- but it also was very helpful through the supply chain issues of the last 1.5 years or so. And yes, we're seeing increased costs, everybody is. But again, the rent growth has been -- and the premiums have been so strong that I think last year, our return on investment for the value-add units we completed was over 30%.

And traditionally, what around 15% to 20%?

Traditionally around 18%.

How quickly can you toggle it on and off?

I'm sorry?

How quickly can you -- if the environment changes, how quickly can you adapt to that?

Very quickly. When the pandemic started and we had a lot of uncertainty as to what was going to happen, we literally shut down more than half of the value-add projects that we were in the process of. The team is ours. So it's not like we have contracts that we have to worry about fulfilling. It's our employees, and we finish what we've -- with the materials we purchased, then we can stop on a dime thereafter.

What changed your mind regarding development?

Well, STAR had 3 properties in development when we acquired them. So that changed my mind.

I have it on the go forward though.

But also I've always -- and I've said this over and over again that I felt that premerger that IRT's balance sheet was just too small to take on the risk associated with development to be holding non-income-producing assets land for extended periods of time while you're going through the development process. Now I think the balance sheet is of an appropriate size and our leverage is getting to the point where I think that we could take on some of that risk. So it is something that we'll be looking at in the future. But for the time being, we're only going to finish the 3 that we have acquired, actually, one just CO. So there's 2 more that have to be finished that we acquired from STAR.

And as you think about kind of go forward, would that be more on balance sheet or more through the JVs?

I think it will be both. It will definitely be JVs. We're going to continue with the JV initiative now. That will continue. I think that has a lot of great attributes to it, and we're seeing good success. We've already acquired the first -- we're in the process of acquiring the first community that's been developed under that program, and we're acquiring it at a 5.5 cap, which is exactly what we wanted to do to get that benefit, that pricing benefit of being in the ownership stack during the development period. So that will continue. We'll look at additional development on balance sheet without joint ventures at some point down the road.

You mentioned leverage. We've had a handful of questions come in live QA here, specific about the balance sheet and how you think about managing leverage and target metrics going forward, I guess, particularly given development and redevelopment?

I'm looking at my CFO seeing if he wants this, but he's not taking it. So I've always looked at multifamily as being the most stable, predictable type of real estate investments. So leverage to me was always something that we should manage down from where we started the company, but at the same time, not worry about raising equity and diluting earnings. So through the STAR merger and through the sales and through the tremendous growth in EBITDA over the last couple of years, we're now at a point where we're at 7.5x EBITDA, which was our target for the end of 2022. So we hit it a full year early. And if you look at our forecast through 2022, we get down to about 7% at the end of the year now and then into the mid-6s in 2023. That's very easy for us to show how it happens. It just happens to EBITDA growth. Again, we don't have to sell assets. We don't have to raise equity. We don't have to do anything other than continue to efficiently manage the company. I think leverage will continue to decline from that point, but it will just be organically over time.

If you're a private company, where would leverage be?

Wherever the other private company is, probably 70%.

We're asking everyone a couple of similar questions. What is the biggest growth opportunity that you believe the market is not giving you credit for?

Well, whether they're giving us credit for it or not, it's the value add, I mean, that's the biggest growth opportunity. There's nowhere else in our type of business where you can generate upwards of 30% returns on investment. You look at cap rates, if you went out and bought a property unlevered, you'd be paying -- you could be getting a 3% return, even in the development where people are talking about you're getting 5.5% returns. This is 30%. So that clearly is a driver for us. We've been doing it. We'll continue to do it. And I think that it should help our multiple going forward.

And then what is your #1 ESG priority in 2022?

So we've always been focused on the Internet -- on the environment through the value-add program and even through just straight apartment turns. We've done LED lighting, we've done low flow faucets and toilets. Every time we sign a lease, we plan a tree, we call it the IR Tree program. We're adding -- this year, we're adding EV stations, charging stations for cars. I think that's something that all apartment REITs are going to have to think about going forward as people's choice of cars changes going forward. But our real focus this year is on the social aspects of the combined staff. We did put together a lot of people from 2 different companies. The cultures were very similar, but we really want to promote that. So we're expanding our diversity and inclusion committee, employee education and engagement and really all of it towards driving in the end a better resident experience, which will drive occupancy and rent growth and ultimately, higher FFO.

All right. We have our first question.

On Page 23 of your deck, you present some details of your reduction in leverage. I'm wondering, based upon your remarks a few minutes ago, if this is going to be achieved solely through internally generated cash. And if so, what does that say about dividend increases, if you're going to devote all your cash. Are you going to devote all your cash to reducing debt? Or what happens to the dividend for the shareholders?

Well, this isn't the dividend. I mean this isn't the debt being reduced from using cash. This is the debt-to-EBITDA ratio declining because of growth in EBITDA. So the dividend policy, we recognize that we are -- of our peer group probably have one of the lowest payout ratios of any of the apartment REITs. And the Board will consider clearly, on a quarterly basis going forward, how they want to manage that going forward. Frankly, though, I like the fact that, that free retained cash pays for all of the joint venture investments we're making at pace, for all the value-add investments. So again, the leverage goes down, not because we're paying the debt down per se, but it's because our EBITDA is going up so much.

Rapid-fire.

[indiscernible] Rapid-fire. I was just curious, if you're getting 30% ROIs on your value-add program, why aren't your peers stressing it the same way you are?

It's a good question. I can only do what I think is right for IRT. I don't know why they're not doing it. To us, and it's frankly more meaningful for us because talking about 4,000 units a year in 2023 on a 35,000-unit portfolio, it's over 10%. If you have 100,000 units, it becomes a much bigger task. So it's more meaningful, I guess, just because the size of this.

Same-store NOI for the apartment sector next year?

7%.

10-year treasury yield next year?

Say it again.

10-year treasury yield next year?

2%.

More or fewer public apartment companies a year from now?

Fewer.

Thank you.

Thanks.