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

Good morning. Thank you for attending today's Independence Realty Trust, Inc. Q3 Earnings Conference Call. My name is Forum, and I will be your moderator for today's call. [Operator Instructions] It is now my pleasure to pass the conference over to our host, Lauren Torres.

Thank you, and good morning, everyone. Thank you for joining us to review Independence Realty Trust's Third Quarter 2022 financial results. On the call with me today are Scott Schaeffer, Chief Executive Officer; Ella Neyland, Chief Operating Officer; Farrell Ender, President of IRT and Jim Sebra, Chief Financial Officer. Today's call is being webcast on our website at irtliving.com. There will be a replay of the call available via webcast on our Investor Relations website and telephonically beginning at approximately 12:00 p.m. Eastern Time today. Before I turn the call over to Scott, I'd like to remind everyone that there may be forward-looking statements made on this call. These forward-looking statements reflect IRT's current views with respect to future events, financial performance, and the merger with Steadfast Apartment REIT, which will be referenced herein at STAR. Actual results could differ substantially and materially from what IRT has projected. Such statements are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to IRT's press release, supplemental information, and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations. Participants may discuss non-GAAP financial measures during this call. A copy of IRT's earnings press release and supplemental information containing financial information, other statistical information, and a reconciliation of non-GAAP financial measures to the most direct comparable GAAP financial measure is attached to IRT's current report on the Form 8-K available at IRT's website under Investor Relations. IRT's other SEC filings are also available through this link. IRT does not undertake to update forward-looking statements on this call with respect to matters described herein except as may be required by law. With that, it's my pleasure to turn the call over to Scott Schaeffer.

Thank you, Lauren, and thank you all for joining us this morning. I would like to begin our call today by thanking our on-site teams, who played an integral part in ensuring the safety of our residents and communities that felt the effects of Hurricane Ian in Florida and the Carolinas. I'm happy to report that we did not experience any significant damage to any of our properties. And now on to our results. In the third quarter, we delivered 11.5% combined same-store NOI growth and 33% core FFO per share growth on a year-over-year basis. We attribute the strength to our portfolio concentration in non-gateway markets in the attractive Sunbelt region, where demand continues to outweigh supply. In addition, we achieved double-digit average rental rate growth of 13.3% in the quarter. We continue to balance occupancy and rental rate growth to maximize revenue for the long term. To that point, this rental rate growth, combined with the start of 8 new value-add projects in the third quarter, put some pressure on occupancy but locked in attractive lease rates, generating a strong revenue earning for 2023. As of today, our occupancy is 95.4% in our non-value-add communities. Over the past quarter and as part of our capital recycling strategy, we entered into agreements of sale for 2 communities, one in Louisville, Kentucky, and one in Terra Haute, Indiana. We also acquired a community in Charlotte, North Carolina, and another in Tampa, Florida, expanding our footprint in these attractive markets. and we entered into a joint venture for the development of a community in Las Colinas, Texas, which is part of the Dallas Fort Worth Metropolitan area and is experiencing strong job growth and population migration. These are all exciting opportunities to grow the portfolio in core IRT markets that have favorable fundamentals. We believe it is important to be patient and selective as we allocate company capital in the current economic environment, and we'll only acquire new communities or invest in joint ventures as part of our capital recycling strategy. We are also making progress with our value-add program, having renovated 795 units this year and achieving a return on investment of 27.1%. While we remain excited about our value-add program and the increased units to be added from our merger with STAR, we expect to moderate our plan in 2023 by delaying the start of renovations at communities in new value-add markets until we have better clarity on the state of the economy. Currently, we expect to complete between 2,500 and 3,000 units next year. While acknowledging current macroeconomic uncertainty, we at IRT remain confident in our portfolio and strategy, that will enable us to continue to drive outsized returns. Our confidence is underlying by the following: first, real estate fundamentals remain strong, and we're encouraged about our position in the multifamily sector. Second, we have an optimal portfolio footprint across key Sunbelt markets that continue to see significant migration in job growth, and we expect to outperform during all points of market cycles. Third, this position of strength has been further bolstered by the STAR merger, which has added scale in our top markets as well enhanced our operating platform. Fourth, as you can see with our performance year-to-date, we continue to successfully execute our portfolio strategy, combining accretive leasing activity with progress on our value-add renovations and capital recycling initiatives, all of which will ultimately drive long-term value for our business. And finally, all of this has been done while achieving the most robust balance sheet in IRT's history, a true signal of strength as we move forward through the current operating environment. With all that said, we're reiterating our full 2022 guidance that we previously raised for combined same-store NOI growth of 13.75% and core FFO per share growth of 28%, each at the midpoint of our guided ranges. Looking forward, it is important to note that we expect 2023 to be a year of continued NOI and core FFO per share growth, and we'll provide a more detailed outlook for the next year during our year-end earnings call. And now I'd like to turn the call over to Ella for an operational update.

Thank you, Scott. We delivered a solid third quarter, led by our ability to drive rent growth in our markets. As Scott mentioned, our average rental rate increased 13.3% in Q3, which is even stronger than the 12% increase delivered in Q2 of this year. More specifically, markets, where we saw the highest lease-over-lease effective rent growth in Q3, were Tampa at 22%, Myrtle Beach at 21%, Atlanta at 15%, and Dallas at 14%. To put it in perspective, our markets with the lowest rent growth were Chicago, Birmingham, and Houston, but they were still averaging 9% to 10% rent growth in the quarter. These rental rate increases put some pressure on our Q3 occupancy levels, along with the addition of 8 new properties, which started value-add renovations in the quarter. In response, we offered some upfront concessions to fill vacant units and balance our occupancy goal with our rent growth goal. This was a strategic decision to lock in a higher rental rate as we head into the end of the year and considering the economic uncertainty. These efforts increased our occupancy at our same-store non-value-add communities to 95.4% as of today. Looking at rental rate trends in the fourth quarter to date, new leases for our combined same-store portfolio have increased 7.1%, while renewed leases are up 8% for a blended lease-over-lease rental rate increase of 7.7%. This lease-over-lease rent growth in Q4 2022 is in line with our guidance and is on top of the 14.2% growth delivered in the fourth quarter of last year. Our favorable loss to lease stood at 12% as of September 30, giving us continued pricing power in 2023. We continue to see good retention throughout the portfolio, with a Q3 average resident retention rate of 57%. While our Q4 resident retention rate is 50%, it's still a bit early, and we expect it to rise over the coming months as our residents make their renewal decisions. The rate at which residents who are moving out to buy or rent a home is declining and stands at approximately 18% of move-outs for Q3 2022. This is down from approximately 21% in Q2. For the residents who are moving into our communities, we continue to see good demand and demographic statistics. New residents over the last 90 days have had an average income of approximately $90,000 with 22% migrating into our markets from other states. We continue to see in migration from the West Coast, Northeast and the Northern Illinois markets. I echo Scott's comments that we believe we are well positioned for continued growth into 2023 with our earnings, loss to lease, and solid renter demand fundamentals in our markets. I would like to now turn the call over to Farrell to provide you with an update on our investment opportunities.

Thanks, Ellis. I'd like to first provide an update on our long-standing value-add program. In the third quarter, we completed renovations on 457 units. For these completed renovations, our renovation cost was $4,022 per unit, and these units achieved, on average, a $262 per unit increase in monthly rents over comparable unrenovated units. This yields an unlevered return on investment of 22.4%. And year-to-date, we've completed 795 units and achieved a return on investment of 27.1%. For the full year 2022, we now expect to renovate approximately 1,400 units, down from our previously guided target of 1,800 units. This change is primarily due to a significantly higher retention rate on our unrenovated units at our value-add communities. Beginning in the fourth quarter and throughout 2023, we will be including an additional 10 properties to our value-add program. These 10 properties are comprised of 3,350 units, and we expect to achieve a return on investment these properties consistent with prior value-add projects. As Scott mentioned earlier, for 2023, we now expect to renovate between 2,500 and 3,000 units. We made the decision to delay some renovations at communities, mostly located in new markets where we do not yet have established renovation teams on the ground. So starting these is not a question of if, but rather a question of when. Now on to our capital recycling program, which is focused on building our presence in markets with strong fundamentals and exiting properties with less attractive growth opportunities. As of the quarter end, we had 2 properties, one in Louisville, Kentucky, the other in Terra Haute, Indiana, classified as held for sale, with the sale of the Louisville property closing yesterday. These dispositions are expected to generate an aggregate sales price of approximately $103 million and an expected blended cap rate of 4.7%. Regarding acquisitions, we expanded our presence in Charlotte, North Carolina, by acquiring in August, a recently constructed 234-unit multifamily community, for $80 million. In September, we acquired a 348-unit multifamily community in Tampa for $98 million. This community was built in 2012 and is an ideal candidate for a value-add program in a top market position for long-term consistent growth. Combined, these properties were purchased at a blended stabilized economic cap rate of 5.2%. And lastly, we entered into a joint venture for the development of a 275-unit multifamily community to be built in Dallas, Texas. More specifically, the property is located in Las Colinas, a master plan community with residential and retail space as well as 25 million square feet of office space, home to over 30 Fortune 500 companies. We expect this product to be completed in the third quarter of 2024 and have committed to invest an aggregate $25.6 million into this joint venture, of which $9.3 million was funded last month. Currently, we have $100 million committed to 6 different projects, with $71.5 million funded to date. We expect the opportunity to purchase these communities as they complete construction and stabilize between late 2023 and late 2024. Before turning the call over to Jim, I'd like to provide some brief information on our expectations for new deliveries in our submarkets for 2023. Currently, CoStar has projected new unit deliveries in our submarkets based on our weighted average exposure at 2.2% of existing inventory dropping to 1.8% in 2024. The vast majority of these new deliveries are Class A, which do not compete directly with our well-located infill Class B communities. Asking rents at newly built communities, on average, have priced $521 per month higher than our communities. Additionally, we do not solely evaluate the growth in supply for our markets, but we also consider growing demand. Over the past several years, our submarkets have experienced robust demand for apartments, and that trend is expected to continue into 2023 and 2024. Currently, CoStar expected demand for apartments on markets to grow by 2.3% in 2023 and by another 2.4% in 2024. I'd like to now turn the call over to Jim.

Thanks, Farrell, and good morning, everyone. Beginning with our third quarter 2022 performance update, net income available to common shareholders was $16.2 million as compared to $11.5 million in the third quarter of 2021. During the third quarter, core FFO grew to $64.3 million, up from $22.7 million a year ago, and core FFO per share grew 33% to $0.28 per share, up from $0.21 per share in Q3 2021. This growth is a result of the earnings accretion associated with our merger with STAR as well as the sizable organic rent and NOI growth we experienced throughout the combined portfolio this year. We started 2022 with 2 key goals. First, we sought to fully integrate the operations of STAR and, second, secure the identified synergies and related accretion. We're excited to remind you that we've accomplished both of these goals and are delivering 33% core FFO per share growth year-over-year. IRT's third quarter combined same-store NOI growth was 11.5%, driven by revenue growth of 10.6%. This growth was driven by a 13.3% increase in our average rental rates. While this NOI growth includes value add communities, we did see similar NOI growth of 11.9% at our same-store non-value add communities, which reinforces the fundamental strength of our core markets. On the property operating expense side, combined same-store operating expenses grew 9.1% in the third quarter, led by higher repairs and maintenance and utility costs as well as higher real estate taxes and property insurance. The increase in repairs and maintenance, as mentioned last quarter, was driven mainly by the timing of projects as well as inflationary pressure on both supplies and services for unit terms. The increase in real estate taxes is primarily driven by some appeals we won in Q3 last year, causing our expense last year to be lower than normal. We continue to focus on managing expenses and inflationary pressure and are excited about some of the centralized initiatives we're rolling out now that will save us approximately $2 million a year in future payroll costs. Now turning to our balance sheet. As of September 30, our liquidity position was $326 million. We had approximately $24 million of unrestricted cash and $302 million available on our line of credit. At the end of September, we settled in 2 -- in full the 2 million shares that were previously sold on a forward basis under the ATM program. The forward shares were settled at a weighted average sales price of $25 per share, and IRT received net proceeds of $50 million. At quarter end, our net debt-to-EBITDA was 7.2x, down from 8.2x a year, and we continue to target a low 7 by the end of this year and mid-6s by year-end 2023.The projects from the upcoming sale of our 2 held-for-sale assets will be used to repay outstanding indebtedness and will increase our liquidity by approximately $50 million. As you think about managing the portfolio through a dynamic macro environment in the near term, it is important to stress the strength of our capital structure. In addition to a strong liquidity position, our debt refinancing that was completed in July enhanced our financial flexibility, with 90% of our debt fixed under hedged and with 90% of our maturities in 2026 and beyond. Regarding our full year 2022 outlook, we are maintaining our guidance for combined same-store NOI growth of 13.75% at the midpoint. We are raising our core FFO share growth guidance by $0.005 to $1.075 at the midpoint. While we're slightly lowering our property revenue growth guidance to 10.7% at the midpoint, we are also lowering our projections for operating expense growth to 5.5% from 6.3%, both also at the midpoint. This better reflects our performance to date and greater clarity on expenses for the remainder of this year. Looking ahead to 2023, we expect inflationary pressure to impact various expenses, including payroll, repairs and maintenance, and contract services. We see lease-over-lease rent growth modeling, but given our strong rent growth in 2022, we have a 5% earning that will contribute to 2023 revenue growth. Our operating focus will include the further implementation of automation and the realization of efficiencies within our business. We'll provide full year 2023 guidance in February, but we can note that we expect 2023 to be another year of growth for both NOI and core FFO per share. Now I'll turn the call back to Scott. Scott?

Thanks, Jim. As we enter the last 2 months of our calendar year and the anniversary of our merger with STAR, I'd like to reiterate the confidence we have as a team in our expanded portfolio, which has undoubtedly strengthened over the past year as we seamlessly integrated STAR and exceeded our initial expectation for annual synergies. I'm proud to say that we have successfully executed our strategy under volatile market conditions and continue to invest in our business while delivering 33% core FFO per share growth on a year-over-year basis in our most recent quarter. Going forward, we'll remain disciplined in our capital allocation efforts, which will be focused on continued debt reduction and selective investments in our value-add and capital recycling programs. We are also committed to driving shareholder value and returning capital to our shareholders. This was proven earlier this year when we increased our quarterly dividend payout and put into place a share repurchase program. IRT is incredibly well-positioned to succeed in the multifamily space due to the strength of our dedicated team and our 121 communities across resilient, high-growth markets. We thank you for joining us today and look forward to seeing you at Nareit's REITWorld Growth Conference in San Francisco next month. Operator, we would now like to open the call for questions.

[Operator Instructions] Our first question comes from the line of Brad Heffern with RBC Capital Markets.

Can you walk through how demand looks currently? Are we at a normal sort of seasonal level? And then, on the concessions, are those what you would consider to be a normal seasonal level as well?

On the demand side, as I mentioned in the call, I mean, what we're seeing from a high level is demand matching up with supply overall. Obviously, every market is a little bit different. And we're seeing in some of our smaller markets, our Myrtle Beach and Wilmington, Huntsville, maybe getting a little bit ahead on the supply side. But our larger markets like Dallas and Atlanta, and Denver, they're seeing 2% to 3% supply with significant population growth that should be able to more than meet the supply.

Yes. I think, Brad, this is Jim. This is just time in there. I think it falls right there. I think with respect to Q4, I think certainly, the level of normal pre-seasonality has returned to the business, but we still see good leasing demand for our units, given a lower exploration curve in Q4. We do -- we certainly do kind of obviously track all those stats and look at it every period. The concessions that were offered were offered in September and early part of October, and we're not offering concessions currently.

And then, Jim, maybe sticking with you. The fourth quarter guide implies a pretty low OpEx figure. I know you mentioned that the third quarter number was affected by the comps from the prior year. So is that improvement largely just comps? And then you gave a little commentary on 2023 OpEx, but is there any sort of direction that you can give us -- or would you expect it to be higher than this year or lower than this year?

Yes, good question. I want to try to not answer the 2023 question. But I think for 2022, the big change is just real estate taxes. We received some relatively high assessments. We pushed back pretty aggressively and are getting some good feedback and some good results from those assessments with the tax assessors. And as a result, we've modified guidance for the year, given that new intelligence around real estate taxes. So that's a real kind of big change. In terms of 2023, we certainly see the inflationary pressures continuing on some of those key categories, repairs on manned utilities, et cetera, probably in the kind of the mid-single-digit growth ultimately for next year, but I would say that's kind of in line with where we are this year. But as I mentioned, we're excited about all these efficiencies of rolling out some of the centralizations of services that will even help us further kind of keep those inflationary pressures in check for next year.

Our next question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets.

I just wanted one quick follow-up to Brad's question on concessions. Were those concentrated within the value-add pool or any specific markets? Just any additional detail you could offer up?

No, they weren't really -- they were -- well, yes, let me start over. They were concentrated in properties where we saw higher vacancy, and they were upfront concessions in order to jump-start occupancy and get it back to where it has historically been, which we have accomplished. And the important thing is that those concessions have now ended and have largely burned off. So from this point forward, it's a full rent collection for the next 12 months.

And then, Scott, you kind of highlighted that economic uncertainty drove the decision to dial back the renovation goals for 2023. But is the 2,500 to 3,000 units the right pace of redevelopment just for the current size of the portfolio? Or do you envision ramping to that 4,000 units if and when sort of the fog of uncertainty begins to lift?

I do anticipate ramping to the 4,000 once the uncertainty is behind us. And we just felt, Austin, that occupancy is -- it's obviously a headline risk. I mean, you look at all the questions that we've received on occupancy, and the value-add clearly puts pressure on it. I mean, if you think about it, every unit that turns when we start the value-add process within a community, every unit that turns, goes vacant for 30 to 35 days. And that clearly has a downward pressure or puts a downward pressure on occupancy. So in the current environment, we decided that we were going to dial it back a little bit. And all we did was we eliminated largely the markets where we were beginning to value-add processing and didn't have any historical experience of work going on. So that way, we did not have to go out and build teams to do the -- because remember, we do it all in-house, largely in-house. We didn't have to out and build value-add teams in those markets, again, with the fog of uncertainty that you mentioned.

So you've talked historically about stabilized occupancy, I think, in the mid-95% range. How do we think about that value-add pool of what the right level of occupancy is as sort of the size of that moves around and you look to manage occupancy for the overall portfolio?

Excluding the value add, we're at 95.5% today. We are 94.2%, Jim was it 94.2%?

Yes, the average for the third quarter is 94.2%.

So it's about 120 basis points on the portfolio as a whole. But I think if you then look at the value add, it's about 92%. So it's about a 300 to 350 basis point reduction in occupancy because of the value add.

And from the elevated levels, you've achieved. So, can you remind us what the targeted returns are for redevelopment? And could we potentially see those returns reaccelerate to where you were previously achieving, I think, 30% plus given the sort of concessions that have been dialed back at this point?

So historically, our target has been 20%, and we have exceeded that over the last 18 months, as you point out, by a significant amount. We think it will normalize in that 20% range. And the reason -- the real reason that I believe that it got as high as it did was because we saw obviously tremendous rent growth across the portfolio, including the value add, and we didn't -- had not yet experienced some of the inflationary pressure on the expenses or on the costs. So now we have a little bit more cost, and some of the rent growth is moderating, but we fully expect it to stay in that 20% range. And again, it's unlevered. So it's still very attractive returns.

Our next question comes from the line of Nick Joseph with Citi.

It's actually Nick Kerr on for Nick Joseph right now. And so, 2 quick ones for me. First, you touched on a little bit of the 5% earn-in. I was just wondering what the current loss to lease looks like as well.

Yes. Current loss to lease in the portfolio is 12%.

And then sort of on the renovation. So just wondering if those returns do come in lower than expected. How easily can you guys pull back on that if, say, there's like an occupancy disruption or something along those lines?

Pretty easily. I mean, it's heavily managed. So as we did during COVID, we were able to pull back pretty significantly. I mean, we would do the same if we see costs increase significantly or premiums drop.

And then, just one last quick one is, what are you seeing on cap rates on dispositions and sort of where those are in the market today?

Yes. I would say in the third quarter, we are seeing cap rates between 4% and 5%. There's not a lot of data points. There are transactions but obviously substantially less than there have been in past quarters. It's a little bit trickier now with the run-up in the 10-year as people don't really know what their debt costs are. So we'll have to see. But our capital recycling, we sold at a blended 5 -- 4.5 on the 2 deals, and we're buying at a blended 5.2.

Our next question comes from the line of Neil Malkin with Capital One.

First one on the demand side, I guess, particularly the in-migration. You mentioned you continue to see strong inflows, which is great. There's been some conversation or rhetoric about potentially a reversion of that in migration as companies kind of reinstitute return to the office. I do not think that's going to happen. But can you maybe talk about that, I guess, in migration as a whole, if anecdotally or from people on the ground in data or something you're seeing that there might be some -- a little bit of a reversion in migration or if it continues to kind of chug ahead at a very impressive rate.

I'll let Ella talk about anecdotally if there's anything she's hearing about from our teams on the ground. But just looking at the data that we're looking at, we don't see a slowdown in the Carolina markets, the Florida markets, to Dallas, Atlanta. I mean, everything we're looking at showing that population and job is going to be pretty consistent and continue in those markets.