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

Welcome to the 11:15 a.m. session at Citi's 2023 Global Property CEO Conference. I'm Eric Wolfe with Citi Research, and we're pleased to have with us today Scott Schaeffer, CEO of Independence Realty. As a reminder, this 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 the AV desk. And the questions that I will ask today during this session will not reflect or implied user opinions for myself for Citi research and are being asked for information purposes only. For those in the room or on the webcast, you can log into liveqa.com and our code Citi 2023 to submit any questions if you don't want to raise your hand. Scott, we'll turn it over to you to use your company and management team and give some opening remarks, and then we'll go into Q&A.

Great. Great. Thank you. As Matt said, I'm Scott Schaeffer. I'm the Chairman and CEO of Independent Realty Trust. And with me here to my right is Jim Sebra, who is our CFO. So I'll start with a quick overview and then we can get into the Q&A. So IRT is now about 10 years old. We IPO-ed in 2013. We're 120 properties, over 35,500 units and 71% of our NOI of the NOI generated from our properties comes from communities in the Sunbelt region of the United States. We're predominantly a Class B operator and in markets that are considered non-gateway markets. So last year, we had a transformative merger with Steadfast apartment REIT. It took us from about 16,000 units up to the current almost, again, a little over 35,000 units, I should say. And we're 14 months removed from that merger, and it has given us the time to take a step back and to reevaluate how the integration went. And if there's any changes we want to make going forward. So we conducted a bottom-up review of all of our property operations. And this really became evident that we needed it, as we saw some cracks in the latter half of last year relative to our occupancy. So we did this bottom-up review, evaluating everything from the people that we had running the combined company to the policies and procedures that we put in place, and we decided to make some changes. So as people know, we brought in a new Head of Property Operations. I'm a person that spent 16 years with Camden and is very experienced. We changed some of our processes. We added a 24/7 call center so that we're now capturing 100% of our leads. We improved our sales training program. It was a big focus of mine as I look back over how we were doing things post merger. For example, our sales and training was being done mostly online through webinars and I insisted that the company get back to doing live in-person training of all new employees to make sure that we were capturing and converting the leads and servicing our residents the way we wanted to. We've improved our technology from the cradle-to-grave technology that we use. So again, to make sure that we are capturing and converting as many of the leads that we can. And we're seeing great results. As we look forward, our lead generation is up our resident retention is up. Our lead conversion ratio is up, and we are well on track to be back to that 95% occupancy, which if any of you listened to the earnings call that we had a few weeks ago, that was our target. We had said that by the beginning of leasing season, give or take, this year that we wanted to be back at 95%. And as we look forward at our pre-leased numbers and again, the traffic and the conversion ratio, we are very confident that we'll be hitting those numbers. Just, again, right before we go to the Q&A, IRT is a very simple story. We own Class B apartments. We don't do a lot of development. We don't -- we're not holding a lot of land. We have a balance sheet that has no debt maturities for the next 3 years more or less and 90% of our debt is fixed rate. So we're not taking any interest rate exposure. And it really puts us, I believe, in a very good position to weather any storm economics when that comes later this year. We have always been for the last -- if you look at our total shareholder return the last 2 years, 3 years, 4 years, 5 years, we're at the top of the multifamily pack, and there's no reason that, that shouldn't continue. So Nick, I'm ready for the questions.

Terrific. Thank you, Scott. We are opening all the sessions with the same question, and that's what are the top 3 reasons an investor should buy IRT stock today?

Well, I think the first is what I already mentioned, which is our portfolio being concentrated in the high-growth Sunbelt region. Again, it's 71% of our NOI the area of the country where we're still seeing favorable population and job growth, and there's still a shortage of housing. You put that shortage of housing together with growth in population, and it just creates a great supply-demand dynamic, which gives you stability and the ability to continue to push rents as much as possible, and I'm not sure how much is possible in the rest of this year, but it puts us at that high end of the range going forward. The second reason I would say is our pipeline of 19,000 value-add units. We already own them. We're generating historically a 20% unlevered return on value-add capital expenditure and that will continue. With 19,000 units, we have a runway of 4 to 5 years of very strong growth from that value-add program without having to go out and acquire any new communities to deliver it. And then again, what I've already mentioned is just the simple capital structure with 90% of our debt either fixed were hedged and no significant maturities until 2026. It just gives us the strength to be able to capture opportunities as they arise and to continue to deliver good results.

Why don't we start with the occupancy. Obviously, that's been the big topic getting back up to that 95%. If you think about what happened in the fourth quarter, how much do you attribute it to the team? How much was it just pricing strategy? How much was a disruption from redevelopment? When you started to see that occupancy start to slip, how were you able to attribute what the cause was?

I think it was a little bit of a friction from the merger that we didn't see in the early part of last year because everything was just so strong. The demand was so strong, rent growth was so strong. It just masked it. As I mentioned, there were a number of changes within policy. We needed to make sure that the information from the sites was flowing up better to the revenue management team. Some of it was personnel. I think there was more of a focus on continued rent growth then there was on occupancy. And you know my goal has always been to manage the 2 together, rent growth and occupancy, so you're delivering the best possible revenue or the highest possible revenue. So I think you put all that together and you're not training your people as well as you might -- or the way we wanted to, and you are having a focus on pushing rents, while the market is changing and rents started to flatten out, and we kept pushing. And that it brought the cracks to the surface, if you will.

As you think about the seasonality of demand, it's a harder time to be building back up to that 95% now versus later in the spring and into the summer. Will this -- will there be ripple effects over the next 12 months from leases signed now as you try to get back up to that level? Or are you comfortable kind of [waiting] more to the peak leasing season to get to 95%?

No, I'm very comfortable with where we're at. And that's why as we look forward today, we're north of 95% pre-leased. And all of the trends are going in the right direction. And as we're coming into leasing season. So we did have a little bit of a backlog in addictions that were a little heavier than normal in January and February. So that's -- we're getting that behind us as well. And that was during what is the slower leasing season. So we had a higher level of evictions while you have less traffic. So it was -- that's not a good combination. But we wanted to push, it sounds terrible. We wanted to get those units back so that they would be able to be turned and ready to go as we get in the leasing season.

Maybe change the incentives at all for the leasing personnel on the ground solved for that can occupancy and rent together versus just revenue.

We have. We've increased the commissions that they earn. And for me, that was a very easy decision because in this inflationary environment, I'm happy to have our people make a little more money, especially if they're doing a good job, and there's nothing like incentivizing somebody to close a sale.

How are you thinking about the occupancy relative to the redevelopment value-add program, right? So there's some vacancy that occurs just with that program. I recognize you're getting the returns associated with that, too. But as you try to balance the 2 today, how do you do that?

Well, it's one of the reasons that we reduced the number of units that we forecast to value-add this year from 4,000 down to -- we give a range of 2,500 to 3,000 units because clearly, the value-add program has a negative effect on occupancy. You're taking every unit offline for 30 to 35 days, which is, if you think about it, it's 8.5%, give or take of the year. And in the end of last year and into the beginning of this year, we started a number of new communities within that value-add program so that every unit within those new communities that was every lease the turn or every unit that turned when went down for -- so that we could do the improvement again for that 30 days. Once a community is within the value-add program for a year or 2, you're turning some of the units that have already been value-added, so they don't go offline when the community first goes into the program every unit goes offline. And that puts anywhere from 50 to 75 basis points of pressure on overall occupancy in the company.

Is there a residual impact for the neighbors on either side as those units turn to?

No, not generally because we've got to do the common areas first in the common areas, so they get the benefit of that and they can enjoy those improved common areas and amenities still at a lower rent. And we don't throw people out in order to do the value adder. We don't push them out of the lease, I should say, we wait for them to leave on their own. But if you figure you have a, give or take, 50% retention rate, half of the community is going to turn every year.

As you think about, obviously, inflation, but obviously, the rents have been moving up too. How are you thinking about the returns you can get on value-add for the projects you're starting today versus what you've seen over the past few years?

So we're back to our historical levels, 18% to 20% unlevered returns, which is where we were in 2018, '19 and '20, '21 and '22 were a little bit better. I think last year, in the early part of the year, we were seeing 30-plus percent returns on the value-add spend. But we're -- for 2023 and beyond, we're back into that, give or take, 20% return. Let me just say that's without the benefit of any cost savings that comes along with having an improved unit. It's all new appliances, it's all new fixtures. So the money that you would normally spend on turns or with appliances having to be replaced we don't have that spend as much on these value-add units, and we're not figuring those cost savings into that return. When we say 20%, it's just the increase in rent that we're receiving over the cost of the improvement.

Is there increased ancillary revenue from those units too from smart rent or anything else I don't think you take that?

Yes, nothing from a smart rent. I mean we do -- we are piloting smart rent in a few of our communities today. One of them happens to be one of our value-add deals. But there wouldn't be necessarily an increase amenity fee or anything associated with that value-add unit.

Okay. For the 20% rent uplift, I mean does that hold over a long period of time, I mean, I guess you look back to value-add stuff that you did, say, 10 years ago? Or do you end up having to kind of do it again? And sort of how does that impact your long-term returns from that?

Well, the company is only 10 years old, so I can't go back 10 years. But it does hold actually and what we've seen over the last 5 years is that even the second turn is a little bit higher rent growth than what we would get in an unrenovated unit. So it does hold.

And that's on the K and B or is that even on the full-scale redev of the community?

Full scale.

Go ahead.

Yes, Yes. The first.

Scott, you mind just repeat the question, please.

Is the revenue management system up to, say, so for the standards that we want at this time. Is that fair? Yes, that's the question. Yes, I believe so. We also changed out the top of our revenue management department. The pursuit that we hired that came from Camden to run all of operations is a certified LRO specialist. So we feel very good about the leadership in that group now as well.

We've seen some movement, obviously, on revenue management systems with some class action lawsuits growing there. Maybe you can talk about how you use revenue management system, kind of the costs associated with the lawsuit and how you see this potentially playing out?

Yes. I mean -- so obviously, we use LRO, which is not necessarily a part of the Class A lawsuit. I think for us, the revenue management system is very much based on the comps that our site teams survey and canvas every week or a few weeks and then feed that into the process with the regionals as well as the community managers in terms of managing that future occupancy and that future exposure to minimize obviously exposure and to maximize occupancy while also maximizing revenue. I think from a standpoint of the costs we were included in some of the class action salt lawsuits and the costs associated with that. We've accrued a little bit already to date, but it's still very much a TBD in terms of how much ultimately it comes to be. We're not expecting it to be hugely impactful to us, but we are watching the lawsuit carefully.

It's predominantly a YieldStar issue, right? And we got dragged in. I will say that STAR used YieldStar before we bought them. So there may be some exposure there because of the past usage. The good thing is that we have some coverage under our D&O policy. So our exposure relative to defense is somewhat limited.

And this takes years to play out?

This one is going to take a lot of years because it will have to end up, I think, being a class action, and there's I don't know how many suits they are, they're going to have to get consolidated. They're going to have to pick a lead attorney and that's not going to happen quickly.

Why don't we turn to operations? Obviously, very early into kind of the pickup of demand. What are you seeing on traffic trends thus far? Is there anything from a macro perspective that you're seeing leak into demand for apartments or how are things on the ground?

No. As I'm saying, this on the ground, as we look forward are good, we obviously track traffic every day. And I get a report that shows it each week. And when I look back over the last 2 weeks, it's much higher than it was in -- from the beginning of January through the end of February. And as I look back and compare it to prior years, it's higher than it was even it would be this time of last year. So that's what gives me a lot of comfort that we're on the right path. But it's not just the traffic, it then goes again to converting that traffic. We never had a call center. We felt that the company just was too small to have that service premerger. It was not our focus through the merger. We now have put one in place. So that will capture all of the leads there's not as many phone leads today as there probably was 10 years ago, but there still aren't enough. And if you don't return a phone call, within the first -- I don't know what the target is like 20 minutes. Presumably, the benefit of that call goes down by 90%. So every call will now get answered, nothing will go to voice mail. So those are leads that will be captured and be able to be worked. So again, we feel very good about where we're at.

I know you collect a lot of data from all of the people coming in. Are you seeing any changes to migration patterns yet?

No. No. We're still seeing lots of in-migration, you want to.

Yes. No. We -- back in our demographic period, we talk about kind of immigration from states and nonstates where our properties are located. It's typically been kind of roughly 25% in migration, and that's been pretty consistent through the third and fourth quarter of last year. And then of that in migration, the migration is coming from California, outside Chicago and Northeast.

Then obviously, we've seen a lot of rent growth. But if you think about affordability of renting versus buying in your markets, it's still skewing towards renting. How are you seeing rent income levels? Are you starting to see any affordability concerns yet? Or are you still comfortable with the rent growth?

So our overall rent income is 22% across the portfolio. There were a couple of markets where it's getting to the point where there could be some concern. Tampa, I think it's 28% for us, and we've all heard about what rents have done in Tampa they're up like 60% or 70% over the last few years. And that's why, I mean, we just haven't kept up. Nashville, it's high, Denver is high. But generally speaking, our portfolio, we're in a pretty good place. I always like to refer back to that if you're applying for a government-backed mortgage, it's a 31%, I think, or a 32% debt cost to income ratio that you need to be inside to be approved. So we're at 22%. We're comfortable where we are and still have room for some additional rent growth.

And so -- go on.

Just trying to understand, going back a little bit into your slide, the 95% slide about what's lease. Could you maybe help us understand a little more what that actually means? Does it mean that right now, let's say, if nothing else changed in 1 month or in a couple of days or whatever that period of occupancy is, you would be at 95%? Does that include churn out? Does that include people you -- that you might cycle out of? Or could you give us a little more clarity?

It means the people that are in the building today, buildings today, plus the leases that are signed for future occupancy, but does not take into consideration anybody that might leave doesn't take into consideration any new leases being signed going forward as well. So as we looked at it, the new leases being signed going forward will offset and it's pretty much how it happens, anybody who is now making a decision from this point forward to leave.

Understood.

So that's why we get.

So there is an analysis of, okay, so this is where we are, and we think that people -- the net negative is going to offset the net positive, and so we're at 95%. So there is something behind that. It's not just -- okay, got it.

We didn't pick the number. It was as of March 1, I think. And I just -- I think I like to say through all of this, we hit all of our targets and I sound defensive, and I don't want to sound defensive. But we hit all of our targets last year. We announced the merger, we put out guidance, we increased guidance. We hit guidance for 2022. So I feel really good where we're at. That was last year. What are we doing going forward? But you'll see.

Maybe to that, are there additional opportunities in the STAR portfolio? Or are we there? It's all 1 portfolio?

It's one portfolio.

Nothing different in terms of operating opportunities. You're not seeing the occupancy different between the 2?

Yes. And I mean I think from the standpoint of a lot of the synergies that we originally identified as a part of the merger, there's still like a slight keeping that we're still obviously working on like repairs and maintenance and stuff some procurement items. But they're on the margin at this point. We've secured all the synergies that we previously promised. Obviously, we're working on some technology initiatives to further help the efficiency of on-site operations to help drive better NOI margin through time. But again, that information is still forthcoming, and a lot of it's already been planned through part of the deck of the materials.

I was just going to ask on -- you mentioned that you just put through like a call center. I was there any other things that you look at the other companies within the space where you could be, like, for instance, implementing like they have AI, virtual [assistants]? Like what's the opportunity to implement sort of best practices? And what could that do to margins over time?

Yes. So I think there's some of the stuff that we're piloting right now, some of the AI chat bots and other things. I mean I think for the -- we're not so sure that the self tours and the self-guided tours are really best for some of our properties and classes. We like the personal touch and the ability for a leasing agent to walk them around a property. So I think generally speaking, we're quite bullish on improving technology or using technology to improve efficiencies, not so much kind of removing it from the sales process. We wrote out a process or a program last year where we consolidated roles for the assisting community managers and that's saving us about $2 million a year of NOI -- sorry, $2 million a year of cost that has been pretty much baked in and is pretty included as part of our guidance. And we think there's additional kind of upside to that for other efficiencies throughout. The big one we're working right now in addition to technology is procurement and procuring kind of nationally based contracts, that will help us continue to save on almost every aspect of property operations from HVAC machines and contract services to various other smaller sundry items that might be smaller in the gram in terms of carpet and vinyl floors, et cetera.

Expenses for the overall apartment sector and across really, I mean, residential in general have been high. And I know there's certain expenses that are out of your control, property taxes. But if you think about the areas that are under our control, I mean, at what point do you think sort of expenses will normalize and we'll get back to sort of more normal run rate of I'll let you define what you think normal is?

I think we're going to continue to see some level of higher-than-normal inflation in 2023. And I think depending on how successful Chairman [Powell] is delivering kind of the historical run rate inflation. I think we'll continue to see some lagging effects even into the first half of 2024.

And then in terms of supply, I think Avalon said that they expect that starts to come down approximately 50% from where they are over the course of the year, at least that's what they see on a national level. what would be your expectation? Obviously, capital costs are very high right now. Land costs are high, labor is high, like -- and for most cases, it just doesn't justify development. So where do you see starts going particularly in your markets and maybe on a national basis as well, if you have a view?

We think that anything that hasn't started is most likely will not start right now until there's a better understanding of where rents are going to be and what costs you're going to be. We're looking at this all the time, obviously. We break it down not just by market but all the way into submarkets. Again, we are in predominantly Class B assets that are a little bit older. So they're in more infill locations. They don't compete directly with new construction. Our rents are, on average, $500 a month below the rents of new delivery. So we're watching it. If you look at our submarkets across the board, there's about a 2s, 2.8%.

2.8%, yes.

2.8% supply increase in 2023. We think that drops off dramatically in 2024, but that's really kind of the historical level for new supply within our submarkets. Again, we're not -- we're in if you think about those cities and how now they have a loop and now they have 2 loops, we're within the second loop. And the new construction is more out where there's land. And we have a better price point and we're generally closer to the employment centers. So it really hasn't affected us.

Sorry, just on the atomics I think charts on Page 6 is pretty important. Because there are a lot of fears about the Sunbelt and supply and what you hear. And there's markets we're here in North of [ 5 ] and people scared about supply. But yes, I mean, you have [ 28 ] and then [ 24 ]. Just curious on the radius of that. Like is there a number? Is it within 10 miles of properties? Or is that you like.

Yes, I don't know the top of my head. I can get that for you.

And then just thinking in terms of your investment activity, how should we think about what your top priorities are there going forward? Your cost of capital, obviously, your leverage is little bit higher than the group at 6.9x, but just sort of if you could give us your priority in terms of thinking about whether it's deleveraging or continuing to invest in the business, where you're putting your free cash flow?

Well, we're clearly going to continue with the value-add. Again, 20%, give or take, unlevered returns. That's a very good use of our capital. We do have some commitments through 2 development communities that we inherited through the STAR merger, both in Denver. One is mostly completed. One is just coming out of the ground. So we will be funding that out of free cash flow, both of those communities. And our CapEx, of course, we didn't guide to any real acquisitions or dispositions. We did announce on our most recent earnings call that we had one property that was being held for sale that has closed. We used that money to delever, that will continue to be a focus for us going forward. We expect just through without any other capital being allocated just from organic growth, that 6.9x times EBITDA at year-end will be down to about 6.5x by year-end 2023. And we continue -- we expect to continue to ratchet that down just through organic growth, wasn't that long ago, Matt, that we were at 10x. So we're pretty happy to be down in the 6x. And again, it's a stable portfolio, income-producing portfolio. And we're not taking any interest rate or any real interest rate exposure because everything is fixed, and we continue to push out maturities.

We had an audience question with capital continuing to be raised for residential real estate investment, how do you think about M&A and maximizing value over the next few years? I would guess I would maybe asking would you consider something strategic at some point? I think it's what it's getting at, but.

Well, I think it has to make sense. It has to be accretive. It has to again, makes sense relative to our cost of capital. When we did the STAR merger, they were not traded. So you couldn't look at a stock price for some kind of validation of value. So we did it as a NAV to NAV. We value their portfolio, they value at ours, and we said this is what the exchange ratio is going to be. So outside of a transaction similar to that, I don't know how anything gets done because the stock prices have been so volatile, who is to say what the company is really worth right now.

Associated question with that was did the need to review the entire portfolio stem from potentially growing too fast? And whether the rising market sort of maybe sort of hit certain issues along the way that you're discovering now?

No, I think it came from that we went through the integration and we -- again, we looked at the team members on both sides or on both companies and the policies and procedures from both companies. And the goal of the integration was to put the best possible people and the best possible procedures in place. And you use the information you have and you think you do it. And then 7, 8 months later, you realize that you may need to do some tweaking. And so that's why we did this again bottom-up review of everything at the end of last year and recognize that there was probably some things that we should change, and we have changed a lot of it, and we are -- there will be a few more minor things being changed going forward. But we're confident now because we're, again, 14 months removed, and we were able to do this very comprehensive review that we feel we're clearly on the right track.

Before we do the rapid fire questions, we've been asking each session, just top ESG priority this year.

So for us, we feel that we're in a good place for both social and for governance. For environmental, we've been doing the LED lighting in the low flow showerheads and faucets and toilets and all of that stuff. But this year, we're starting some EV charging stations around our communities. As we all see the growth in electric cars, we know it's going to become a need for residents going forward, and we want to make sure we're out in front of that. So we right now have it. We have stations slated to go into 10 communities, and we will continue to put more communities into that program going forward.

Unless there's other questions, we do the rapid fire. What will same-store NOI be for your property sector in 2024, so not for your company, but for the property sector?

Well, I'll tell you, I'm an optimist. I said 6%, Jim just told me that I was probably a little too high and it would be 4%. So I'm going to settle on 5%.

Great. 5%. What is the best real estate decision today, buy, sell, build, redevelop or hold?

Redevelop. Redeveloping then hold.

Okay. And will there be more, fewer the same number of companies in the apartment sector by this time next year?

Fewer.

Fewer. Interesting. Any venture a guess on Huntsville?

No.

No. Okay. You're the first person I heard say fewer, so I'll give you credit for that. So that's great.

I'm a realist.

Well, thank you very much. I appreciate your time today. Thank you.

Thank you, everyone.

Thank you.