Mid-America Apartment Communities, Inc. (MAA) Earnings Call Transcript & Summary

An a.m. session at Citi's 2020 Global Property CEO Conference. I'm Nick Joseph with Citi Research. We're pleased to have with us Mid-America's CEO, Eric Bolton. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the disclosures tab. For those in the room or the webcast, you can sign on to liveqa.com and enter code citi2020 to submit any questions. Eric, I'll turn it over to you to introduce the company and the team and provide the audience 3 reasons why investors should buy your stock today, and then we'll get into Q&A.

All right. Thank you for being here. On my immediate right here is Al Campbell, our CFO. On my immediate left is Tim Argo, our Director of Finance; and on his left is Andrew Schaeffer, our Treasurer. And in terms of your question about the 3 reasons why investors should buy MAA today, I think I would start with feeling that we really believe that we're in a very strong position over the next 2 to 3 years to see some of the best demand growth for what we do. I would really start with the premise that we continue to be glad that, frankly, we're in the residential housing business, a product and a service that, obviously, people have to have. And MAA's focus on this Sun Belt region of the country continues to, I think, capture demonstrated strong demand as a consequence of good job growth, good migration trend, good population trends. MAA is uniquely positioned across this region, as some of you know, by a focus on a number of large as well as some very strong secondary markets across the region. Coupled with that, we have a price point and a product that appeals to a broad segment of the rental market. And as a consequence of the orientation and focus on the strong demand region of the country with good balanced diversification across the region, we really believe that as a consequence, our earnings stream has more of a full cycle performance profile to it. And it captures the benefit of the demand of the region without some of the volatility. Secondly, I would point to, we really believe we've got some great momentum over the next 2 or 3 years beyond just the regional dynamics as a consequence of a number of redevelopment and repositioning opportunities that we have underway across the portfolio. We have a pretty significant step-up this year that we're embarking on with redevelopment of some of the legacy Post assets. And we've got our normal interior upgrade initiatives underway, coupled with a new high-speed Internet technology package we're rolling out as well as smart home technologies. All of these things are going to continue to fuel organic earnings growth, if you will, off our existing asset base for some years to come. So we really like the momentum we have with the existing asset base. And then thirdly, I would point to, just we really believe that we are ready in the sense that the balance sheet is in a very, very strong position. We've got a lot of maneuverability and capability to execute on transactions from one-off to larger-scale events. We've done it before. We know how to execute. And we think that between the opportunities that we think are going to continue to emerge, we've got about a $490 million development pipeline at the moment, another $100 million -- close to $150 million in lease-up. So we really think we've got some external growth momentum teeing up as well.

Thanks. We're opening each session with the same question. ESG is of increasing importance for all company stakeholders. What is the one thing your company is doing to improve your overall ESG score over the next 12 months?

Well, we went through an outside third-party review and scoring last year. We'll be going through that process again this year. We'll be issuing our inaugural sustainability report later this year. So we've got quite a few initiatives actually underway. I'm going to let Tim address a specific agenda item that we're pushing this year.

Yes. I'd say we're doing a lot of things, frankly, that will help the ESG score, I would say, this year. One thing I'll point out that not only helps our ESG score, but frankly, is good for business, good for the bottom line is our LED lighting program. So starting in Atlanta this year, we're going to go and replace all of the common area exterior drives lighting with LED, which certainly is good for the energy consumption and good for utility costs as well.

Great. Maybe let's start just with coronavirus obviously impacting or potentially impacting the entire economy. How is MAA handling that from a property level perspective?

Well, there are a lot of things that we're doing internally in terms of just communications with our employees as well as communications with our residents about things and actions that people should be taking in an effort to mitigate the risk of infection, if you will. And beyond that, we are spending some time scenario planning and thinking about the potential surrounding a given property or a given department, if you will, at the home office and the corporate office, being forced to keep a number of employees home for some reason as a consequence of, particularly, hypothetically, one person being infected and the whole group of people associated with them, likewise, having to be quarantined. So we're doing some planning as it relates to that sort of thing. In terms of making sure that we, as a company and we as a business, are in a position to continue to operate and execute the services that our residents are planning on for us. So we've got that underway. Beyond that, I think kind of a secondary question surrounds what are the implications surrounding a more widespread slowdown with the economy in general and how does that play out as it relates to our business. And again, we've been through recessions before as a company. And we've operated very well through those periods of time. But largely, we tend to see in these kind of environments where resident turnover begins to slow down a little bit, resident retention picks up, which is frankly one of the better rent growth areas of our company. So we think that there are some positives. In that sense, I do think that you might very well see new lease activity start to slow a little bit potentially if the broader economy were to slow down. So there's give and take, both, but we're spending a lot of time thinking about that right now and planning for it.

And I recognize it's very early days, but is there anything you're seeing from a leading indicator in terms of traffic or showings -- that is showing any impact yet? Or is it more just planning for potential future?

Yes. No, we have not seen anything yet. I think that at this point, as you point out, it's a bit early, but no indications as of yet.

Maybe just on the operations. If you can provide an operating update on how things are trending thus far into the year.

Well, broadly speaking, things are moving ahead pretty much like we would have expected. As we talked about in our earnings call, we have a number of markets that are seeing higher levels of new supply this year. And we certainly dial that into our expectations for the year. And occupancies are running in line with what we expected, 30 basis points or so below last year, which is what we really contemplated. But again, it's still very early in the year. Rent renewals are continuing to remain very strong in the 6% plus -- 6% to 7% range. This is the time of the year where new lease pricing tends to be the weakest, and that's certainly what we're seeing playing out. So overall, I would tell you no surprises at this point. But as we work into March and April, we fully expect to see leasing activity start to pick up.

And you mentioned the new supplier. Have you seen anything from a concession standpoint that's out of the ordinary?

No, not at this point. Dallas continues to see a number of concessions depending on the submarket. Atlanta is seeing a little bit of concession activity as well. But nothing out of the ordinary. Raleigh continues to do quite well. Phoenix is doing incredibly strong. We think that we'll continue to see good trends this year out of both Orlando and Tampa as well. So no -- again, no real changes at this point.

You talked about in the past or during a recession, typically turnover is going to become lower, you're going to rely more on the renewals. What we've seen this cycle is turnover just continued to decrease. And so do you think turnover would decrease even from these low levels? Is there an opportunity to go even further? Or do you think we've already seen a lot of that lower turnover, and at this point, it's more structural?

No. I think that if we really do see a broader, more severe slowdown in the economy, I think that it very well could fuel even lower turnover than what we're seeing right now. I think that when you look at the reasons for turnover, the -- almost 1/3 of the turnover that we have is a function of people changing jobs. And arguably, in a recession, you'll start to see that moderate a little bit and that would have a tendency to drive turnover down. Probably 18%, 19% of our turnover, close to 20% is a function of people leaving to go buy a home. Likewise, I suspect that people would get into a little bit more of a conservative mindset as it relates to that sort of decision. And as a consequence, I think it's likely we would see turnover even fall off a little more than what we're seeing right now.

We have a question from LiveQA specific to Atlanta. How long do you expect -- how long do you envision the Atlanta market to continue to be as attractive as it is today? And what's the largest long-term risk for that market?

I think Atlanta continues to capture a lot of job growth. I think that there's nothing -- and of course, the airport there offers businesses that locate there, the access to the world, frankly. And so I think that as a consequence of just -- and it's a very affordable market to live in. We haven't seen the level of migration from the West Coast into Atlanta like we have seen in Dallas, Phoenix and Austin, but we continue to see migration out of some of the Northeast markets affecting us in Raleigh, Nashville and Atlanta. And so it's hard to point to anything that I can think of right now that would cause Atlanta to reverse course in terms of a job growth hub. I think that I don't see the state or the city near term doing anything to get more aggressive on taxes or anything that would be counterproductive to attracting employers to the area. So we continue to like Atlanta a lot.

Any questions from the room? You've been focused on improving the operating platform using technology and different means. Where are we maybe in terms of innings of operating efficiencies based off of the platform side, putting aside smart home technology or anything in apartment units, specifically?

Well, I think we're in the very early stages of really trying to identify how technology is going to continue to alter the way we do business. And the implication to margin improvement is something that I still think we're just now discovering. Certainly, we will be doing some things this year. Particularly, as it relates to smart home technology that we're implementing, we'll be installing roughly that technology in roughly about 24,000, 25,000 units over the course of this year. We're also rolling out a new mobile maintenance technology platform that will drive a little bit more efficiency in terms of how we execute move in, move-outs. But I think that what will be interesting to see play out is that as the smart home technology continues to offer the ability to control thermostats, control lighting, control access to the unit from the office, from a central location, the long-term implications for then getting into more self-touring activities really starts to open up in a big way. And then as the consumer, our residents and leasing prospects, continue to embrace these technologies, and I think that ultimately, it does have implications for on-site staffing levels and our ability to potentially pull back in some ways the level of staffing that we have on site. So I think that, that coupled with a number of things that we're doing just with our property management, software and how we interface and prospect for new residents, how we interface with our residents, payment processes, again how they submit maintenance requests and things of that nature, all these things, ultimately, I think, are going to continue to create more ability for us to leverage a fixed overhead cost structure on-site to a lower level than it is today and drive more efficiency with our fixed cost structure on-site. And I think you could see margin expansion, easily a couple of hundred, 300 basis points or so, I think, over the next 2 or 3 years.

And how do you think about testing and deploying and implementing these initiatives versus the risk of either obsolescence or picking the wrong technology or upsetting your existing tenants or employees?

We tend to take a careful -- pretty careful approach with it, starting with the -- not forcing certain services or technologies onto an existing resident. As an example, we're installing these smart home capabilities in the units, and we're finding great receptivity from our existing resident base. But if somebody, for some reason, doesn't want it, then if they're on lease, then we'll say fine, we'll wait, and we don't force it on them. Whereas the high-speed technology package that we're rolling out, high-speed Internet technology, everybody wants it. And so that's kind of mandatory. Nobody is really pushing back on it. I think that the other thing that we're -- so it kind of depends on the product and the service in terms of how we sort of push it with the consumer and the resident, making sure that there's good receptivity to it. We're not prone to want to create turnover if we don't really have to. I think beyond that, one of the things that we also -- as you point out, we're being very thoughtful and careful about who we partner with because we want to be sure that the companies that we get dependent on to some degree with this technology are going to be long-term players. And we -- we've talked about this in the past, we're co-invested in a real estate technology venture fund along with UDR and Essex and a few others to really find some of these new emerging technologies, and the companies and the people behind those companies that we really believe have the wherewithal to make a successful go of it. And through this fund, we are able to not only provide capital for some of these companies to really get going, but more importantly, we work with them and refine their product and their technology and make sure they've got a very viable product that is going to be embraced by the broader industry and really make a success out of their product. And the third thing I would point to that also is really, really important is that as we continue to introduce more and more technologies onto the platform, while there's great efficiencies and capabilities that come from that, there's also vulnerabilities that one has to think about, whether it be the threats surrounding cyber risk, things of that nature that we're constantly thinking about and making sure that as we introduce a capability that we think about the risk surrounding, either that system being hacked, if you will, in some fashion and/or just going down due to some other reason and backups and the ability to execute some of those services to the extent we can in other ways, if the technology somehow shuts down is important. So it -- there's a lot of things to think about. And I think that we have to be, as an industry, careful about seeing some new mousetrap that everybody sort of likes and then just implementing it and embracing it. You got to really be thoughtful about it because the more dependent you get on it, there are some things that you have to be mindful of.

And when you think about implementing different technology across the existing portfolio versus new development, are you seeing more of an opportunity to do it on the new development side or through redevelopment? Or is it easy to retrofit existing communities with some of these initiatives?

Most of what we're able to do, it's easy to go into an existing community and implement it. I think for any of these services or products to really have a viable future over the next 2 or 3 years, they've got to have a capability to do a retrofit, if you will. If someone's introducing something new that is solely a function of having it as part of a new development, I think it's going to be a tougher business model to sustain.

So I think the second point you made in terms of why someone should buy MAA, the redevelopment, repositioning. You've talked about the price point of new developments being about 25% higher than I think the -- your product in the market. How big of a redevelopment opportunity is there? And how do you pick which assets should be redeveloped in the near term?

Well, we think the opportunity is pretty significant. As you mentioned, if -- we do a pretty detailed market analysis every year, late in the year, as a part of our budgeting and forecasting for the coming year, and we do a kind of a 1 and a 5-mile radius study of every property we have. And as you mentioned, the supply coming into the markets that we have based on this radius definition, on average, the new product is coming in at roughly 25% higher rents than where we are, which, we think, says good things about our locations, but it creates a huge opportunity for us. We may find some near-term pressure as we currently are experiencing with some of these new properties doing lease-up concessions and things of that nature. But they're going to have to adjust their pricing at some point in an effort to justify the investment that they made. And there really becomes the opportunity for us to go in and enhance the product in some form or fashion, offer -- get a meaningful rent increase as a consequence of that, on average, whether it's the unit interior upgrades, some of the more extensive repositioning. I mean we're seeing kind of mid-teens plus returns on capital -- cash-on-cash returns on capital for these investments that we're making and the immediate rent growth that we're getting. So in terms of risk-adjusted use of capital, this is the most advantageous use of capital we have. So we think that over the next 2 or 3 years, as a consequence of supply coming into the market, it's going to continue to fuel opportunity out of our existing asset base. I mentioned the 25% discount between where we are versus where the market is. In Dallas, that discount is 40%. So -- and that's obviously a big market for us. So we really think that we're -- while, in some ways, we fret about the new supply coming into the market, we see a silver lining to it that makes us feel pretty good over the next 2 or 3 years in terms of what we can do with our existing asset base.

What spread between where new supply is delivered and where your rents are makes it interesting?

It really -- it's an analysis on -- and we do it property by property, almost unit by unit -- unit type by unit type. We'll do a -- I mean the way our revenue management system works is we look at all the comps around our property. We look at the spread that they're getting versus what we're getting. We do a test, if you will, to evaluate what is it about the product that we could enhance that would make it more appealing versus the new product and can we -- what would we need to change, whether it's the countertops or cabinetry or flooring or whatever it may be. And then we test it, and we see what sort of rent growth that we can get. And internally, we have a hurdle of kind of mid-teens returns or better in terms of the rent increase amount that we need to achieve in terms of a 15% or more return on the incremental capital that we are investing. And so for us, it really starts with, can we get and prove it out? Can we get a rent bump that generates that level of return on the incremental capital that we're spending? And if we can, then we'll go, and we keep going, and we continue to monitor and continue to test it. And we compare it to the rent growth that we're getting on non-renovated units to make sure that we're getting not just the market growth, but we're getting market growth plus the incremental return we have to get on our capital. And the beauty of the way we approach it on a case-by-case basis is if market conditions change for some reason, then we'll just stop and wait until the return opportunities emerge. So for us, it's really not so much what's the gap between us versus the market, but what's the return on the incremental capital that we're going to spend and can we get a certain threshold return on that capital.

And from an organizational or risk mitigation perspective, how comfortable are you to increasing exposure to redevelopment?

Again, I mean, we utilize a lot of our existing maintenance teams for this activity. We've got staffing in place to do this. We've got some -- I mean we added, I think, 3 new people this year to execute some of the more extensive renovation work that we're doing with some of the legacy Post assets. But we're not really staffing up, if you will, to execute on this in any sort of big way.

And then in terms of new development, I think you've talked about 3% to 4% of enterprise value. Why is that the right size for the pipeline?

We just determined that based on looking at a future funding obligation to -- I mean, effectively, what we're trying -- what we're saying is that, for whatever reason, if we had a certain volume of forward funding commitments associated with new development and the capital markets absolutely seized up for whatever reason, as they did back in 2008 or 2009, and we were put in a position of having to complete funding off of our existing balance sheet capacity, could we do that without blowing up credit ratings, without putting the balance sheet at risk in any form or fashion, including dividend coverage. And that's kind of where we pegged it. Now having said all that, today, at roughly $489 million of development underway, it's less than 2% of enterprise value. So we're very comfortable with where we are right now. Frankly, I don't think we're going to see it scale up much more than it is right now because we just can't find the deals that pencil out in a compelling enough reason right now. We've got one other site under contract in Austin that we may start very late this year or next year. But other than that, we don't plan to start anything else this year.

What's the densification opportunity with the existing portfolio today?

It's something we're taking a look at. We've got a couple of opportunities in the uptown area of -- near Downtown Dallas, some legacy Post assets there, McKinney Avenue, that we're starting to look. Everything up -- going up around us is much taller than we are. And it starts to beg the question of -- I mean it's creating a great redevelopment opportunity for us right now because these are all brand new assets, and we've got great locations. And so for the moment, right now, the best use of capital is just continue to repositioning the existing asset as opposed to tear it down and go vertical. So I think over the next few years, we'll continue to evaluate that. But as long as we're getting the returns, we are just re-purposing the existing asset base. That's largely where our orientation is.

Maybe on the acquisition market. Are you starting to see any more opportunities? Or is it still kind of very competitive? Anything on the merchant build side of supply delivery that would become interesting?

Yes. It's still really, really competitive. We continue to look at a lot of things. We did close on an acquisition in Greenville, South Carolina late last year. We are working on an opportunity in the Fort Worth market at the moment that may or may not come together. But it continues to be just incredibly competitive. And we see a lot of private equity -- big private equity players coming into the market and working the brokerage community very aggressively to try and preempt, even taking deals to market. And so increasingly, it's -- I mean if something actually goes to market, it just becomes almost prohibitive to even work it. But more and more, what you're seeing now is a lot of people are reaching out to developers and brokers, as we are as well, attempting to preempt any plans to take something to market and try to buy it, so that you avoid the competition. But the deal we bought in Greenville was typical of what we are doing, similar with the opportunity we're looking at in Fort Worth. Currently, these are transactions -- or properties that have been under contract previously. And for whatever reason, the buyer fell out on the contract and the seller becomes a little bit more motivated to do something. And that's really the only opportunities, kind of the rebound place is where we're finding success at the moment.

You obviously added D.C. as part of the Post acquisition. What are your thoughts for kind of that market going forward? Does it make sense longer term for MAA?

For the moment, it certainly, we think, makes sense. We had, had a position in kind of Northern Virginia for some time. And so that kind of loops in from a regional perspective for us. But some of the absolute best redevelopment opportunity we have with some of those legacy Post assets are in that market. And so we are -- we, for the moment, certainly committed to those assets in that market. I don't think that that's a market you'll likely see us grow in, but we certainly like what we own there at the moment and think that we can continue to increase the value of those assets and the earnings from those assets in material way through the redevelopment that we're doing.

I'm wondering, in light of the precipitous drop of interest rates with the U.S. treasuries this morning, trading at 1.04%, whether this decline in rates has affected your parameters and affected potential acquisitions. And whether -- are you seeing any impacts as yet in other transactions in the marketplace?

At this point, we haven't really seen the transaction market change in any way. I think certainly if -- we're in a period of uncertainty right now. And I think that we're going to see -- if the rates stay as low as they are, coupled with increasing uncertainty about the broader economy, if we begin to see broader economic slowdown, I think it will start to affect the transaction market in some ways. It's -- the low rate environment will certainly continue to favor the higher leverage buyers that are out there. But if the operating fundamentals begin to show any kind of deterioration that could likewise have an impact on NOIs at some level. But I think that multifamily real estate continues to be, I think, in every sense of the word, a pretty favorite asset class and fundamentals continue to be quite good. There's broader demographic trends and other sort of macro issues that, I think, are going to continue to fuel healthy demand for apartment real estate. And so I would be -- I think things would have to radically change from an operating environment in a materially negative way for a prolonged period of time before you would really begin to see any sort of impact on cap rates and values.

We have our rapid-fire questions to end the session. Will the apartment sector have more or fewer public companies a year from now?

I think fewer.

What will same-store NOI growth be for the apartment sector overall next year in 2021? And this year, it's -- 3.1% is the average.

Let's say, 3%.

What will the 10-year treasury yield be a year from now?

Certainly hard to see it go higher, and nobody would have thought it would go lower. So I would say probably range-bound where it is for quite a while.

And then finally, in what year will the U.S. enter a recession?

I think we're potentially shaping up for a mini one here in Q2 or Q3. But I would put it probably in 2022 in terms of a real recession.

Great. Thank you very much.

Thank you.