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

Good morning, everyone. For those of you who don't know me, I'm Josh Dennerlein, Bank of America's senior analyst, covering the residential REITs. Global Real Estate and I are extraordinarily pleased to have with us Mid-America Apartment Communities Chairman and CEO, Eric Bolton; also joining us is Executive Vice President and CFO, Al Campbell; and then Senior Vice President of Finance, Tim Argo. Before I turn it over to Eric to introduce his team and provide an overview of MAA, I want to remind everyone that if they want to ask a question, please use the Veracast software to input your question at the bottom of the screen. You could -- for those who have it, you could also shoot me an IB over Bloomberg, and I'll be looking for those questions and I can ask on your behalf. With that, I'd like to turn it over to Eric for his prepared remarks. Eric?

Thank you, and I appreciate everyone joining us this morning. I think a number of you probably pretty familiar with the MAA story. So I won't take a lot of time introducing our story. And I think as most of you know, we are a company focused -- apartment REIT only-focused on the Sunbelt region of the U.S. I think there are 3 or 4 things that I would point out that I believe really put us in a very strong position at this point and enable what I believe us to continue to deliver outperformance within the apartment sector and ultimately outperformance for shareholders over the next 3 to 5 years. First, I think our orientation to the Sunbelt is going to continue to very much work in our favor for a number of reasons that I think most people are familiar with regarding job growth, population growth, migration trends. Unique about -- one of the unique attributes of MAA that I think is sometimes lost is that not only do we have this orientation on the Sunbelt, but we have, I think, a very unique diversification across this region of the country with a healthy investment exposure to some of the larger markets such as Dallas, Atlanta, Phoenix, Charlotte, Tampa, but we also have good exposure to some of the dynamic secondary markets of places like Nashville; Charleston, South Carolina; Jacksonville, Florida. And what we find is that a combination of this exposure to both the large and the dynamic secondary markets of this region really provide us a strong performance profile through the full cycle. We appeal to a broad segment of the rental market across the sector of the country, and I think puts us really in a position to continue to outperform. Our presentation that hopefully you've all seen talks a little bit about this unique footprint that we have highlighted on Page 4. And then also, I'll draw your attention to Page 5, which really recaps a bit about what the rent growth prospects look like between now and 2025 across a number of markets in the U.S. and supports the thesis that putting for suggesting that we are very strong -- in a strong position to continue to outperform. The other 2 quick things I'll point to is, in addition to just the strong dynamics of the region, we're very excited about the ability to basically capture even better performance as a consequence both of a lot of redevelopment and repositioning activities that we have in a way that's highlighted in our presentation, as well as the number of things we're doing on the technology front that are going to continue to drive margin expansion, we believe, across the portfolio. These are information recapped on Slides 11 through 15 in the presentation. And then finally, I'll point to the strong balance sheet that MAA has in place on Pages 18 and 19. We have one of the stronger balance sheets in the sector with great coverage and metrics, strong rating from the agencies and actually performing at a level above the rating that we're currently at. So I think that when you put all these things together, it supports my belief that MAA is in a very strong position to continue to deliver outperformance, both from an operating perspective as well as from a shareholder perspective as we move forward. So with that, Josh, I'll turn it back to you.

Thanks, Eric. I appreciate those introductory remarks, and I think you hit on my first question, what are the top reasons to buy your stock today. You laid out a compelling case. I was wondering to maybe just kind of explore something that you touched on. You mentioned the technology that you're working on. Kind of love to hear just more detail on what you guys are doing internally that can drive growth on that front?

Well, it's a [Audio Gap] focus that we've had for quite some time, and we really organized a lot of our technology, smart Home technology, automated door locks and thermostat setting, like control, those sorts of things, which is really a pretty supporting continued rollout of the ability to execute more actively on full virtual leasing and self-touring. We'll be rolling out some new capabilities along those lines later this year on that. And a number of things that we're doing relating to how we are using our connectivity for -- on the website and a lot of things that we're doing in terms of our connectivity with the ILS and the search engines with Google and others that we think are going to continue to put us in an opportunity to outperform in terms of search engine optimization. One of the things that I'm really excited about, frankly, over the next 4 or 5 years is, how frankly, as an industry, particularly with the big large public platforms like MAA, how we are going to continue to bring onboard new prospects, automating the lease execution process and then how we're continuing to automate the interface that we have with residents as they continue to stay with us. And I think that these technology capabilities are going to really enable us to show greater operating margin performance out of real estate in these markets as compared to what is sort of the average, if you will, in these markets, which tend to be more dominated by smaller owner-operator models who don't really have the wherewithal invest in the technology to the extent that we do. So I'm pretty excited to see what we're able to do over the next 4 or 5 years with this technology. And I think obviously, ultimately, the proofs of the pudding, we'll see what we're able to do with the margins, but I'm very optimistic of what we can do there.

Yes. I was going to ask, have you kind of quantified or thought about maybe the margin expansion opportunity into this technology?

It's still evolving. We're eliminating 30 leasing positions this year as a consequence to some things that we've done with automating and making some changes with our centralized call center. We'll be eliminating another 30 or so positions next year based on some early analysis that we're doing as we continue to migrate towards more virtual leasing. We're also rolling out some new technology in terms of how we track our maintenance operations on site. It's still kind of early to determine exactly what staffing opportunities may emerge on the maintenance front, but the way we're able to automate scheduling, make these calls, track move-in, move-outs, I think without a doubt, over the next 2 to 3 years, it's going to also drive some efficiencies there from a staffing perspective on the maintenance operation. And when you look at our platform, I mean the biggest -- the largest number of associates that we have perform leasing and perform maintenance operations. And so to the extent that we can drive more efficiency with staffing in those 2 operations, I think the margin opportunity is potentially quite meaningful.

Yes. No, it will be interesting to watch. Another thing to explore your opening remarks, you mentioned kind of these bigger Sun Belt markets versus the smaller markets. How do you balance the exposure between the 2? Do you have targets? Or is it driven by like opportunity sets within the markets?

Yes. It's a combination of things. We're looking to ultimately achieve not only good diversification. And so we don't want to have obviously too much concentration in any given market, but we're also looking at trying to capture as much of staff and other sort of overhead cost. And so a market like Charleston, South Carolina, which is a very dynamic market, offers some great, we think, long-term properties in a market like that is probably as far as we want to go as compared to a market like Dallas, which is obviously significantly larger and able to support or submarkets across the large metroplex market like [indiscernible]. So it varies a bit. We're just now getting into the Denver market. We've got several others on the drawing board for development that we get started on. One is actually under construction now. We're going to start out some more next year. And then another new market for us, a development project there. At the moment, we've got another one that is in early strategies of planning. So I think that what we have found is that over a full cycle -- part of the cycle, these secondary markets, some of the smaller markets tend to hold up a little bit better. They don't tend to be as heavily influenced by supply as you -- when you get into a really strong part of the recovery part of the cycle. We sometimes see the larger markets we're able to drive a little bit more robust rent growth than what you see in some of the smaller markets. So it varies a bit depending on where you are in the cycle. And ultimately, we think having healthy exposure, call it, 60-40, somewhere in that range between sort of the larger markets and collectively, what I'm referring to as the secondary market is a good balance to have that ultimately drives outperformance over the full cycle. And that's what we're really all about, that's what we're trying to accomplish. [Audio Gap]

Okay. And maybe just stepping back or what is it that you look for when you enter a new market? Like what attracted you to Denver and Salt Lake City?

It's job growth. As we look at the various factors that drive demand for housing whether it's employers finding the market to be attractive for various reasons, either lower cost of doing business, the access to an educated workforce quality of lifestyle that will enable them to recruit to the market. Frankly, the outdoor venues, the ability to attract young people is important. Good transportation. Good sort of airport operation. We also look at the stability of sort of the local and state governments. Are these governments with in practices that seem to support a sort of pro-business environment and sort of what employers need to be mindful of as they think about growing their businesses. So it's a combination of those factors. And when we started looking at the both Denver and Salt Lake City, we realized that in both markets, they continue to attract a huge influx of people in both of those markets. Job growth is strong. And so particularly in a market like Salt Lake City, it's a much more stable market. It has held up very, very well during the downturn -- COVID downturn. And again, that provides a stabilizing influence in terms of overall portfolio performance that we think serves us well over a full cycle.

Thanks, Eric. Maybe now is a good time for an audience question to lead that in. How do you face your ability to grow the platform in light of very low cap rates in the marketplace today?

Well, it's certainly a challenge to buy anything on a fully marketed basis. Cap rates based everything -- I mean, we're very active in the transaction market. We underwrite a lot of deals. But when we look at some of the cap rates and pricing being paid today in the 3.5, 3.75 range, we just -- we have a hard time rationalizing that level of investment. And so for us, the focus is really on growth through development. We have 2 different programs in place. We have an in-house development operation as well as what we refer to as a prepurchase program, where we essentially partner with third-party developers to build properties for us. We pay them to build it, and we lease it up in some cases. In some cases, they lease it up, but upon completion, upon stabilization, then they walk away. It allows us to essentially buy the properties on a wholesale basis versus going into the market on a fully marketed basis and paying full retail. And we think that, that really puts us in, again, a unique position. As you are probably familiar, we've seen some of our REIT peers make a decision to more embrace these Sunbelt markets and a lot more activity going on with people buying properties. And there's an article yesterday in one of the Atlanta Papers, talking about one of our peers that just coming into the market new for the first time and buying a brand-new property, just built a 5-storey wrap product, structured parking, interior hallways and paying just the property just stabilized. They're paying $353,000 a unit. Meanwhile, we've got a project we just started in the same exact same market, exact same type of product, 5-storey structured parking, interior hallways. We'll deliver in early '22 or early '23, I should say, on this project. And instead of paying $353,000 a unit, we're going to be all in at $260,000 a unit. And so for us, we've been in the Sunbelt markets for 27 years. We know these submarkets. We know how to underwrite, and we think that we're going to continue to be able to capture a good growth through our development operation. You'll see in the presentation there that we've got on Page 16 and 17 in our presentation, we have a little over $600 million currently underway. You see that scale up to close to $800 million by year end and next year, that number will be approaching $1 billion. We continue to find opportunities. We've got several projects in predevelopment right now. The new project in Tampa, new project in Raleigh, North Carolina. We've got 3 other projects in Denver that are getting teed up. So we're optimistic that we're going to be able to capture good growth, but more importantly, we're going to be able to capture that external growth on a very disciplined basis with an investment basis and a disciplined strategy that is putting capital out in a very careful, thoughtful manner.

And I mean what are the kind of the spreads between what you can develop at or some maybe where you can buy the retail market? Is...

We're going to be delivering product as outlined in our presentation. The product that we have underway at the moment right now, we expect to stabilize yields around 6%. We will probably -- given what's happening with construction cost, we'll see those yields on the new stuff that we're starting over the next year, probably somewhere between 5.5% to 6%, which is a 6% yield, which is a very healthy spread to the 3.5% to 4% sort of cap rates that are currently being required to buy in into these markets for a comparable product. So we think that 200 basis point spread or so is attractive. And as long as we can kind of capture that kind of spread, we think it makes sense to grow through development versus going into the market and paying full retail price for growth.

Yes. No, that's a nice yield even with the rising construction costs. Maybe just switching over to operations. I'm not sure if you brought an update on how the portfolio is performing for August and September. Just if you could share any color there. And then maybe just across markets where you're seeing the best and kind of the weakest kind of fundamentals?

Well, Tim take that.

This is Tim. So we did -- for everybody there's a presentation, Slide 8. We included an operating update that has pricing data through as quarter-to-date. And so we continue to see acceleration, both on the new lease side and the renewal side. So blended pricing and this is for leases effective in Q3, July and August, 14.3, which is driven by new lease pricing of 20% and renewal price of 9.7. As we look into September, similar trends, not seeing any kind of slowdown in September either. And I think the encouraging thing is just the breadth of the pricing power and the depth of it across our markets. So we have markets all the way up at 20% unblended and our lowest market of 7%. So we have Houston and D.C., which were a couple that we noted at the begin of the year will probably be a little weaker just with little less job growth combined with supply, but even those are still in the 7%, 7.5% range for blended brand for Q3. So encouraging. And we've also been able to do this with occupancy staying strong. We're at 96.4%. Average physical occupancy Q3 to date. So strong occupancy, selling pricing, seeing the demand continues. So feeling good, obviously, with where it's headed right now.

No, it's impressive to see. Do you think is the leasing season, has it been extended? And then like do you think we see like a normal kind of seasonal slowing as we get into the fall? I feel like normally kind of start to see a little slowing down? So interesting that on your September comment.

Yes. I mean we do expect still to get some seasonality, particularly as we get into Q4 as you get closer to the holidays and the demand and the traffic slows down naturally, but certainly, in a little bit a higher point than we saw. And I think your point is right. I think the leasing season sort of on a couple of months longer than you would see in the typical year. Typically, we see new lease pricing kind of peak in late July, maybe early August that start to trend back down, and renewals are generally pretty steady. You've got -- you don't have the seasonality impacts there that you went on the new lease, but we've seen new leasing, again, accelerate through to now. So I think instead of July being the peak perhaps, September is the peak, and then you start to see a trend down some. But then on the renewal side, still the strength where price renewals 60 or more days ahead of time. So able to go and lock in some of those spreads based on today's demand. So I would expect as new lease pricing perhaps starts to moderate seasonally, but those renewals still hold up pretty well.

And do you have an estimate of maybe your loss to lease? And how long you think it might take to kind of capture that across our portfolio?

Yes. Right now, if you look at everything we're pricing today at today's prices and put every unit of that, and certainly, the loss to lease today is strong and as high as probably upper single low double digits. But I think as we said, as you get into Q4, it will start to trend back down. So if you said, what if we price everything at what we price come in December, it will be a little lower. But the way we typically try to explain it or talk to people about it is, if you take our full year blended lease-over-lease expectations for 2021, which in our latest guidance back at the end of Q2 when we release Q2 was somewhere in the 7%, 7.5% range for the entire year, January to December, all leases that we've signed. Typically, half of that is going to carry into next year, and then whatever we price in 2022, will contribute the other half. So suffice to say, we have a strong earned in, baked in, blended in, whatever you want to call it, rent roads head to 2022. And everything we price right now while it certainly helps 2021, it's actually contributing more to the growth that we'll see in 2022. So it's setting up strong for next year.

Okay. One thing I've kind of heard is maybe some operators were able to maybe put more of their leases rolling into kind of a typically seasonally stronger months. So they're set up pretty well for 2022. Do you have that ship going on? Or is the distribution of when things are rolling kind of standard is kind of what it was pre pandemic?

I would say, it's what it was pre pandemic, but we've always sort of priced in that way. We've always had 60% or more of our leases expiring from, call it, April to September, Those middle 2 quarters, obviously, on purpose with most of the demand. So I would say, a typical spread is 18% to 20% in Q1s and Q4s and then Q1 and Q4 and the balance in Q2 and Q3.

Okay. And maybe switching over to supply at this point. What are your latest thoughts on the outlook for supply growth across your markets?

I would say, it's fairly consistent. So we've seen -- if you go back to really 2018, 2019 in our markets, we've seen it somewhere in the range of averaging probably 3% of inventory sort of across the portfolio. Sometimes a little lower than that, sometimes higher than obviously vary somewhat across different markets. I would expect somewhere in that range over the next couple of years. I think we will see some moderation a little bit in 2022 based on we saw permitting and starts to drop as we got into 2020. So those would likely deliver mid to late 2022, maybe early 2023. So I think we'll have, call it, a 3- or 4-quarter window where it drops a little bit. Not significantly, but maybe some 3%, 2.5%, 2.7%, 2.8% of inventory. But then I would expect it does kind of get back to that level around 3% as you get into 2023 and 2024, just given we've seen permitting. It's picked back up this year and it starts to pick back up. And then as talked about earlier, just the level of demand and the amount of capital out there and the developers out there willing to do it, it's going to continue. And so going back to Eric's original point, that's why we kind of bet on the demand side with our markets, expecting that supply is going to be there, but the job growth and demand will be there to more than offset it for sure, over the next 6 to 8 quarters, I would say.

Yes. I guess kind of curious if the increased competition from some other REIT entering some of the Sunbelt markets. Like do you think you expect that over time results in higher supply than what we've seen historically?

This is Eric. I don't think that some of our peers coming into the Sunbelt is really going to matter much at all as it relates to supply trends and supply performance across the region. Frankly, I think the bigger impact is going to be in terms of what it does to cap rates. As I mentioned earlier, we're seeing some incredible cap rates being paid for stabilized apartment real estate. And I think that whether it's some of our public REIT peers or whether it is private equity that continues to want to get more positioned in Sunbelt apartment real estate. The impact on cap rates I think over the next number of years is likely to be quite significant. And the historical gap that you've seen between sort of Sunbelt cap rates and the bicoastal markets, I think that gap is going to be more narrow than it's ever been and likely will persist for quite some time. And that's just a function of more and more people coming into the market, wanting to buy a proper real estate in this region or country.

Thanks, Eric. It looks like we got a few more audience questions. The first point, I believe, is on affordability. They're asking where can rent to income go for your portfolio over time? Maybe...

We have a slide in the presentation on Page 9 of the presentation that gives you a bit of a snapshot by market. Some of our major markets where rent to income currently is. And it's interesting to note that the rent to income broadly is in the sort of 20% to 22% range across the portfolio, and this holds true across all of our markets. And I will also tell you, this holds true for what it's been for the last several years. While we've certainly seen rent growth moving up, fortunately, we've also seen income is moving up at a commensurate rate that has allowed that ratio to remain very steady. And as a consequence of, I think, just how the demographics continue to evolve for the renter profile across our portfolio, increasingly more affluent, older, staying in place, staying in the rental market a lot longer coupled with the strong job growth and wage growth that we're continuing to see across this region, the rent to income is very comfortable in the low 20% range. And most will tell you that affordable rent is -- most comments will call that 30% rent income is kind of where you want to be in terms of affordability. So with our range being where it is in that low 20% range, we think we've got a lot of room to keep going with rent growth. And again, our objective in all those in terms of how we're deploying capital. We're trying to deploy capital in a fashion to create and appeal to a broad segment of the rental market in an effort to create the strongest growth and the strongest stability we see over a full cycle. And we think the renter profile that we have today is enabling us to accomplish that. And obviously, if that rent to income in the 20% to 22% range, where it's been for some time, we think that we've got room to keep going with same pricing.

Just looking at the percent of people signaling there, you just start making couple and also it's a lot more affordable.

Yes.

Your technology rollout, you're running a data again.

Yes. Yes. I thought that I have to keep that around.

And another audience question. Just asking maybe why are the development yields so wide? Because that 200 basis point spread, I guess, just curious, it seems pretty healthy. Maybe there's some other development spreads I've seen.

Well, I think more than anything, the reason for the big gap at the moment is investor appetite for stabilized apartment real estate is so huge, so significant now that it is driving pricing to all-time highs. And so I think that ultimately, what we're able to do on the development side at 5.5% to 6% yield is a function of, frankly, us being invested in these markets for 27 years, having strong relationships with the builders and the developers and the contractors that we've done business with for many, many years. We've got a number of land sites that we have tied up, and then we've had on a contract for a while. And despite some pressure on construction costs, we've been able to keep our costs at a reasonable level and broadly, put us in a position to deliver product at yields -- stabilized yields that are way north of what it takes now to go into the market and buy something fully stabilized, fully built out, given the very attractive interest rate environment that we find ourselves in, particularly in the private equity side where they can bring in some very attractive financing. They are able to still get a spread even at those low cap rates of 3.5 to 3.75, and based on whatever underwriting they're doing, make it work. And so I think that as long as the investor appetite stays as strong as it is for these apartment assets in Sunbelt, I think that gap is going to persist, and you won't see us making any announcements on making acquisitions, but you will see us ramping up our development.

Yes, makes sense. Nice healthy spread. And then maybe turning to Al, just kind of curious what's your thoughts on capital planning and the current stage of balance sheet as you head into 2022.

Yes. No. As Eric mentioned earlier, we really feel good about where the balance sheet is, and certainly, we've worked a long time to get there. I think part of the strength starts with just the outcome of the strategy that Eric was talking about. I mean it starts with a high-quality stable cash flow stream that comes from a diversified portfolio, both in terms of location and product type and all those things. But then certainly, our balance sheet today is, we have capacity to support a growing development pipeline. And we have very low cost debt and equity from the -- so it tells us that our structure is, I won't call it optimal, but it's in a pretty good place. And our metrics say that really we should be at the next credit rating. We should actually, eventually get another reduction in our cost of capital there. So we feel good about that, and we're going to focus on that a bit. But I think one of the things you saw us do earlier where we had a bond deal earlier, a couple of bond deals. That was a bond deal, $300 million 5-year, $300 million, 30-year, very good rates that show the strength and the cost -- low cost that we talked about. We also did a forward -- a very small $200 million forward equity transaction really to just -- we really like the yields you're talking about, but now 6% yields on new development. We know that we're going to increase that pipeline. We have a definite need for capital over the next couple of years, not a significant need, but because we have asset sales and we have our internal cash flow funding part of it, but the remaining equity part that we made. That's what that was about, funding out for 2 years and locking in that spread that we feel very good about. So we're positioned well both for short term, I'd say, in the long term on our balance sheet, supporting the strategy there as outlined.

Thank you, Al. I think we're now out of time. We like to wrap up these panels with 3 rapid fire questions, hoping we get some answers from you guys. So the first is, which of the following is the greatest challenge facing U.S. public REIT today? A, Fed action and higher rates; b, supply chain issues, which include labor and logistics; or c, flows to nontraded REITs.

My guess is that a rise in interest rates will cost some capital to rethink of how they value some of the REITs a little bit, but that's probably the biggest one I would look to.

Okay. And I think I might know the answer to this one for you guys, but over the next 5 years, which markets will outperform? Urban, coastal or Sunbelt?

I'm going to go Sunbelt on that.

And then for the final question. For your company's office plans post pandemic, will you, one, have no change from pre pandemic; two, leave it up to the teams; three, offer hybrid; or four, go full remote?

Well, we've been fully back in the office as June of last year. So I would say, we're back to normal, frankly, have been fully on top.

Right. Well, Eric, Al, Tim, really appreciate your time. And yes, we'll leave it there. Thank you.

Thank you.

Thanks a lot.

Thank you.