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

Welcome to the 9:45 a.m. session at Citi's 2022 Global Property CEO Conference. I'm Nick Joseph with Citi Research. We are very pleased to have with us MAA, CEO, Eric Bolton. 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 at the AV desk. For those joining us here today in-person to ask management any questions, please step up to one of the mics we have located in the center aisle of the room. If you're joining us remotely, simply type them into the question box on the screen, and they will come directly to me, and I'll do my best to ask them during the session. Eric, I'll turn it over to you to introduce the company and the management team, and then we'll get into Q&A.

Okay. Well, thank you, Nick, and I appreciate everyone being with us. Just a quick introduction with our leadership team here. To my immediate left here is Tim Argo, who runs our Strategic Planning and Analysis group; Al -- I'm sorry, Brad Hill, our Chief Investment Officer; Al Campbell, our Chief Financial Officer; and here on the front is Andrew Schaeffer, our Treasurer, who runs Capital Markets for us. I think, most of you know our company, our story, we've been in the public market, public for 28 years. Our strategy is focused on the Sun Belt, and it has been so for 28 years. So our information, there's a second page in the presentation there, the company a glance that gives you some key stats. We have a little over 300 communities, a little over 100,000 apartments. We go as far west as Denver, Salt Lake City, Phoenix, heavy throughout the Southeast in Texas, Florida, Georgia, the Carolinas and go up to Northern Virginia. And as I mentioned, our footprint has been in this area of the country for the entire time we've been publicly owned. And a little bit of a differentiation about our strategy is not only we do we have the regional focus, but we have an intentional diversification across the region with a concentration in not only the large markets, but a number of select secondary markets, believing that ultimately that, that drives not only an outperformance over a long period of time, but also take some of the volatility out of our earnings performance over a full cycle. Our strategy has long been sort of based on this principle and has served us well.

Great. We're open all the sessions with the same question. What are the top three reasons an investor should buy your stock instead of any other listed property company?

Well, I think it does start with our strategy. As you'll see in the materials there in our presentation, you look at our total shareholder return over most performance windows that you can think of. MAA is going to be well above sector average, and in most cases, frankly, the best performing apartment REIT for shareholders, particularly over longer periods of time. I think that these Sun Belt markets have recently found more favor with capital than they have years ago, and we continue to see more and more capital being drawn to the region for all the reasons you might imagine regarding job growth, demand growth, household formation, population trends, migration trends. We're capturing very strong rent growth at the moment. So I think the strategy itself would be reason number one. Reason number two, really, gets to the opportunity that we see over the next 3 or 4 years to really drive some strong earnings performance. We've got some great opportunity with further margin expansion that we'll capture over the next few years through a number of redevelopment initiatives we have as well as some technology initiatives we have that we think will deliver some pretty meaningful margin expansion, coupled with a higher level of external growth that we're executing on. And then the third reason I would point to, Nick, is just is the stability and the strength of the leadership team that we have. The executive team at MAA has an average tenure with our company of over 20 years. I've been CEO for 21 years. I've been with the company for 28 years. So a lot of stability in our leadership.

Maybe on that 28 years with the company, it's obviously a unique operating environment today. A lot of strength, a lot of kind of headwinds and tailwinds in terms of the macroeconomic economy. How are you thinking about kind of this cycle versus past cycles?

Well, it's interesting time in that -- I think that the drivers of demand for housing broadly across the Sun Belt have -- in my view, have always been pretty strong and I think have tended to -- on the demand side of the equation have tended to outperform a lot of the coastal markets over long periods of time. Those trends were there well before COVID. COVID, of course, sort of hit -- caused a number of things to sort of be looked at in a different way. The things have sort of been reset in a number of ways. More than past recovery cycles, we see the overall cost of housing becoming an increasing challenge for households. The cost of single-family housing, in particular, has gone up a good bit. And I think that, that trend is likely to persist for some time, and I think continue to drive more households to stay in the apartment rental market. And perhaps you might see in a normal recovery cycle. I think that the greater sort of flexibility that people are thinking about in terms of where they choose to work versus where they choose to live and remote working, I think, is going to continue to favor more so than in past recovery cycles, some of the demand drivers for housing across the Sun Belt. And then I will also tell you that a bit unique this time around versus past coverage cycles, the cost of delivering new supply is becoming increasingly more expensive and putting increasing challenges in front of the ability for supply and developers to react to this growing demand, securing land sites, the cost of land, securing construction labor, securing materials, the pricing of materials, all these things, just the capacity for local officials to do the necessary inspections and to do the permitting, the pipeline is full. And I think supply is going to have a hard time reacting more so than past recovery cycles. Supply is going to have a hard time keeping up with demand. And so I think that what I would characterize is different than past recovery cycles is I think the recovery period is going to persist much longer than it has historically.

You talked about the trends kind of benefiting the Sun Belt that were in place pre-COVID, and clearly accelerated with remote work and kind of the movement of different people. How much of that is a pull-forward of what you would have expected over the next few years? And how do you view the risk of kind of life going back towards pre-COVID and maybe people moving out of some of these markets?

Well, I see the risk is pretty low, frankly. I think that -- I think there's a bit of a reset going on right now. And I think that the historical perspectives on how people looked at the attractiveness, whether you're an operator or whether you're an investor, looked at the relative attractiveness between the coastal markets and the Sun Belt markets, I think there's a reset going on. I think that as people look at the overall cost of living, look at the impact of taxes, look at the -- just the quality of life and the appeal of living in these Sun Belt markets, I think that there is going to be a lot of reason to argue that a lot of the demand that was there before and that got accelerated or heightened during COVID, I think that a lot of -- I think it's reinforced people's perceptions, positive perceptions in this region. And as I think most people understand and see, we're seeing a lot of really smart capital now coming into these markets at levels that we've never seen, frankly, whether it's some of our apartment REIT peers or it's particularly private equity, has gotten extremely aggressive in buying an apartment real estate across the Sun Belt at levels that we've never seen. And these are all smart people, these are smart investors, and these are not -- and they're buying it with the intention of owning it and keeping it for a long time. So I think that there is a reset going on. I think that the disparity that perhaps has persisted in the past between sort of cap rates and perceptions of value between coastal versus Sun Belt, I think, it's been reset, and I think it's likely to persist for a long time.

How do you think about that? I mean, you mentioned kind of construction costs going up, but obviously, the demand is very much there. So how does that interplay into projected future supply?

Well, I think that certainly, we're in a window at the moment where supply levels have come down a bit from where they were last year as a consequence of a lot of permitting and starts that hit the pause button during the early days of COVID. We do think that as we get to late '23 into early '24, we -- based on permitting data, we show a little higher level of delivery than what we're currently experiencing. But supply is only a problem if there's not enough demand. And based on what we're seeing on the demand side of the equation, that ratio of demand to supply is likely to be very supportive of continued robust rent growth and continued -- as I was mentioning a moment ago, the cost development has significantly increased over the past couple of years, it shows no signs of going down. And we've got -- we've -- as I mentioned, we've been operating and investing in this region for 28 years. So I mean, we know the markets well. We understand where to focus our energy, and the pipeline that is laid out in materials there, if you're doing anything in the inner loop of any of these cities, you're pretty much going to have to tear something down and you're going to have to get the land rezoned. It's added probably a year to the delivery process from what we have seen historically. It's certainly added to the cost. And then you start to think about the suburbs and you think about pushing out. A lot of these Sun Belt markets, these suburban areas tend to be, what we refer to as satellite cities, they tend to have their own jurisdictions, their own police, fire, safety, school systems, and their resistance to adding a lot of apartments in a lot of these satellite cities is very, very strong. And so it is not getting any easier to add supply, it's getting harder. And so, I think, just that those variables, coupled with what I was referring to earlier about just permitting and the necessary staffing you have to have in these cities to do the inspections that you have to have and so forth, I think we're going to -- there's going to be a natural restriction on how big that pipeline can get. And given what we're seeing on the demand side, I still think we're going to see very healthy demand versus supply characteristics for the foreseeable future.

You put out an operating update, I think, on Friday at the end of last week: blended lease rate growth over 16% in January and February; and guidance is calling for about 8% for full year. So how are you thinking about the start of the year relative to expectations and then the trends going forward?

Well, I would tell you that the expectation -- or the trend starting out this year is pretty much in line with what we expected. Fundamentals for our business continue to be very strong and the ability to push rents continues to be very strong, and we have not seen that really change at all. As we think about the full year, there are a couple of different things going on. One is that we think the trends are going to continue to be quite strong. But what we have assumed in our guidance at this point is that we do return back to a more normal seasonal pattern, where we get to the fall and particularly into the fourth quarter and the holiday season, typically, we see leasing activity start to slow and resultingly, pricing trends start to slow. And that particularly is true as it applies to new move-in customers, new leases, if you will. Last year, we had -- for the first time in my 28 years, we did not have a seasonal slowdown. And as you see in the presentation there, I think it's on Page 13, if you look at what transpired last year on new lease pricing, you look at how that performance played out for the first 6 months of 2019 versus the last 6 months of -- I'm sorry, 2021 versus the second -- the back half of 2021, there is a huge difference there between how new lease pricing performed. So we think, at this point, based on just an expectation of a resumption of normal seasonal patterns, coupled with an expectation of -- or recognizing that we've got tougher comparisons that you'll see some moderation likely occur as it relates to new lease pricing in moderation, in terms of year-over-year performance. The rents are going to continue to move up and we think the trends are going to continue to be quite strong. But when you just look at year-over-year comparison on new lease pricing because of the comparison as well as just an assumption of seasonality performance and return to seasonal performance, we would see some moderation take place there. We think renewal pricing will stay in that kind of mid-double-digit range really through the course of the year as we complete our mark-to-market pricing, if you will. We've always tended to be pretty strong in renewal pricing. So when you blend all that together, that's where we get to, which is kind of midpoint around low double digit, and we'll see what happens over the next few months.

Are you self-governing at all on renewals or are you moving everything to market as they roll?

I mean, we're pushing renewals pretty hard. And we -- as you probably know and some of you may know, I mean, we've always had pretty strong renewal pricing, and we continue to push that agenda as hard as we can. I mean, we keep an eye on a couple of things to be sure that we're not pushing too hard, if you will. We continue to keep a close eye on being the level of rent to income in the portfolio, and there's information in the presentation there that shows that the rent-to-income ratio is still in the 22%, 23%, 24% range. It varies a little bit by market. That continues to be something we're quite comfortable with, suggesting to us that the resident profile that we continue to attract to our markets and to our communities. Good wage growth and a lot more knowledge-based jobs, a lot more technology jobs come into these markets. It continues to support the level of rent growth that we're seeing, and the rents are affordable, if you will. The other thing that we continue to monitor quite closely is how much turnover are we creating as a consequence of putting through rent increases. And if you take all of the turnover that we have, we turn over about 45% of our apartments per year. And of that 45% of the apartments that turn over, about 13% of that is occurring because residents don't want to pay the rent increase that we're asking. And we're okay with that right now because vacancy still is quite low. We've got people coming in behind them that are, in fact, willing to pay the rent. So we continue to monitor that. But at this point, there seems to be no sort of a headwind or resistance that's causing us any concern to suggest that we're about to run into some resistance on the rent growth that we are performing and targeting to achieve.

As you think about markets, are those comments kind of across the board? Are there any markets that are either outperforming or underperforming so far at least your initial expectations?

Tim, why don't you take that?

I mean, it's pretty broad-based strength. There's -- the ones we expected to be the strongest, and that's all the Florida markets. I think, out of our top 6 markets year-to-date in terms of pricing, 5 of those are Florida markets. Kind of expected that. Phoenix has been a really strong one. And it's all sort of relative. We point out in the presentation that Houston and Washington, D.C. are the ones we point to as weaker. But 6% is kind of the weakest blended lease of the lease pricing that we have so far this year. So it's all relative. And it's really a job story to the extent some are weaker. It's a little bit less job growth than others. But it's broad-based. We're at 16% year-to-date. And with 6% being the weakest, it's strength across the board.

You mentioned the operating platform. You guys have been active on the technology front and on the update or on kind of enhancing the operating platform, even beyond where it is today. How are you thinking about the opportunity kind of relative to where you've been and where multifamily has been over the past 5 to 10 years?

Well, I think that proptech is changing a lot. And when you look -- when we look at our portfolio, we are actually in the midst of rolling out new what we refer to as CRM platform. Right now, it's being implemented. It extends for customer resource management, which is essentially the tool that we use, our leasing agents use to manage leasing prospects. And it's going to drive a lot more efficiency across the portfolio and across the markets for how we manage leasing prospects. Historically, the technology was built around a property-focused sort of structure. Now with the new CRM that we're rolling out, it's really more of a customer-centric focus that we are going to have, which is going to further support our virtual leasing and our remote leasing capabilities, leasing staff at one property can handle leasing activity, particularly virtual and remote leasing at another property through this new platform. We are continuing to roll out Smart Home technology, which gives us the ability to remotely activate thermostats, lights, door locks, gates, things of that nature. We'll be eliminating probably 50 or so positions in our leasing function over the course of this year, and on track to, I'm sure, do at least that much or more next year. There are a number of things that we're doing with -- that's also outlined in the materials there relating to redevelopment, repositioning. To give you some perspective on this, I mean, we really believe that we've got an opportunity over the next couple of years to drive another 150 basis points of margin expansion -- NOI margin expansion across the portfolio. And given the scale that we're at, I mean, that would equate to $28 million of incremental new NOI. And where we're being priced now as an implied cap rate, that implies $700 million worth of value. So it's significant, and we feel pretty confident we can deliver on that over the next 2 years or so. And a lot of that is -- a lot of the technology that we've already introduced, there's some new things that we're doing with our maintenance staffing, with technology as well that we think, ultimately, then leads to an ability to start looking at headcount levels as it relates to maintenance operations as well.

So it sounds like most of those are on the expense side. Are there kind of other revenue opportunities you're looking to capture as well?

Well, one thing to keep in mind, and this is -- it's hard to sort of measure this, but with some of the new things that we're doing with virtual leasing and some of the things that we're doing with the ILS platforms to secure leasing traffic, we are driving up leasing volume. We're driving up the volume of prospective renters that are viewing our communities and coming into our communities, and our revenue management system reacts to that. Our revenue management system's algorithm looks at a number of different variables that sort of drives our pricing trends. And one of the more important variables that it looks at is how much leasing traffic are you getting. And so anything that we're doing to drive more leasing traffic, particularly when we're doing it on a more cost-efficient basis. And also, it's not going to help us on the expense side, but it's going to have a derivative impact on how our pricing system is going to continue to push rents as well. So I think that we -- that, probably as much as anything else, will be happening on the revenue side. We also have some other things that we're working on with new technologies to better manage what we refer to as rentable item space. These are parking, self-storage and other kinds of additional revenue opportunities that we feel like we can capture more aggressively with this new software on the revenue side as well.

I want to move to capital allocation, but we did have one more operational question come in. At what level of rent-to-income -- I guess, maybe where is it today? And then at what level will it -- would it worry you?

You start to get to the upper 20s, 30%, it probably starts to become more of a headwind. Most economists will tell you that a household expending or devoting more than 30% of their monthly income to housing is starting to become a stress. And obviously, you get much above that, 45%, 50% becomes a problem. So we think that, in that low to mid-20 range, we're fine. The thing that we're gratified with is, while we've been pushing rents pretty aggressively for the last couple of years, incomes are going up across the portfolio, and we're seeing wage growth move, both as a function of just normal inflation -- wage inflation that's occurring, robust job growth across the Sun Belt markets, coupled with more jobs coming and more highly paid jobs coming, all these things are fueling, I think, an ability for incomes to keep up pretty well with the rent that we're currently -- rent growth we're currently capturing.

You've done public-to-public M&A a few times in the past. We've seen a handful of M&A deals in the apartment space, I guess, over the last year. What's your appetite for growth in, I guess, either M&A or larger portfolio deals today?

We've looked at all those opportunities and really have not had an interest in trying to actively pursue it for a couple of different reasons. One is, when you look at the asset quality, frankly, in most cases, it's not really comparable to what we have today. Average age of a lot of these bigger portfolios that have traded, the average age is older than our existing portfolio, and we just did not see it being helpful or additive in terms of asset quality. Frankly, just adding a little more scale doesn't really do a lot for us. I've always approached bigger transaction opportunities with an eye towards making sure, that there was a strategic benefit derived that there was something -- that we got stronger, that we got better as a consequence of doing the transaction. Just getting bigger in and of itself, to me, has never been adequate. And then, two, if you're going to pursue the opportunity, then obviously, you've got to be able to capture it at a price that makes sense and that is value accretive. And where some of these portfolios are trading right now, in my opinion, they're paying for the value that they're going to have to create, and that doesn't make a lot of sense to me. So we haven't really had an interest in doing that. What we're able to do instead is, because of that focus that we've had on these region as long as we have, we are still finding more development opportunity, and Brad and his team are working on a number of projects that have -- detailed in the presentation materials, additional projects will start this year. We'll see our external growth pipeline approaching $1 billion, $1.2 billion by the end of this year. We think we'll stabilize all these deals in the 5.5% NOI yield range and certainly a much more accretive use of capital than anything we could capture by going out and buying something in today's environment.

And so how do you compare that 5.5% to kind of going-in cap rate in your markets?

What would you say?

Yes. I would say, going-in cap rates across the board are high 2s, low 3s. That's certainly looking at trailing 3-month financials on these assets. But on a stabilized forward-looking basis, you're year consistently at 3.25%, 3.5%. So we're able to deliver these assets still at 5.5%. The ones that are constructions ongoing right now, we're at a 6% yield. So that's a very meaningful spread to what we could do right now in the acquisition market. So we still believe that the best use of our capital right now is through development as long as we can continue to find the opportunities, which we've been able to do. We've got $700 million going right now in under construction and in lease-up. And with what we have identified this year, as Eric mentioned, we see a clear path to growing that pipeline to $1 billion, $1.2 billion, but importantly, not just to grow it but to keep it at that level. And that's really what our focus is, is to grow that pipeline so that we can do that on a consistent basis.

And how are you thinking about construction costs trending for underwriting for future deals versus the ones currently in the pipeline?

Yes, it's certainly a challenge, I mean, construction costs we're seeing certainly go up. We are very conservative in our underwritings. As you see in the packet, the deals that we look to start this year, the yields have come down a little bit to about 5.5% from those 6s that we were doing. So construction costs are having an impact. But really, what we do is if we're going to start an asset construction late this year, we do not trend the rents. So that's very conservative. When you're in a market where you're expecting 8% to 10% rent growth, by the time you get to construction start, you've got some increase in rents that's able to help you support those higher costs. So we're monitoring that situation and certainly being very conservative in our underwriting and our expectations.

How much of those construction pressures or inflationary pressures are impacting the redevelopment side of the business?

Not a lot on the redevelopment front. I mean, these are sort of different materials, different vendors, and we have not really seen any significant deterioration, nothing in the way of deteriorating our yields where we may be a little bit more apt to prepurchase some of the materials and inventories and things on site, if we are seeing a lot of redevelopment opportunity at a given location. But we haven't really run too much issue there with redevelopment.

And how are you thinking about that pipeline on the unit, kind of the interior redevelopment opportunities? And obviously, it's a pretty high return on capital. So how are you thinking about the pipeline over the next few years, particularly as rents have moved up?

Yes. I mean, we continue to go as fast as we can. I mean, as you know, we do it on time so that we can adequately and accurately really measure the return that we're getting. So we plan to do another 7,000 units or so this year, which is in line with really what we've done in the last few years, continuing to get somewhere in the 20% to 25% cash-on-cash return. And so the good thing is, we've been doing this program really at some level for 10 or 15 years. And so we've identified, I think, 14,000 or so units currently. We'll knock out probably half of that this year. But new opportunities present themselves as we go along, either with assets aging or new supply coming into a market that creates sort of a rent gap is really what we're looking for is to be able to redevelop a property, create sort of a new feeling unit, but still tuck-in under -- well under the new rents coming into the market.

One thing I'll add to what Tim said that I think it's important to keep in mind is that this redevelopment of our existing asset base, it is, in my mind, one of the best sort of earnings growth opportunities that we continue to have moving forward. And it's really an outgrowth of what's happening with supply coming into the market at much higher rent levels than our existing portfolio. And that spread between new product delivering today, in most cases, is going to be priced at rents somewhere between $2.10, $2.25 a square foot. The rent in our portfolio today averages about $1.50 a square foot. So we can go in and make the investment to upgrade the unit, effectively make it feel brand new, charge $1.60, $1.65, $1.70 a square foot, create a great return on the incremental capital we're using, but still be priced below where new product is coming into the market at. So it's a real opportunity to play that is -- we're going to continue to execute on and I think, generate a lot of value from.

What's the biggest growth opportunity that you believe the market is not giving you credit for?

I think it really is back to what I was just describing. I think that the upside opportunity we have to harvest value from the existing asset base, either through the introduction of new technologies and new efficiencies to other things that we're doing to drive top line rent growth opportunity, is going to create a lot of margin expansion from the existing asset base that, I think, is going to create a lot of value, low risk and a great return on whatever incremental capital we spend is going to be hugely accretive.

What's your number one ESG priority in 2022?

I'll let Tim answer that.

Yes, I'll take that one. I would point to on the E side or the environmental side, we recently hired our first Director of Corporate Sustainability. And one of his big focuses for this year is to continue to gather data and gather information and put ourselves that by the end of this year, we can commit to a framework for net-zero emissions, likely end up being the science-based target. But that's what we're looking at right now.

10 seconds for rapid fire. Same-store NOI growth for the apartment sector in 2023?

7% to 8%.

10-year U.S. Treasury yield a year from now?

Hard to not to see it 50 basis points or so higher than we are.

And then finally, will the apartment sector have more or fewer public companies a year from now?

Fewer.

Great. Thank you very much.

You bet.