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

Welcome, everyone, to the 9:15 a.m. session at Citi's 2023 Global Property Steel Conference. I'm Eric Wolfe and I'm here with Nick Joseph with Citi Research, and we're pleased to have with us Mid-America Apartment Communities and CEO, Eric Bolton. This session is for Citi clients only. If media or other individuals on the line, please disconnect now. Disclosures available on the webcast and at the AV desk. And as a reminder, the questions that all ask today are not the opinions of Citi or myself and are being asked for information purposes only. For those in the room or on the webcast, you can sign on to liveqa.com and enter code GPC23 to submit any questions if you do not want to raise your hand. Eric, I'll leave it to you to introduce your management team, give some opening remarks, and then we'll go into Q&A.

Okay. Thanks, Eric. With me today to my immediate left here is Brad Hill, our Chief Investment Officer; Al Campbell, our Chief Financial Officer; Tim Argo, Executive President of our Strategy and Asset Management and then coming here is Andrew Schaeffer, our Treasurer and Capital Markets Investor Relations. So with that, I'll turn it back to you, Eric, for questions or whatever.

Perfect. more to ask about. So we've been starting out each session with the same question, which is what are the top 3 reasons to buy your stock today?

Well, I think it starts with really -- we believe we have a REIT platform that's really positioned for full cycle outperformance that has shown an ability to be particularly strong on a relative basis during periods of economic uncertainty or worrisome times. And this is really due to a uniquely diversified portfolio focus on the high-growth Sunbelt markets, a diversified product portfolio, a rent price point for the portfolio that appeals to the broadest segment of the rental market. And finally, a very strong balance sheet, which has the lowest leverage in the sectors, monitored and rated by all 3 rating agencies. Secondly, I'd point to really the exciting introduction that we've been making last year and continue this year of a lot of new technologies to our platform that I think is going to really transform in many ways how we execute business on site at our various properties that I think is going to lead to more effective services for our residents is going to support a more effective and efficient execution of all the activities that we perform on site. And ultimately, we think lead to some pretty meaningful margin expansion over the next 2 or 3 years. And then thirdly, I would point to our external growth strategy that is poised to deliver some pretty meaningful earnings growth over the next 2 or 3 years. So asking anything that we've done historically as a public REIT over the last now over 29 years. And all this external growth supported, as I mentioned, by a very strong balance sheet.

Great. So maybe we start with the margin expansion opportunity. Could you just sort of tell us what are the specific things that you're focused on and everyone loves numbers. So if there's any way to sort of quantify sort of where margins are today and where you think you can go over time?

Tim, do you want to run that please?

So I think with us, we priced it probably a little bit differently than some of the others, we think back starting to 2020, we kind of looked at some of the revenue opportunities we had on the technology side and then specifically tied to the Smart Home technology. So as we sit here today, we've rolled out over 80,000 units on our Smart Home platform, getting about a $25 rent increase for each one of those. And what that does is gives the residents automated control of their lights, their locks, thermostat and has some leak detection functions as well. So as we finish the rollout of that this year and get into kind of mid-2024, there's about $25 million to $3 million of NOI that will be embedded into our NOI stream related just to that Smart Home platform. That's about well over 100 basis points of margin opportunity that we started getting kind of in 2020 and will continue into 2024. As we sit here now, we're also focused on -- we put in a new CRM system during last year, which gives us a lot more visibility into multiple properties, and we can have 1 property manager managing multiple sites and have the visibility into properties across the market. So we've started to roll that out this year. We have about 15 of those we're calling pods in place right now. We expect to continue to roll that out. That particular initiative is probably $5 million to $10 million, we call it 30, 40 basis points of margin expansion as we roll that out. So over the next three years, I would say we had a couple of hundred basis points of margin expansion. But those 2 things, we're continuing to do some things on the AI and chat technology that's driving more and better leads, which creates -- that's more on the revenue side, demand side, creating more right leads, if you will, but also has some time saving impact to it as well. And so when you factor that, some things we're doing on self-touring, some things we're doing to centralize some of the more less -- or the less value-add tasks that we're doing on site all of that together, we think, like I said, kind of a couple of hundred basis points over the next 3 years or so.

And you just gave guidance, and I think it's pretty consistent across the board, if you look at all of the residential companies, not just within your space but outside and SFR, MH, expense growth across the board is pretty high. I guess as we're updating our models and we're thinking about what 2024 could look like, is there a reason to believe that some of these expenses should start normalizing by the end of this year? Or do you think we're just going to be in sort of structurally higher expense environment for some time, and that's kind of the expectation we should have at least for the next, call it, 1 to 2 years?

Well, I mean, I would suggest that we think this year is probably a high watermark in a lot of ways on the expense side. Our biggest line item of course, is real estate taxes. And as I think everyone knows, that's a backward-looking game. A lot of the tax bills coming due in 2023 are a function of value assessments performed in 2022. So I think as we are transitioning to sort of a different pricing environment, I think that suggests to us, at least, that taxes in 2024 are likely to look a little better than they did in 2023. We think '23 may be slightly below '22. But we are optimistic as we get into next year that we start to see some relief in that regard. Beyond that, a lot of the inflationary pressures that we saw with materials and repair and maintenance expenses as well as in the labor front. A lot of those pressures were really evident in the early part of 2022. And we think that as we get into the back half of 2023, that we start again to see some relief on a year-over-year basis in that regard. And then some of the things that Tim has just mentioned with some of our staffing model changes that we're working through. We'll be implementing some of that this year more in 2024 that will continue, we think, to have some benefits to our labor cost line, which is obviously another big expense that we have. A lot of questions yesterday in our meetings about insurance costs and we -- the way our program is structured, we renew our policy effective July 1 each year. So the first 6 months of this year is really the renewal that we put in place last year, which is about running about 13% higher than it was previously. We've dialed into our expectations this year for a 20% increase in July 1 on that line item. That line item constitutes about 4% of our expense structure. So it's not a particularly impactful line item. But that's probably the one area of our expense component of the P&L that we think is unlikely to see any relief over the next year or so but more to come on that. But yes, we do think that this year becomes sort of a high watermark on expenses.

That's helpful. And sticking with operations, you put out your update for February looks like 4.2% blended growth. But obviously, you should have, at this point, I think, reasonably good visibility into March and April just based on where you're signing leases today. So could you just give us a sense for how March and April are shaping up? And then you guys you think beyond sort of the next 2 months, sort of what are the forward demand indicators telling me about how the overall peak leasing season could end up?

Yes. So for those who have the presentation, Page 11, we updated some of the pricing and occupancy stats and on the renewal side, saw 8.7% in January, 8.8% in February. And from what we're getting in March and April, it's right in line kind of in that 8% range for those 2 months, and that's what we've actually gotten accepted or signed, if you will. And we expected, particularly with the way pricing went last year, where new lease pricing overtook renewal pricing that we would have some pretty good tailwind on renewals for the first 6, 7 months of this year. So it's kind of do what we expected, where renewals have been really strong. And then we're starting to see new leases slowly sort of accelerate. So I think as we get into the spring and summer, we'll see new leases start to pick up, renewals probably moderate a little bit just from a comparison standpoint, probably back to that 7% range is what I would expect and then have some of the new leases taken on a little more of the acceleration as we get into spring summer. But so far, I would say pretty much everything is kind of going in line with what we expected kind of a return to normal seasonality, though, I mean, this January, February, even with new lease pricing slightly negative, is still better than outside of 2022, better than any new lease pricing we've seen in this time of the year for really as long as we've been tracking it.

The other thing I'd point to is one of the things that we really track is what we refer to as exposure, which is a combination of the vacancy we currently have, coupled with the notices to move out that we have in hand. And it's -- I'm comforted by the fact that our exposure at this point in the year is lower than the exposure at this point last year. So we think that we're well positioned as we head into the spring and summer. And it's obviously the important part of the year for us from a leasing perspective. We have much -- many more of our leases set to expire in the second and third quarter of the year as opposed to the first quarter. So more to come, but we think we're about as well positioned now as we could be.

And then in terms of markets, we got some questions from the audience. First question is, besides Austin, what other markets are you concerned about supply in both 2023 and 2024? Do you feel the demand is strong enough to surpass supply?

We'll be on Austin. We're keeping an eye on Phoenix, Charlotte, a little bit as well as Nashville. But I think that historically, for us, we've always sort of built our strategy around the idea that we wanted to be invested where we expect the demand to remain more resilient and stronger over the course of a full economic cycle. And recognizing that in return, we have to be willing to incur a few quarters from time to time of supply pressure which can create some degree of moderation. But certainly, historically, the demand for particularly the last 2 or 3 years has been just incredibly strong. And market that we saw, particularly heavy levels of new supply last year, for example, in Austin, also happen to be one of the strongest rent growth markets that we had last year. So I think from a demand side, as we think about what things look like heading into the spring and summer, I'm still very confident that we will -- while things have moderated a little bit as a function of some of the supply that the demand dynamics are still very firmly in place, particularly in the Sunbelt markets. We're continuing to see job growth. We're continuing to see wage growth. We're continuing to see migration trends to the Sunbelt markets. And importantly, we also continue to see very low turnover. The ability for our resident to go out and purchase a home is still very tough and move outs to buying a home are down significantly. So as we think about the tailwind from that home buying challenge, coupled with what we are seeing in the sunbelt markets as continued steady employment trends. We're pretty comforted by what we think will be healthy demand over the course of the summer. Really the only sector that we've seen news of layoffs is really in the tech area and the 2 markets are probably are more at risk in that regard and our portfolio would be Austin and Raleigh, to some degree. But on the ground, we've not seen any evidence of people coming in and saying, "Look, I've just been laid off or I lost my job, and I've got to move. I've got to get out of the lease." We're not seeing that at this point and continue to also have a lot of confidence in the pretty diversified employment base that we have across the Sunbelt markets service-related industries continue to see strong job growth, manufacturing, a lot of the other industries that really drive job growth in this region continue to hold up quite well.

You mentioned the kind of the shifts in population that have really been a benefit over the past few years, probably accelerated by COVID. Are you seeing any changes to that, either the rate of kind of traffic coming in from out of state or anything else from a population growth perspective relative to the past few years?

Nick, it's still running higher than it has historically pre-COVID. I mean pre-COVID as you look at the leases that we were writing for people coming into the Sun Belt markets from outside of the Sun Belt. It constituted somewhere around 8% to 9% of the leases that we were writing during the sort of the peak of COVID, it jumped to not a lot to about 14% of the leases that we were writing. Today, it's running around 12% of the leases that we are writing. So I think that the migration trends to the Sun Belt markets have always been there to some degree, COVID accelerated it and certainly, I think one of the things that we got out of COVID, a couple of things. One is just I think there's a healthier appreciation for living in some of these Sun Belt markets perhaps than there had been before. And then, of course, I think we've all discovered a little bit more flexibility in terms of where we live and where our employer is based. And I think that is going to continue to support these trends. My guess is we don't go back to 8% to 9% of the leases, maybe we hang out at 10% to 12% for a while. But we haven't seen any sort of giant reversal back that would suggest that all that happened over the last 2, 3 years is somehow going to become undone. We're just not seeing that at all.

That's helpful. And how about the reverse, right? You track where residents are moving out to, you know how many are moving out to buy homes. Are you seeing trends pick up of people leaving the states at all?

No, about -- when we look at the move outs, about 4% to 5% of the residents that leave us or turnover are people moving back to cities outside of the Sun Belt. And that 4% to 5% has been fairly consistent for -- since we've been tracking the data, frankly. So I haven't really -- we didn't see a lot of change in that regard, certainly during COVID, and we haven't seen a lot of change in that regard post-COVID.

So one of the most, I think, common questions and comments that Nick and others have heard is simply that when they look at the Sun Belt markets, they like where the demand is today, but they're concerned that if you look at sort of the cadence of supply that there's going to be this wave of supply that hits later this year and into next year, at the same time that the job market starts slowing. So I guess who knows what the job market is going to do, but maybe you speak to the cadence of supply sort of when you think sort of the deliveries will peak in your market, if that's later this year or early next year. And then on the reverse, if you think that they're going to come down materially simply because of where capital costs have gone for developers, land costs, construction costs.

Well, I'll start with the fact that I've heard about supply concerns for 30 years. And we've been in this region in these markets forever. And I've always said, I've never really been worried about supply pressure. What really would keep me up at night and what I worry about more than anything is the demand side of the business. And I think that moderation can occur as a function of supply in a given market, but disruption on the demand side of the equation is where things can really get ugly. And so we think that we're -- for that reason, we've always focused our capital on these Sun Belt markets. I do think that, clearly, the statistics and the starts and so forth out there suggest that we're going to see more deliveries this year as compared to 2022. The last -- but it's not as significant as you might think. The last 2 years or so, we've seen particularly last year, we saw deliveries coming into our markets as a percent of existing stock somewhere in the 3% to 3.5% range overall. That will be up a little bit this year. And of course, it varies a good bit by market, as we talked about earlier, Phoenix, Austin, Charlotte, Nashville or some markets we're keeping an eye on. But all the information that we see and talking -- Brad, talking to developers and others suggest to us that permitting has absolutely come to a screeching halt. And with the rise of construction costs that took place over the past year or so. We really think that we're going to see sort of a peak from a supply perspective, probably late this year, first half of next year time frame. I do think as we get towards the back half of '24, we'd probably begin to see a little relief in that regard. And certainly, as we get into '25 and '26 we think we're poised to see some significant pullback in supply dynamics. Underwriting, what's likely to happen in terms of the broader economy and the employment market, it's hard to say. And I just would point to the fact that we think that on a relative or comparative basis to some of the other regions of the country that is more likely than not that the Sun Belt markets continue to capture more stability at least. I don't know to what degree job growth continues in an accelerated fashion. If we find ourselves in a weaker economy or slip into a recession, but I do think that these Sun Belt markets have demonstrated a resiliency to the demand side of the business on a comparative basis to some of the other regions of the country. So while we may see the balance between demand or demand and supply moderate a bit over the next, call it, 6 to 7 quarters. We do think that we'll probably hang in there pretty well. and feel pretty good about our ability to continue to deliver results compare favorably within the sector. And then as we get into '25 and '26, we're very bullish.

One point I might add that I think is somewhat of a mitigating factor is looking across all markets, the new development coming in is about 20% or so higher than what our rents are. Our average rent is about $1,650 or so across the portfolio. So quite a bit higher in what's coming in. So I think that creates a little bit of mitigation as well.

And that really gets back to the full cycle performance profile that I started our comments with. We have a unique approach, not only do we have a more affordable price point, which I think provides some ability to mitigate some supply pressure from time to time. But we have a very broad diversification across this region. And while we have exposure to a number of the larger cities, we also have significant exposure to some of the secondary markets across the region, places like Jacksonville, Charleston, Greenville, South Carolina. Savannah. And we find that these markets don't tend to get quite as supplied. They're not quite as volatile and it brings a little bit more of a stabilizing influence into the performance of the portfolio when we find ourselves in a period of higher deliveries.

How do you think about the redevelopment opportunity coming off of that higher price point of supply?

It's fueling a lot of redevelopment opportunity for us. We've been focused on unit interior renovations for the past several years, running anywhere from 7,000 to 8,000 units that we'll renovate each year, and we'll obviously do that again this year. And as Tim alluded to, with that gap on average of a 20% difference between rents coming in with new supply relative to where we are it really creates the opportunity to do the repositioning or do the redevelopment, capture meaningful accretive returns on that use of capital, but still offer the rental market a price point that is at a discount to new supply. And in particular, we got a lot of that opportunity enhanced or embedded in the portfolio through the acquisition we made a little over 5 years ago post properties, which is in some superior locations, but the product had some age on it that we've been able to address and I think is going to create some continue to create some good organic or internal earnings growth opportunity for us.

Those rent bumps that you get when you reposition, do they normally hold? I'm just curious whether the rent bumps over time reflect the longer-term IRR that you can expect? Or is that at some point, you need to actually just kind of redo the same thing over and over such that the IRR gets compressed a bit.

Yes, we underwrite it on a leveraged basis, kind of 10%, 11% IRR, and that's really giving really no terminal value kind of a 7- to 8-year run. I mean -- but what we've seen is typically they hold up and then perhaps there's an opportunity, as you mentioned, to do it again. 8 or 10 years as case change or designs change in the neighborhoods are strong. So like Eric said, I mean, we've been doing it at some level for probably 15 years or more and we still have 15,000 units we've identified or so right now that we think we can do that. That tends to be somewhat evergreen, we'll do, call it, 6,000 or 7,000 this year. and we'll start looking at additional opportunities. And typically, we can find some pretty good opportunities to continue that going forward. And the way we do it, we do it on turns and measure against non-renovated unit helps us ensure that we are getting that rent increase that we intended. And if we're not, we can halt it or stop it or change it up.

Eric, you mentioned that your contacts had told you that the permits have come to a screeching halt. We're not seeing any distress yet, but maybe that's finally as maybe a first sign of some stress happening cap rates are widening. So I guess my question is a number of your peers and others in the private side have been looking more like mezz lending, structured investment opportunities. Is that something that sort of interests you in this environment, maybe just not only for the return that you get, but also potentially to get your hands on some high-quality assets that are either in lease-up or under development right now?

No. It doesn't. I have long believed that in an effort to sort of meet our obligations as a REIT that one of the things that sort of founding principles that we have to protect is a high-quality earnings stream. And I have long avoided any sort of investment opportunities that have sort of a short-term element to it. And anything that is structured as mezz financing or any sort of joint venture structures that we've ever entertained it was absolutely essential that we have a clear pathway to definitive ownership of the asset when that relationship ended. And so I think that introduction of nonrecurring revenue streams into our profile is something that we don't really endorse doing -- we do have, like many of our peers, we do have a merchant builder program, if you will, we call it essentially a prepurchase program where essentially we will structure a JV with merchant builders in the region, and we will bring the capital to them. They have a land site or they have some opportunity tied up and we bring the capital, they build it. Sometimes they lease it up. Sometimes we lease it up. but it's with a clear understanding that upon lease-up and upon stabilization, they leave, and we own it. And we've had that program in place now for several years that Brad manages. And again, it provides a mechanism for -- I mean as we're investing money through the development in a JV structure, we know we will own the asset. And we've got the recurring revenue stream that will come from that. So any sort of just mezz lending with the opportunity to maybe or maybe not get the asset is not something that we're interested in doing.

And in your guidance, you have about $400 million of acquisitions, I think, at around a 3% yield. I mean that's a really specific number. So should we take from that, that you're already pretty far along with some of those opportunities, and that's why you're guiding to that? Or is that just simply a sort of a conservative placeholder at a low yield?

Yes. I mean that's just a conservative placeholder at this point. I mean, what we've -- where we found success in the acquisition market over the last 5 years has really been assets that were early on in lease-up. And so I think -- our view is, as we get later in this year, again, our ability to be successful in the acquisition market is likely going to be in lease-up properties. So a property when it gets at CO is generally about 30%, 40% leased. And so we're assuming that these assets are right out of construction, have their CEO and early in lease-up. And so that's where you're getting the 3% yield number from. But I'll tell you, the $400 million is also back-end loaded of the year just based on what we're seeing in the transaction market right now. It just takes a little time for buyers and sellers right now to see pricing through a very similar lens. And I think as we get closer to the back half of this year, there'll be more transaction volume, and we'll start to see some opportunities there. But we're very early in that. I would say we're starting to get a lot more inbound calls from developers and sellers in our markets. So it feels like we're on the early stages of that beginning, but that's all back end of the year in lease-up assets.

And I guess everyone has been talking about the live bids spread is what closes that spread, just simply that the people that you're getting calls from just don't have other capital options and they're coming up on debt that's due in 2 or 3 quarters. I guess what's changing between today versus the second quarter and third quarter that's actually going to lead to more normal transaction environment?

Well, I think it's a couple of things. I think, one, visibility that everybody is seeing that the interest rates are likely to remain higher for a longer period of time. I think what you saw at the end of last year, first part of this year is folks are just buying time trying to push off in the hopes that interest rates are coming down next year. I think what we're seeing is that's likely not the case. And so the sellers that -- for all of the projects in our region of the country, they're predominantly merchant developers where those assets do need to trade. That's the way they make their living, sell their assets, move on to the next deal. So those will need to trade at some point. The lenders are not likely to extend their loans. And so I think when visibility of the interest rate environment becomes a bit clearer, which I think it is now, the realization that interest rates are not coming down begins to hit. And so I think the visibility into pricing and cap rates occurs more transaction volume. And until we get more volume, your 1031 buyers, your loan assumptions are really what's driving the market right now. So we need more volume to really get visibility there.

Got you. And I guess on the flip side and dispositions, I know you've been asked this question before, Eric, but just in terms of the DC portfolio, you're still holding on to numbers from the post properties exposure there. At what point does it make sense just to kind of lower that just get rid of it and just say, purely focused on the Sun Belt? Or do you actually like the little bit of balance that it provides.

I'm sorry, you were asking about D.C.?

Yes. Okay. Sorry, if it's not clear.

No. My wife tells me I'm hard of hearing because I am. But I would say that really most of what we have in that area, frankly, is predominantly more Northern Virginia. We have -- we only have one property actually in the D.C. market per se. We've got -- we sold one up in the Maryland market, submarket last year. We'll sell another one this year. So I think that basically, what we're left with is some exposure to suburban Northern Virginia, and we like that. And so my guess is we'll probably hang on to that for a while. We've done some repositioning of those properties that is working out quite well. So no immediate needs to do anything with the residual we have up there at the moment.

So there's no investor questions. We've been asking in each session, top ESG priority this year?

Andrew, do you want to?

Yes, I'll take that. As we recently reported, MAA achieved a 22% reduction in energy use it production 31% reduction in greenhouse gas emissions intensity from our 2018 baseline, meeting our goals 7 years before our original 2028 target. So in 2023, we'll be establishing new targets on both energy use and GHG emissions.

Great. And since we actually have a few more minutes, then I ask one on top of that. And what's the technology that you're most excited about, Eric, if you think about the sort of ability to change your business to sort of redefine how it works, what could surprise people say 5 years now when they look at the apartment business versus how it's run today?

Well, I think that the CRM program that Tim alluded to, which stands for customer relationship management program is really and an opportunity to, I think, not only be more effective and more efficient in our leasing operation, but it's what also gives us the capability to -- for an individual sitting, frankly, in front of the computer anywhere to work with the leasing prospects anywhere. And I think that -- and then also some other things that we're doing with AI and chat and some other technologies. We're getting better about screening the traffic such that we're only spending our energy and time on the transaction or the traffic that we think has the highest probability of conversion. And so I think the opportunities from that not only benefit ultimately some staff saving opportunity. But importantly, we think it drives, frankly, a higher level of quality traffic that leads to more leases and ultimately has some benefit on the revenue side in terms of pricing as well. As Tim alluded to, we've been very mindful of trying to think about margin expansion, not just from cutting overhead or cutting people and cutting staffing. It's as we talked about yesterday, we have a $2 billion revenue line and our operating expenses are $700 million. So what I don't want to do is -- one of the things we have to be really careful with as we get in our zeal for efficiencies and cutting something on that $700 million of expenses. I don't want to cut a dollar of expense and wind up losing $1 revenue along the way because our service, our product has deteriorated in some way. So I think the technology surrounding CRM allows us the opportunity to not only drive some benefits on the expense side, but I'm very mindful of the importance of also protecting quality of service, quality of product and quality of brand along the way. And I'm as interested in growing revenues as I am cutting expenses.

Really rapid, what would same-store NOI be in 2024 for your property sector?

I'm sorry, same store...

NOI in 2024 for apartments.

I would put it 6%.

What's the best real estate decision today; buy, build, sell or redevelop or hold? Best real estate decision today?

For us, it's renovate and then develop.

Right. And then will there be the same fewer or more apartment companies this time next year?

Fewer.

Thank you.