The RMR Group Inc. (RMR) Earnings Call Transcript & Summary

[Audio Gap] retail broker-dealers and the exchanges for Citigroup and underneath the asset managers. So I bifurcate that between the traditional asset managers and some of the alternative managers. And today, I'm pleased to have The RMR Group with us, which we sort of put into our alternative space, which is a sort of a real estate investment -- external manager for real estate investment trust. With us today is Adam Portnoy, who is President and CEO; Matt Jordan, CFO and Treasurer; and Michael Kodesch, who's Director of IR. So first of all, thank you very much for coming to the conference today and spending some time with us. I appreciate it, and welcome. And again, I have a lot of questions here. But if anyone in the audience would like to ask a question, just hit the mic and we'll get it to you. And then when you guys speak, just hit that gray button.

So first off, welcome. Thank you for coming. Just given, as we've sort of discussed before even my own coverage, the name doesn't come quite as much as some of your peers like a Blackstone or a KKR, but I think that's the opportunity as well. Can you maybe spend just a couple moments just big-picture down, a brief overview for investors as sort of what RMR is?

Sure. And thank you for having us. RMR, we are an alternative asset management company. We have about over $32 billion of AUM, almost all of it focused on commercial real estate. We've been in business since 1986. And if you look at our AUM, about 90% of it is managed -- is held through managing 4 publicly traded real estate investment trusts that are traded on the NASDAQ. Those REITs are SVC or Service Properties Trust; ILPT or Industrial Logistics Properties Trust; DHC, which is Diversified Healthcare Trust; and Office Properties Income Trust, or OPI. Those 4 REITs make up 90% of our AUM, 90% of our revenues at the company. We went public about just over 3 years ago, and we did a secondary offering last summer. The company itself has got a float of about -- less than half the shares are publicly available for float. The other half or just over half I own myself. The company -- when you look through it at all as a manager of real estate, folks in the real estate space would probably think of us as a core manager of real estate or core real estate. We touch pretty much every sector of real estate. The only sector we don't have a major foothold in is multifamily or residential. But we touch all other types of real estate: office, industrial, health care, hotels, even specialized, within office, medical office buildings, life science buildings, and as well as retail. When we touch retail, we don't own, let's say, malls or strip centers. We typically own more single-tenant net lease retail, think of fast-food restaurants, casual dining restaurants, repair bays for cars. Those are type of retail that we own. Historically, we've been very focused on managing those 4 equity REITs, which provide a very stable source of income from us. But in the last 6 months and certainly into 2020, we're very focused on trying to diversify our revenue base, grow AUM away from just those 4 public vehicles. And that's been very much of our focus here at the company for the last year. So I think that's a good overview of the business as it stands today.

Great. That's very helpful. So maybe to sort of tie into some of the big-picture down, some of the things you're doing. So on the fourth quarter call, you spent a lot of time talking about 2020 might be more a year about execution to now the valuation gap on these 4 flagship REITs that you do manage to help bolster revenue. So maybe a 2-part question. Can you provide an update on these initiatives to reposition the REITs to maybe level set where you are, the remaining time lines? And then, secondarily, where do you sort of see the sort of tier, the opportunity set of where you might see the greatest inflection of the 4 REITs that would be helpful?

Sure. So just to provide a little bit of context, over the last 1.5 years, there's been a lot of restructuring that's gone on down at the managed REITs -- at the 4 equity REITs. And there's been some merger activity at those REITs. There's been some dispositions, acquisitions. Disposition is really focused on trying to get leverage in check. Just all 4 REITs have had sort of a lot going on in them. And I could go into detail on each one, but to keep it at a very high level, essentially, the company that's come sort of out of the restructuring first is our office REIT, OPI, Office Properties Income Trust. And really starting the third quarter of 2019, we really put the repositioning effort behind us. And the good news is the stock has responded very well to that repositioning and getting that behind us. So that's probably the company that's the furthest along in terms of its repositioning. Next would probably be our industrial REIT, ILPT or Industrial Logistics Properties Trust. The update from the fourth quarter call, we talked a lot about forming a joint venture with some foreign private capital to try to make investments alongside that REIT in some industrial buildings. Just late last week, we announced that company closed on a joint venture with an Asian sovereign wealth fund for 12 properties, $680 million joint venture. They took a 39% interest in the JV. So that's -- I think that's a very much a positive for ILPT, and I think that's going to be seen as a catalyst in the stock price. Next is Service Properties Trust, which is our largest vehicle. It's over $12 billion of AUM. It's focused on net lease hotels as well as retail investing. That company is probably the furthest along in terms of repositioning. It's not so much repositioning there as much as it's entered a new space just in the last couple of years, where it has been in the net lease retail space for some time, but made a $2.5 billion acquisition in that space last year. And there was a little bit of dispositions that had to be done on the tail end of that acquisition. And we're more than halfway through with $800 million worth of dispositions there. And so I feel pretty good that we're well on the way to completing that, and that will be done within months or weeks. And the company has probably got the most runway still in front of it to sort of get behind the repositioning or finish up the repositioning is our health care REIT, DHC, Diversified Healthcare Trust. It's probably got another 6 months of activities where it still got to dispose of about $700 million or $800 million of properties. They're well on the way -- they've announced that they are very far along in that process. But I think it's going to take us until mid-2020 until we see the fruits of that.

Okay. And just a couple follow-ups to that. Just one just technical one. And I know we -- Matt, we spoke about this one. I just want to make sure my understanding is correct. As you dispose of these assets, does this impact your fee-paying AUM in any way? Or conversely, is there a revenue offset -- an accelerant that might offset any lower AUM levels?

The short answer is no, but I'm going to let Matt take the floor and talk through about the way we get our fee-paying AUM. In fact, selling those assets -- it's going to sound counterintuitive. Our fees can actually go up. But I'll let Matt explain it.

Yes. So the other thing that makes us unique at a high level when we think about RMR is our contracts. We have 20-year evergreen relationships with our REITs, the 4 big-equity REITs Adam's talked about. So every December 31, you add the 20th year back on. And the way those -- the way our business management contracts work, especially the base fee arrangement, is we're paid 50 basis points on the lower of enterprise value or invested capital, and invested capital being the price we paid for an asset, which is -- internally we use the word and in our public filings, gross AUM, and then fee-paying AUM being what we actually calculate our revenues off of. So to get back to Bill, so you have a very durable cash flow stream that underlies our relationships with these REITs. And another -- I guess before I get into answering Bill's question directly, the other point we'd probably make is a number of the asset managers are dealing with fee compression these days. Our fees at 50 basis points are locked for the duration and cannot be revisited without revisiting the whole contract as a whole. But back to Bill's specific question. So theoretically, when a REIT disposes of assets, especially a REIT that's paying us on an enterprise value, which 3 of the 4 are, especially the ones going through the repositioning Adam's highlighted, theoretically, they're going to sell that asset, use that money to pay down debt. And yes, our fee-paying AUM will decline. But what we've seen, especially at Office Properties Income Trust, which is the furthest along is that with the execution of that repositioning and the paydown of debt and getting leverage levels back to where the rating agencies would deem ideal levels, we've seen share price improvement. And just to give people a sense from -- since September through last Friday, before the events of the last couple of days in the market anyway, OPI had seen a 15% share price increase. So we had more than offset the impact of paying down debt as it relates to our enterprise value by share price appreciation. So we're hoping we'll see that trend continue as the market sees us execute and that will play itself out at DHC as well.

Okay, great. So maybe we could shift to the JV and talk a little bit about that. So just a couple of questions. Maybe you could sort of frame out exactly what the purview of the JV is, and how do the economics might flow through to RMR. And then I have a follow-up question to that.

Sure. The JV is pretty simple as it stands today in the sense that it's a JV down at the REIT itself. And so the ILPT, public trade REIT that we manage, put 12 properties into a venture, installed a 39% interest in that venture towards Asian sovereign wealth fund. The fees paid to RMR, because the vehicle is still majority-owned by the REIT, are unchanged because it's still covered by the ILPT's contract with RMR. But we think this is sort of an interesting purview or precursor to doing more with some sovereign wealth funds, where we can maybe parlay something like this into a separate managed account. And so that's what we've been talking about how we're very keen to do these JVs down at the REITs because we think that's the first step, establish a relationship there and build off that to then do maybe a separate managed account, where there the fees would be incremental to RMR at that point. Today, with the JV, there's no change in the fees paid to RMR. It's 100% neutral or indifferent. But we think it has sort of intangible benefits that we could -- it could be the first step in sort of locking in other separate managed accounts to earn incremental additional fees.

Just excuse me and I have to tell you this question. Could you sort of walk me through the mechanics of this JV? Because first, it seemed -- I appreciate the -- this isn't the sort of the phasing, the -- so the early stage, maybe you set the managed accounts to be incremental to RMR, but just a notion that sort of a push to economically remove some of the punch to what you mentioned. But can you maybe just help me better appreciate what this JV will do from an operational perspective that could then allow you to say, "Hey, look, we did this, now let's go scale it up to other separate managed accounts?"

Right. So in the real estate space, the most -- there's probably -- the 2 most sought-after real estate sectors are in commercial real estate or industrial and multifamily. They're both dealing with secular trends that are really changing. What's -- the demise of retail has really been the boom for industrial. And we -- and so there's a lot of capital -- foreign capital, especially, and domestic capital. Especially private capital, is very focused on trying to buy more industrial real estate. And if you look at most folks that have an allocation to commercial real estate in their portfolio, universally, they're almost all underallocated to industrial. It's really been the last couple years that folks have become much more enthused about trying to add industrial. The big food groups have historically been office, multifamily, maybe a little bit of retail and then maybe hotels. That's been sort of the big 4 food groups. Health care has almost been a secondary food group in that sense. And so we're very -- the way the JV works now is pretty simple. They have a 39% interest. We can continue to add properties to the JV going forward. And from ILPT's perspective, it's another way to effectively raise capital at ILPT, maybe to better and lower cost of equity down at the asset level rather than at the entity level for ILPT. And that's how we can maybe get more AUM at ILPT going forward, which will flow through to RMR. If we're successful doing that, we have had discussions -- and ILPT's talked about this publicly on their earnings call as well just last week. We've had discussions with some additional parties that could come into that JV and take in other significant interest. Let's say, for example, another sovereign wealth would come in for another 39% interest. So then all of a sudden, you have 2 sovereign wealths in for 39%. ILPTs at that point becomes a minority holder, 22%, just an LP. At that point, the fees flow directly to RMR, if we were to do something like that. And the whole purpose of a vehicle like that is it -- think of it as like a structured JV or a separate account with 2 investors or 3 investors, and you just basically try to grow it from that point. And again, it's in an asset class that a lot of investors are very -- they're seeking it. They want to invest in industrial.

Okay. And maybe just to belabor the question one more time. Just following asset managers, JVs have had sort of bit of a mixed track record overall. How do you think about governance of some of the operational risks associated with that? How would you -- I get the economic waterfall of 20-some-odd percent to -- or more. But how do you manage the properties? How you think about growth? And who manages that sort of that governance overlay?

So at the property level, one of the things RMR brings to the table is we're over $32 billion of assets. We got about 600 people in 35 offices all over the country. We manage -- we property manage, we asset manage all of the property that are managed out of RMR. The way this JV is being structured, most sovereign wealth funds are very focused on having not control -- not all, but many are focused on not having control of the asset because it can put at jeopardy their tax status. And so that's why we're talking about partners that have minority stakes in the structure itself. They're very comfortable ceding control to RMR to, let's say, be the GP and make all the decisions regarding the property, other than major decisions like whether to sell basically.

Very helpful. Okay. Just in sort of being -- having covered the stock for a little while now and so the debates that we get into with clients are sort of twofold. One is just sort of the value proposition of external versus internal manager, and then, secondly, just in terms of -- and you mentioned earlier in your description of the company, the high inside ownership and sort of the waterfall economics, if you will. Could you sort of address maybe the corporate governance angle to the stock a little bit just in terms of, A, where do you see the value proposition for an external manager versus internal, and then, secondly, how the economics sort of flow through to the shareholders?

Sure. So it is true that for equity REITS, and that's REITs that own direct investments in property, being externally managed and being publicly traded is -- were unusual. There's not a lot of us anymore. I will point out for those who don't know, up until the early '90s, all REITs were externally managed. You couldn't get a revenue ruling to be internally managed. And I also want to point out, if you're a mortgage REIT or BDC or closed-end fund and you're publicly traded, they're all externally managed. It's really just when the equity -- or you're MLP, for example, they're all externally managed. The vast majority of them are externally managed. It's really just in the equity REIT space where we play that the market has tended to become more internally managed. That all being said, several years ago, we made some significant changes to our management contracts, and Matt alluded to it earlier, the way we get paid. We are highly aligned to the shareholders of the REITS. Meaning, if we do -- if we buy a property and the investors think it's a bad deal and we overpaid and the stock price goes down, we get less fees. Conversely, we could sell property because we're trying to rightsize the ship, as Matt talked about. Stock price goes up. We get more fees. We're highly aligned with the shareholders of the REITs because of the way we've structured our management contracts with the REITS. And that's really a result of about 4 or 5 years ago we restructured them. Unfortunately, there's a lot of -- I believe, there's a lot of misinformation in the marketplace because they used to be structured very differently. It was just 50 basis points on historical gross investments in assets. So you can make the argument, it didn't matter what the stock price did. If we bought a property and put it in the REIT, we could just keep issuing dilutive equity. It didn't matter. We got more fees. After talking with shareholders and many of our largest shareholders at the REITs, about 5 years ago we restructured those agreements based on the feedback we got from them. So I actually think -- and unfortunately, we spent a lot of time down at the REITs talking about this because we're trying to get this information out there. There's a lot of stigma and leftover beliefs about how these external management -- external vehicles operate. We're actually highly incentivized to get the stock price up rather than just grow AUM, highly incentivized. We can make more money today just getting the stock prices up rather than buying properties at the REITs. Now with regards to my inside ownership, again -- I think, again, it's alignments of interest. The economics -- it flows through. It's about 52% myself and about 48% -- 48.5% public float. The economics -- there's no preferential -- other than I will point out, and you've asked, on governance, I do have super voting rights on the shares, but I have about 52% economic, and I have a 10:1 voting rights. So I have about 92% of the vote.

Just on that, we just hosted a panel on ESG and just covering a lot of your peers in the alternative space that have shifted from PTP structures to C-Corps, just that ease of ownership. Does the super voting rights come up at all as a gating factor for capital raising or other investors you're speaking with?

No. But I think it's because it's 52% economic rights, I think that's why. So if I didn't have the super voting rights, I'd still have majority. So I think that's why it doesn't come up, to be very honest with you. And there's no plan to take my interest down, let's say. I will say on the ESG front, we are very focused on that. As a real estate company, the E is probably the most important that investors are focused on, the environmental. They are -- yes, the S and the G, social and the governance as well. But the E, given we run real estate, there's a lot of CO2 emissions from buildings that we operate. I can tell you that that's become a big focus of our largest shareholders now at the REITs. As well as when we go out now and talk to private capital investors, sovereign wealth funds, pension plans, endowments, is becoming a bigger, bigger, more important part of what they evaluate about a manager is what your ESG score looks like. And we actually got a big initiative in-house on this point, and we're going to have an ESG report at RMR that will then also flow through to the 4 REITs this spring. That's going to be pretty comprehensive. I mean, we've been doing a lot to be environmentally friendly at the REITs in terms of green initiatives. In fact, one of our REITs, OPI, the office REIT, has consistently won a Green Lease Leader from the GSA, Government Service Administrator (sic) [ General Services Administration ]. We have a tremendously high number of buildings that get LEED designation. And so we do a lot, but we're now trying to aggregate all that good work we're doing and create a report to really highlight it and showcase it to investors.