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

Great. Good afternoon, everyone. My name is Ronald Kamdem, and I'm one of the REIT analysts at -- on the Morgan Stanley research team. We are so excited to be having you guys join us for our third annual CRE symposium. We've got a great 2-days plan of speakers and content, and we really hope you get a lot out of it. So before we get started, there's some disclosures that I need to read. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. So with that, we -- hopefully, you guys can see me and can hear me on the webcast. Feel free to ask us any questions. We can see it, and we'll try to get through them throughout the webcast. Without further ado, let me kick it off to our speakers from RMR Group and have them introduce themselves.

Hi, everyone. This is Matt Jordan. I'm RMR's Chief Financial Officer.

And this is Michael Kodesch. I'm the Director of Investor Relations for RMR.

Great. Thank you both for joining us and partnering with us in this conference. So there's a lot of people that are listening on the line right now that probably don't know the story that well. So maybe we can start off with you -- if guys can introduce the company and sort of give us the key highlights.

Yes. Thanks. And it's a dynamic organization, and I'll try and do this in 5 minutes or less. RMR, The RMR Group, is an alternative asset manager primarily focused on commercial real estate. At the end of March, we ended the quarter with $32 billion in gross assets under management, primarily across 10 client companies of ours, 10 different vehicles. Our platform of companies touches pretty much all sectors of real estate, short of multifamily. And we think that diversity is a strength, especially in trying times like we're in right now, and I'm sure we'll talk more about that. We're a vertically integrated platform, which is also something we're very proud of with a national reach. All of our assets are primarily in the United States, the assets we manage. We're a 600-person firm, approximately half of which reside at our corporate office here in Boston and the other half is spread across 30 offices around the country. And most of those folks are direct property management personnel and regional leadership that represent insights on the various markets we operate in and focus solely on our assets. We do not manage for any third parties, just our own assets. RMR itself, in terms of the 10 client companies I referenced, 4 of those represent about 85% of our recurring services revenues and almost 90% of our gross assets under management, and those 4 clients are all publicly traded equity REITs, all listed on the NASDAQ as is RMR. Our REITs are externally managed, which is unique in the equity REIT space. That be externally managed, meaning those REITs have no employees. They have an independent Board of Directors representing their shareholders. But otherwise, RMR is responsible for all the day-to-day operations, and we're contractually bound to provide certain services to those REITs. Those 4 vehicles each have a unique investment thesis. So we minimize conflicts of interest by the need to having a unique focus. Our largest is Service Properties Trust, which is about $12 billion. It's about 60% hotels and the remainder is triple net service retail. Our second largest at about $9 billion is Diversified Healthcare Trust, which is about half medical office and life science and the other half, senior living. Our third largest at $6 billion is Office Properties Income Trust, which is primarily focused, as the name would suggest on multi- and single-tenant office properties. And our smallest and newest REIT is Industrial Logistics Properties Trust at about $2.5 billion in AUM, that's focused on industrial and logistics properties. One of the most unique aspects of our organization from an investors perspective, in my opinion, is our contracts, and it would probably be the one takeaway for those who are new to our story. Our 4 equity REITS, again, that represent 85% of our service revenues, have a 20-year evergreen contractual relationship with RMR. And the evergreen piece being a very important facet. So every December 31, we're adding that 20th year back on. And those 20-year contracts are in 2 forms, first being a business management arrangement, that is driven towards the strategic activities of the REITS: buying and selling assets, asset management, investor relations, things of that nature. And we're paid a base fee under that arrangement of 50 bps on a recurring basis. And what also makes that contract unique and it's something I'd like to highlight in terms of an alignment of interest with shareholders of those REITs, is we're paid 50 basis points on the lower of enterprise value or gross cost of assets. So in times like the current environment, when our REITs' share prices are depressed, RMR is earning less service revenues and as those share prices improve based on actions we undertake, RMR's revenues increase. So there's a strong alignment as an external manager between RMR and the shareholders of our client companies. We're also entitled to incentive fees to the extent our REITs outperform their respective peer indices, whether it be the office, hospitality sector or the industrial sector. The second contractual arrangement we have, which is very similar to that of CB, Jones Lang LaSalle and others is a property management agreement. So we're responsible for the day-to-day operations of our REITs, of the -- primarily the office and industrial assets. We are paid a 3% property management fee on gross collected rents, and we're also paid fees to manage things such as super -- construction. We're also entitled to have the payroll of employees, RMR employees, that we allocate to the buildings, people such as engineers, reimbursed to RMR. The final important facet, which really underlies the strength of our contracts is the termination fees. If by chance the REIT Boards, the independent directors wanted to terminate the relationship with RMR, we would be entitled to the remaining cash flows present valued back to today. That is a sizable number in excess of $2 billion, if all 4 REITS, at the same time, decided to terminate their relationship. So we think that is an extremely strong aspect of the RMR story, these 20-year contracts with the security that underlies those. I'll end with a quick overview of our financials. We're generating between $40 million and $50 million of recurring base revenues each quarter. We have what we believe are industry-leading operating margins at over 50%, which translates to about $18 million to $25 million of free cash flow per quarter. As a company, we've committed to a dividend of $0.38 per quarter or $1.52 a year, which is about a 4% yield today's share price. That is a well-covered dividend and one we've remained committed to through this pandemic. And the final aspect is our balance sheet, which we believe is also a differentiator as we head into a post-pandemic world. We ended the March quarter with $380 million in cash. We have no debt, which positions us well as we think about growing the platform. So that's the overview.

Great. That's very helpful. If I can dig into -- I think one of the interesting things about the company is you have exposure to a lot of various different subsectors from office, industrial and the list goes on and on. And I think it would be helpful for our listeners, maybe, if you could maybe provide some subsector insights. How are various subsectors performing in this sort of COVID environment? And how are you guys thinking about it?

Yes, that's a great question. And I do think having a diverse platform is very helpful versus being a singularly focused entity. So we have the full spectrum as most listeners can probably guess based on hearing me talk of our 4 primary equity REITs. So on the positive side, our industrial REITs and our office REITs, both have occupancy levels in the high 90% range. They have a significant concentration of investment-grade tenants. They have healthy weighted average lease terms. They are well positioned, given the current environment. They've seen strong cash collections, and they've seen limited rent deferral request. So those are 2 vehicles, as we come out of the current environment, we fully expect could be able to take advantage of opportunistic buying opportunity and capital recycling opportunities. They're both well capitalized and again, have a strong base to build from and have taken advantage and done some strategic things over the last 2 or 3 years to put them in this position. So they're clearly on the positive end, and we expect that to continue into the later part of 2020. On the challenging side, which, again, should not be a surprise to those listening, Service Properties Trust, it's 60% hotel base is clearly challenged. The positive they have is when we look at their hotel composition, they're much more weighted towards extended stay, which is actually, while seeing depressed occupancy levels, it's fared better than a lot of full-service brands, which have had to temporarily close because they've been able to take advantage of group whether it's first responders or other medical professionals or government agencies who've had to come into certain jurisdictions and have been able to at least provide some occupancy. The other side of their portfolio is the triple-net service retail. And with the stay-at-home orders over the last 2 months, that has clearly been an area that's also been challenged as it relates to movie theaters, gyms, quick service restaurants. Service Properties Trust just did a significant bond issuance. They're well positioned to move forward and get through this. But when you talk of how the various sectors have been -- performed, they've actually seen challenges on both fronts. As it relates to Diversified Healthcare Trust, that's a mix story. Clearly, the medical office and life science side of their business has done well. They've seen strong rent collections. A lot of those life science tenants are in critical parts of the COVID-19 fight or other key medical matters. And that's been fine. The other half of their business on the senior living side is obviously facing this pandemic head on and is not seeing a lot of new move-ins and is doing everything in their power to contain exposure within the various communities they manage and own as well as manage rising costs in this current environment. So we're seeing the spectrum of the impacts of the current economic crisis across our platform.

Great. That's very helpful. I think one of the things that was interesting that you mentioned in your comments is a lot of the fees are tied to the share price of the public REIT companies. Obviously, we're all living through some of the most volatile markets we've seen. But just to put a bow on it, what are the opportunities, right? What are the opportunities to improve the REIT client share prices? And what have you guys done to sort of get that?

So that's a great question, and that's one point I'd probably like to even highlight further. So the way our contracts work as it relates to our base fees, when we're being paid on the lower of historical cost or enterprise value, at the end of March, that delta was $12 billion or about $55 million in annual service fees because of the rapid deterioration in the equity markets at the end of March. So our fee paying AUM, as we like to call it in our public releases, was just over $20 billion as compared to the gross number I mentioned earlier, of $32 billion. So short of doing anything else, just getting the share prices up, represents a $50 million plus organic revenue opportunity, the bulk of which is going to be 100% EBITDA flow-through because our cost structure is what it is. We have a core obligation to manage the assets we're responsible for. And when the share prices go down, we're not in a position to cut headcount and other costs in any meaningful way. So when we look across the platform, there was a big part of just the general economic crisis and things that were far out of our control. And quite frankly, Ron, we're seeing, when we look at our May average -- and our fees are calculated monthly. So we have the benefit of seeing real-time results. March averages were at the lowest point I had seen in a long time. April and May, we're seeing a significant uptick in average share prices across the REITs, which reflects the markets as a whole, I think. And then in early June, we've seen a rapid continued increase in those share prices. And I think in terms of the things we're doing at OPI and ILPT, which is the office and industrial side, I think a big part of that is reinforcing the story, and they've been out doing investor outreach and reinforcing the characteristics of the portfolio, the strong rent collections, the limited rent deferral requests and really reinforcing the opportunities within each of those platforms. On the other side, those entities that were challenged being SVC and DHC, our hospitality and health care REIT, what each of those did -- those were obviously 2 sectors significantly hit, as I talked about. They recently went out and raised $1.8 billion in financing, which I think provided their shareholders significant security in the sense that they can weather the storm. And that they will get through this on top of the fundamentals of their business and their portfolio. That extra liquidity is a critical aspect to their long-term stability. And we've seen those share prices react really positively after those financings.

Great. That's helpful. And as a reminder, if there's any questions you want to pose to the company, feel free to send them through the webcast. I know we're getting a few questions already. Look, one of the questions we get a lot on the real estate team is on rent collections, right? And our team has put out a tracker where we're tracking sort of the rent numbers across property types. So I'd like to get your thoughts on how are you guys thinking about rent collections. What do you feel the most -- the best about it? And maybe what are you watching the most closely? Just any thoughts there for our audience would be great.

No, that's great. And we're watching them daily and have been since the pandemic started, and it's a great question, and I know many are reporting on this data. So across our platform, I think we've been very fortunate. We collected about 92% of cash in April, and I'm talking across the platform, all 4 of our equity REITs. May got even better. What's that?

That's pretty high compared to some of the...

Yes. We're very happy, and it got better in May. We're at 95%. We ended around 95% cash. And so far, in June, we feel optimistic. We're trending with April and May collections through the same business day. So we're feeling good. And the delta that's uncollected, the other positive, in my opinion, is those tenants that didn't pay have engaged us to talk about either lease restructures or rent deferrals. And I think on a personal level, I've been pleased. We saw rent deferral requests spike at the onset of the pandemic, but they've really stabilized, which may be a function of stimulus monies coming through, a function of stay-at-home orders being lifted. And some of our folks around the country would also say in April, there was a panic, a fear of the unknown, and a lot of tenants may have reached out under that premise. So we're feeling pretty good as a platform. And as the country comes out of the stay-at-home phase, we're hoping these numbers will stay on track.

Great. Just -- I want to touch on external growth opportunities a little bit here. But I think the first thing was you made some really interesting comment about the balance sheet as a differentiator. If you could just tell us what's the philosophy behind that balance sheet? And you're maybe one of the few companies that's lucky enough to sort of have dry powder. Maybe provide a little bit more context on how the management team is thinking about protecting that balance sheet.

Yes. So we've been fortunate. We went public in 2015. And over the last few years, we've accumulated cash both from our recurring operations. So we generate anywhere between $100 million and $120 million in free cash, 1/3 of which goes to our dividend, a 1/3 of which goes to taxes and 1/3, we reinvest in the business. On top of that, the first 4 years we went public, we averaged just under $100 million in incentive fees every year. So this cash balance has been the accumulation of those cash flows and the incentive fees we've earned over that time. And our -- from a capital allocation perspective, the Board and Adam, our CEO, has been committed to our dividend, a dividend strategy that we want to make sure our dividend remains well covered. We've seen it increase, I think, about 3 or 4 times since we went public. But the bulk of that cash is earmarked for growth. As folks who are listening may know, Adam and the Portnoy family own about half the company. They're committed to the long-term -- a long-term vision for this organization. They'd be -- we've been asked frequently by investors, "Should you do a special dividend? Should you rapidly increase your recurring dividend? Should you do a share buyback?" In most of those situations, Adam and his family would be entitled to half of those benefits, but they are keeping a long-term view and the $380 million of cash we have and the strength of our balance sheet is dedicated to growing this platform for the long term. So that's kind of the macro view of how we look at our balance sheet.

Great. That's helpful. And I think one of the things that you've talked about was potential sort of external growth opportunities to grow the private capital vehicles. Maybe if you could sort of update us on what's the thinking there? Number one. Why does it make sense for you to grow that private capital vehicle? I mean the answer seems kind of obvious but we'd love to hear how you guys are thinking about it. And then the other piece of it is, how are those conversations going? Has COVID sort of impacted that -- those conversations?

That's a great question. We have -- we -- as I talked about earlier, 4 of our companies represent 85% of our revenues. Those companies are bound by very strong contractual relationships with RMR, and I talked about the termination fees. So those 4 companies aren't going anywhere or shouldn't be going anywhere. But nonetheless, that kind of concentration is something we want to move away from. We want to diversify. And the bulk of our $32 billion in assets under management is all tied to public vehicles. So it's been a stated goal of ours for some time to diversify towards private capital. And one way, obviously, is to grow it ourselves. We launched our first ever open-end fund 2 or 3 years ago. That's going to be a slow and methodical process, given we're a new player in that space and a new name as it relates to high net worth, sovereign wealth and the pension environment here in the United States. A faster way and a way we've talked publicly is growing through acquisition. And we've had our sights set on real estate private equity firms with over about $5 billion in AUM with a focus on core real estate, which is pretty -- which is very similar to the portfolio of assets we manage. And probably the most important attribute is we want to find an entity that has strong and deep LP relationships, which is what we're finding is the most critical aspect of expanding the private capital space. So do you have a direct line of sight to the pensions and the sovereign wealth environments and a history of fundraising with those environments that we can leverage and grow? We have invested a lot of time. We have folks helping us on this front, and we were making significant progress as our quarterly calls, hopefully highlighted. COVID-19 has definitely been a significant speed bump in the process both in terms of the diligence process and the live interaction that goes with executing a transaction. But also the reality that both we and any acquire -- any potential acquiree really had to look inward over the last 3 months and stabilize their portfolio, stabilize their relationships and make sure their houses were in order, for lack of a better term. So that has significantly slowed some of the momentum we had really underway when we think about M&A activity and growing our platform in the private capital space. But my hope is this summer, as I do see a normalcy starting to return, we'll have some significant progress to update on that front.

Great. And we're getting a bunch of questions on the webcast now, and I'll make sure to touch on them. One of them is just sticking on this sort of private capital. Is there -- is there one -- what are some of the hottest subsectors, right? Where are you seeing sort of the most interest in terms of capital raising on the private capital front?

Clearly, industrial. Specifically, industrial, it's direct-to-consumer more so than direct to the mall and the retail environment. I think there continues to be a lot of money chasing those assets and people who manage those types of assets in terms of acquisition targets. The second one, which would be new to us, but also would be interesting and complementary is multifamily, continues to be an area of focus. And if we could find a real estate private equity shop that met all our attributes and also brought multifamily expertise to our platform, that would be a real positive in terms of rounding out the various sectors that we play in and our in-house expertise.

Great. Here -- there's another question on -- a few questions on this topic actually. I think there's a joint venture opportunity that you did with ILPT on the industrial side. Number one, maybe just provide some context and what that was, and how that came about. And I think the corollary, I think what the audience is asking is, can you comment on the dry powder on the sidelines targeting commercial real estate? And when will that be deployed? What does your crystal ball sort of say?

Well so number one, let me talk about ILPT. So as part of, I talked about our slow in-house growth in terms of the private capital space. Adam had cultivated a relationship with a large sovereign wealth, Adam being our CEO, for those who don't know. A couple of years ago, DHC did a large joint venture with a significant asset here in Boston in the Seaport District. That relationship has been very successful and an opportunity. That entity spoke to interest in getting in the industrial space. And that same partner bought an interest in a package of well-leased, strong industrial assets, which -- and the interesting aspect of this venture is it's not only buying an interest in assets that ILPT owns today, it includes a commitment to keep growing and investing side-by-side with ILPT as we identify more potential acquisition opportunities. So that was a real positive element to that transaction, and that could end up being a private capital vehicle that other partners come into and commit capital to continuing to invest side-by-side with ILPT, that sovereign wealth investor and others down the road, which in turn is a very good thing for RMR in terms of management and our recurring service revenues from managing that venture. My impression is there continues to be significant capital dedicated to real estate. I think everyone's being a little more thoughtful right now. I think the deal flow is naturally just slower as people try and figure out what is the new normal in the acquisition space. I think it's fair to say from our own experiences when we meet as a capital allocation committee, the deal flow is a little slower as I think seller expectations and buyer expectations are still being reconciled. But my guess is this summer, we may see more distressed situations come to market based on numerous situations that may exist. But there still seems to be a healthy pool of capital dedicated to real estate.

Great. And I think one of the interesting that you mentioned and we're getting some questions on, who are some of your competitors, right? Because maybe people listening are thinking that you're competing with sort of the Blackstones, the KKRs of the world. You're all in that space, but it sounds like some of the capital that you're targeting may be a little bit smaller than that. Maybe you have a little bit of a niche there. So maybe can you talk a little bit more about that? Who do you compete with? And how do you see yourself fitting in that industry with these giants?

Yes. It's a good question. We clearly view ourselves as a peer to those entities, though at a much smaller scale, obviously. Though, in fairness, if you just broke those entities down by their real estate concentration, we don't look as small at $32 billion in gross AUM dedicated solely to real estate. But that is the space we play in, the alts. That is who we view as our peers. Our permanent capital vehicles, the 4 equity REITs and our 20-year contracts, make us a little bit of a unique player in this space. I think the Blackstones of the world are expanding their permanent capital vehicles. But in a lot of ways, we remain somewhat unique as an external manager of equity REITs. Though as we expand our private capital space, our goal is to continue to grow towards the Blackstones of the world and be more comparable on size.

Helpful. I think we probably have time for one more. I'll just try to summarize because you got a couple on these. On this one was, and I'm sure you've gotten this before, which is on the -- I think a couple of listeners picked up on the external management structure. The question really is, is there pressure from investors to internalize? How are you guys thinking about sort of the external versus internal management structure right now?

I would say there's no pressure at this point. I mean, for those that don't like the external management structure within the REIT community, they may choose not to invest in our REITs. But I think we've done a good job since we went public and since we restructured our contracts back in 2014, I believe, was to reinforce our organization. And our contracts are aligned with our client companies, and there's no better alignment. While some of our internally managed REIT competitors may be taking, say, pay cuts at the senior management level during a COVID-19-type environment, we're taking a $50-plus million fee haircut because of the way our contracts are aligned with our REITs. And that, to me, is a significant point and our incentive fees are also being harmed right now and the potential for earning those. So I can go chapter and verse. I think our structure, the depth of our management team, the G&A burdens we pass to our REITs are all extremely valuable to those REITs being externally managed. But on top of that, I think the alignment is something that continues to be overlooked in the sense RMR's fees and the way we're paid are directly tied to how well our REITs perform.

Excellent. You couldn't time that any better. We're right on time, 1:35. As a reminder to our listeners, you have a 10-minute break. The next session starts at 1:45. Welcome again to the CRE symposium and thank you for partnering with us.

Thank you.