UDR, Inc. (UDR) Earnings Call Transcript & Summary

The 3 p.m. session at Citi's 2020 Global Property CEO Conference. I'm Nick Joseph with Citi Research. We're pleased to have with us UDR and CEO, Tom Toomey. This session is for investing clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the disclosures tab. For those in the room or on the webcast, you can sign on to liveqa.com and enter code, citi2020, to submit any questions. Tom, I'll turn it over to you to introduce your company and team and provide the audience 3 reasons why investors should buy UDR's stock today, and then we'll get into Q&A.

Thank you, Nick, and thank you again for having us back at this conference. I think this celebrates 25 years for me being here, and it's been a joy. With me today is Mike Lacey, UDR's Senior Vice President of Operations, on my left; and on my right is Joe Fisher, UDR's CFO. Last week, we posted an updated presentation on our website. So for those who are listening, please access through udr.com. And for those in the room, does everybody have a presentation? If not, raise your hand, I'll get one to you. Great. Let's move forward. So UDR is a $21 billion S&P 500 Apartment REIT that operates a diversified portfolio in 20 markets with over 51,000 apartment homes. Diversification is an important element to us, not only by the number of markets that we're in, but also within the confines of a 50-50 balance between suburban and urban and a 50-50 balance between A and B quality price point products. We consider ourself a very good operator with a flexible approach to capital allocation and an investment-grade-rated balance sheet that allows us to perform well through all parts of apartment cycles. In summary, I'd say, UDR is a full cycle investment. Nick, on the performance level of that full cycle investment, I would highlight a couple of things. Our primary goal is, again, to grow cash flow above average -- above our peers' average, which translates to a superior TSR. Over the last 3 years, we've delivered 6% annual FFOA growth and a 5% dividend growth, and 2020 projects to be very similar. On the TSR front, the last 10 years, we've averaged 16%. And in my tenure of 19 years, this year, it is 15% annually. Looking ahead to 2020, our guidance midpoint, again, puts us above average in the peer for cash flow, same-store revenue, expense and NOI growth. And we'll talk more about those operating forecast and what we're doing to achieve those. And again, our primary focus for '20 and has been for the last couple of years is our next-generation operations platform. And Mike will be leading us through that part of the Q&A. With respect to 3 reasons to own UDR: First, full cycle investment company with a proven track record of outperforming in both up and down markets; a value proposition and upside potential from our next-generation operations platform, culture and ESG focus; and a flexible and disciplined capital deployment strategy. With that, I'll turn it back to you, Nick.

Thank you. So we're starting every session with the same question. ESG is of increasing importance for all companies' stakeholders. What is one thing that UDR is doing to improve your overall ESG score over the next 12 months?

Nick, we've noticed you've been asking that question, and we're prepared to answer that. If you will, I'll direct everyone to Page 19, which highlights some of the many efforts that we have under with respect to ESG and its programs. But I think the most impactful for us will be the combined effort of looking at our portfolio, our opportunities from an ROI cash flow growth and enabling our ESG, particularly in power, water and solar initiatives.

Great. Thank you. We're also opening with this question. In terms of coronavirus, obviously, there's a lot of unknowns. But what is UDR doing both from an on-the-ground perspective as well as from a corporate perspective to be as prepared as you possibly can be for it?

Well, certainly, as this arose, what we first did is dashed off our prior plans with respect to pandemics and the implications thereof. And we've had no impact to date with respect to residents or the workforce or any knowledge to our operations. But what I can say is, our general business approach is twofold. One, accommodate. Rather, that's our associates who have been working at home, if they have to care for ill ones or they are ill themself, giving them the accommodation necessary, and we extend the same courtesy in respect to our residents with respect to their ability to function or provide shelter for them. We'd expand beyond that in the accommodation aspect that we reviewed our preparedness plans in detail. And what we found is, over the last 10 years, we've made great progress with respect to technology penetrations and that our residents by today, 90-plus percent can pay their bills, be serviced by us and that our workforce can work from home as well. So I think we're prepared for a short disruption and feel good about our position on this. We just hope it doesn't come to fruition.

Great. Maybe let's start on operations. You put out an operating update ahead of the conference, recognizing we're still very early in the year, not too far from when you issued guidance. How are things trending relative to expectations? And are there any markets that you'd call out on the outperforming or underperforming initial expectations?

Sure. Thanks, Nick. If you go to the last page on our pitch, Page 28, you'll see our operating trends. To date, we are right on track with plan and where we would expect to be. And you can see that our spread from our blended rates is 2.8% versus at 3.0% this time last year, that spread was actually 70 basis points in 4Q. So we've seen that seasonality kick in. And as far as submarkets go, I can tell you one that surprised me to the upside today is Seattle. In just about every submarket that we have there we've seen close to 5% growth. It's doing a little bit better than we would expect because that is a very seasonal market. On the flip side, you do see supply on -- in Boston more down towards the Seaport area, expect around 200 to 2,500 units being delivered down there. So still seeing concessions in that 6 to 8 weeks in some cases, and that's probably a little bit weaker than we expected.

Other than those markets, when you look at concessions being offered in the market, are there any that are giving you concerns as the leading indicator?

Not necessarily, Nick. There's a few pockets within submarkets around the country where you do see upwards of 8 weeks. But it's a few deals here and there, and I can tell you, outside of Boston, maybe in that SoMa area in San Francisco, we're seeing a little bit of that pressure. But we have such a different unique property in there, it hasn't impacted us as much.

You mentioned the next-generation operating platform, PropTech, and operating efficiencies has been a big topic really across the entire residential sector. Where are you guys in terms of rolling out the next-gen operating system? And what should we expect over the next 12 to 24 months?

Certainly, let me start, and then I'll hand it to Mike to walk you through the details. And for those who are listening or those in the room who are not aware, the next-generation operations platform, I don't know if each of us have noticed to the same degree in our lives, but every interaction we have with the business has moved to a self-service model. Okay, why? That's where our customers are. That's where your mindsets are. You want it when you want it at your convenience, and you want it in a transparent way. I hate to tell you that real estate hasn't always been in that mindset or have the technology capabilities to achieve that. But our overriding goal, and one of our principles in our company is, is we do a very good job of listening to our customer and our associates, and they drive the direction of the enterprise. And then probably where they have driven us to is the conclusion that a self-service model in the apartment industry is achievable, desirable and our direction. Mike is going to walk you through the first 2 phases of that and what we hope the results of that are. But we already know this, our customer is already at a self-service desire. Their actions indicate that. The rest of their lives indicate that. And we, as a good operator should be striving to achieve that. Mike?

If I could direct you to Page 9, I can walk you through the different phases. We started back in 2016-2017, realizing this is where our resident and our prospect wanted to be. And at that point, we realized the cost for the foundation for this would be anywhere from $25 million to $30 million with the expectations of NOI at a run rate of $15 million to $20 million by 2022, which on our multiple is around $350 million to $450 million in value. Now we've been laying out how we're going to measure this. And it's really 3 things: it's controllable operating margin, which is up 60 basis points since 2018; it's our headcount reduction, which is down 18%; and it's our resident satisfaction scores, which we measure by NPS, is up 15%. These are our leading indicators, and these are the things that we'll be continuing to measure as we move forward. But as it relates to the 3 things: the first, centralizing a lot of those admin and sales functions as well as outsourcing some of the maintenance functions. We've been working through that for the last 18 months, still working through it through the rest of this year. We've also added about 33,000 SmartHomes to the portfolio, and we have about another 7,000 to go, and we should be around 40,000 at the end of this year. The next piece is self-service. We really started this anywhere from 6 to 9 months ago. And this allows our residents and our prospects to tour on their time. As we move forward, we've developed an app that we're rolling out over the course of the next 3 to 6 months, and this will allow us to take this to the next level. The third piece, which I'm happy to say we're slightly ahead of schedule on, is our data science. This is our big data, and it's really 2 things. We're using heat maps to basically look at data spatially as well as big data, encompassing everything into one data hub, where we can Googleize, if you will, our information.

Nick, if I could add a couple of points to Mike. If you think about an operating platform, there's 2 pieces of it in our mind. The first is your ability to do business with your customer. And certainly, you can see the SmartHome technology, the ability to do self-guided tours, pay, interact 100%. We believe the industry will achieve this in some different path, one way or another, but all good companies are going to get there. On a competitive landscape basis, we don't see the fee or the private owners making much progress on that front. So we think it represents a competitive advantage not only for our company, but all the REITs that are well capitalized and capable. The second systems around this platform deal a lot with how we manage our cost structure and our revenue structures. And no surprise to many of you in the room, you've been following apartments for some period of time. You've certainly seen the convergence of the public company's revenue to being very tight. Well, one, that's a credit to all of us doing a pretty darn good job. But it's also exposed an interesting element or dilemma, which is, we're all using the same pricing tools. Hence, if you think about the airline industries 20 years ago, all using Sabre for their reservation systems and their pricing, and then it created price wars, but they are all of these competing with each other. Well, we've grown to do that to ourself as an industry. We think there's an opportunity to revisit that pricing engine with the data science capabilities that Mike and his team are building and believe that there's upside. And we have back-tested it on 1/3 of our portfolio -- that we've been back-tested it on 1/3 of our portfolio and found we probably mispriced our product over the last 10 years to the tune of about $3.5 million each year. And that's just because we are relying upon a system and not pricing individual apartment homes, we are actually pricing floor plans, as an example. The second aspect is, is the power of big data gives us the ability to not only use the machine but learn from a machine and groupthink. So all our prior data has been in silos and not connected to one cohesive database around the business unit called, our customer. Instead, it's been built around apartment communities. And now this gives us the access and capabilities to look across that whole spectrum of communities and interactions and customers to ultimately determine where is the profitability potential of the enterprise, whether that is in service, whether that is in purchasing or revenue management. It is hard to convey it here. But if you would think about other businesses that have moved well into this, the airline industries and their revenue models, now you said, not just in a business seat or a coach seat, but you actually pay for a window, an aisle, an exit, that will be introduced in the apartment industry in the near future, as an example, or how to optimize your cost structure. So I'm excited about what the platform can bring. If you want to go to an example of it, Joe can probably walk you through a recent acquisition and give you some numbers that might give you a little bit more confidence about the potential of this, particularly, again, Mike mentioned it, we think about evaluating our business model and acumen on 3 criteria: customer satisfaction; number two, our margin, and how we grow it; and number 3 is the size and scope of our efficiency, meaning our workforce.

Nick, you want me to take you through an example?

Yes, I think that would be very interesting.

Perfect. So I think everybody here knows, last 12, 18 months, we've been extremely active on the external growth front. Issued well over $1 billion of equity, about almost $1.9 billion in assets. And so we've had a cost of capital signal. What we've communicated to The Street is that we're going to go out there and acquire and target markets, acquire assets that are year 1 accretive, that have long-term growth potential at a greater degree than our existing portfolio, make sure we do a risk-neutral leverage-neutral match funded. And that the operational outlook for these assets matches up well with the initiatives in this platform. So when we do that, we've kind of said we can get 5% to 10% upside relative to private market NOI run rates. And so that translates into about $0.03 to $0.04 in 2020. When you look at our FFO growth relative to the peer set, that puts us #2 this year on total FFO growth of 6%. A lot of that being driven by these ops initiatives combined with the external growth. So on Page 16, if you go to it in the presentation. We get questions as to how we can actually drive that extra 5% to 10% over a private market operator. So we thought it'd be helpful to take one of our assets. In this case, Commons at Windsor Gardens, a $270 million acquisition in Boston. Older asset, B quality with a renovation potential, located directly on a train station. So we have our own dedicated train station here. So the discounts relative to Boston proper, about 30%, 35%. But you also have only a 30-minute commute. So a pretty good value proposition to start with. When you look through here, we're expanding margin by about 90 basis points or NOI, I should say, by about 90 basis points in terms of taking it from a 4.8% up to a 5.7%. About half of that just comes from regular old market rent growth. But these other 3 pieces are the pieces that we talk about when we have the ability to add where others may not. CapEx, we have about a $13 million, $14 million CapEx program going on this asset. CapEx at the prior owner was not interested in spending on the asset to freshen it up and keep it up to market standards. So things like landscaping, exterior painting, going into new and SmartHomes, upgrading HVAC and electrical repaving, things of that nature. So we have some NOI upside related to those. When you look at the ops initiatives, I think Mike and his team are very well known for what they've done over the last several years on ops in terms of pushing the parking initiatives, going out there and doing short-term rentals, doing common area rentals. A lot of these things that help above and beyond just regular old rent growth. We don't see many private market operators do that, and I think we've been a leader on the public side. So we'll continue to do that with these type of assets. The other piece of next-gen operating platform. We put a little bit of the benefit in here for optical purposes, really Phase 1 and Phase 2. So the centralization, the outsourcing, the self-touring, that's more concrete and easy to grasp when we go through and look at these individual acquisitions. The Phase 3, the big data piece that we know is coming that we see upside to, as Mike referenced, that's a TBD in this case. And then the last piece, we've talked in the past about the predictive analytics platform, what we do on the quantitative side as well as qualitative assessment. We think Boston is going to be one of those markets that outperforms over the next 10 years. So we believe we got a little bit better mousetrap than most others may in terms of capital allocation on that front. I think we'll get upside NOI growth there as well.

How much data do you need to make the predictive kind of heat maps, pricing and occupancy decisions really meaningful? So you talked about on an acquisition, obviously, if you have an operating history for a specific asset or unit type over 10 years, I'd imagine that really gives you some indication of where it could be priced. But on a new acquisition, how much historical data until it can really move the needle?

Well, it's interesting on this case, Nick. When we bought this property, we were just starting to get the heat maps. We put in the historical data, and we found that they basically priced at the floor plan level, and that's it. So they didn't have any amenity pricing for the fact that they have a train going through their -- middle of their property. Three buildings, we're able to go in there and increase those rates $50 at a pop and we haven't seen any issues.

And then Tom, you mentioned maybe going forward, the haves and the have nots in terms of operating systems between the better capitalized, maybe public companies and maybe some of the private owners. Does that make third-party management interesting which we see across other asset classes within REITs?

Nick in a word, no. I don't see us using the platform for third-party's benefit. I think that's a disservice to our shareholders. I prefer us getting the signals from The Street when we're successful using our capital to buy long-term cash flow growth than management contracts which can be canceled readily.

And when you think about underwriting new acquisitions, are you pricing in some level of NOI increase from putting onto your platform on the pricing decision or is that more of the cherry on the top?

Yes. That's a constant debate and push-pull internally in terms of we know what we can get in terms of upside, but it should not allow you to pay more for the asset. We want that gravy to accrue to the shareholders. So when we look at it and say, we can underwrite on a market basis, meaning the ingoing yield, plus 3%, that's how you should justify that return you're getting and therefore, the price that you pay. Everything that we get there on Page 16, above and beyond market rent growth, is what we hold back and what drives that excess IRR. So if market IRRs today are about 6.5% in our markets, this is what gets you to about a 7.5%. So we try not to give that away to the seller.

From a -- from the predictive analytics model that you mentioned, Boston screens well. Obviously, it's not just near term, it's really over 10 years. This is something, I think, you've rolled out 12, 18 months ago. When would we expect to be able to back-test some of the investment decisions that you're making today?

Yes. So we have both a 4-year and 10-year predictive model. 10-year is really for long-term asset allocation, 4-year is more geared towards the timing and implementation of those decisions, but both help inform the decision as does overall management acumen and then this qualitative process. We've really been spending a lot of time and resources building out, focusing on things like climate change, rent control and regulatory, political situations, business friendliness, tax wherewithal, underfunded pension liabilities, things of that nature. So it's going to be a while before we can really go back and test. We've clearly gone back and tested historical results, meaning tracked data well into the '80s. So we have over 30 years of data that we go back and build these models off of. But that's history. We got to make sure, on a go-forward basis, we continue to monitor and make sure the markets perform as we expect.

When you think about how micro you can get there, right, so you have, obviously, the MSA level, but it really comes down to submarket and what corner you're on. Where are you in terms of being able to micro target where you think it's going to have the best 4- and 10-year return?

Yes. It's really at the market level at this point, you typically get the greatest level of dispersion of returns at a market level. You get into a submarket or asset specific, you get kind of the rising tide lifts all ship phenomenon. So I think predictive analytics on some of that work is harder to fair it out at the submarket and asset level. It really lies a lot more on local expertise of transactions team, operations team working in conjunction with each other and trying to look at local market demographics, local market fundamentals, they're going to -- is that the right asset for the portfolio.

You mentioned the regulatory environment. Obviously, that's been a big topic, New York, California, other markets as it's been discussed. First of all, what are your views on Costa-Hawkins coming back on the ballot and the tweaks that were made there, recognizing it was soundly defeated 2 years ago?

Yes. We -- in terms of being back on the ballot, of course, expected it to be. We've been monitoring it along with all the other REITs. I think you know we have the coalition that was formed several years ago. That coalition never disbanded. So it's remained in place. I think we're going to hit the ground running relative to where we were 2 years ago, where we're kind of getting up to speed, working on funding, getting the people in place, testing messaging, making sure that we had the correct communication. So we're much further ahead of the game on that side of the equation. Given from a political standpoint, a lot of what's been active in the last couple of years, i.e., AB 1482, some of the house bills that have been put in place. Those are all geared towards addressing the affordable issue. Some in good ways, some in ways that we probably don't agree with as much, but we like the densification, the rezoning, the upzoning potential. So I think the political landscape is one where there will probably be less support for Costa-Hawkins in the sense that, let's wait and see if these other measures actually start to benefit the affordable issue. The flip side is, the language is a little bit less friendly to those on our side of the table. In addition, we have an election year. So depending on turnout levels and enthusiasm, there could be more support on that side. But it was soundly defeated last time. And I think over the next 3 months or so, we'll probably have more to talk about in terms of preliminary polling and some of those things.

Sure. And then maybe we can touch on New York and then also some of the other markets where it's been discussed in terms of Washington and Colorado, Massachusetts. Do you expect any movement in any of those states?

No insights probably that you don't have already. But on New York, obviously, the Tenant Protection Act of 2019 was a little bit of a surprise in terms of how far it went and the speed with which it went. So I don't want to say we're not going to be surprised next time, but we're monitoring what's going on in New York in terms of market rate units and trying to understand what we can do from our side and trying to be proactive to help out in the effort to just communicate in terms of what that does to forward supply. Does that really solve the affordability issue or should we have more of the things like the density, the upzoning, the public-private partnerships, those relationships. So we're monitoring it. It's part of the qualitative assessment we make every time we're looking at a market, do we want more or less exposure. The same goes with the other markets that you mentioned. Some markets have put in more palatable type of measures, such as CPI plus 7, CPI plus 5, clearly more palatable in some of what we're seeing on the affordable side.

Any questions in the room? You put out a release Monday morning concerning Mack-Cali, and I guess, the discussion that had been occurring, at least within the market there. How far along did those discussions get? Were there any discussions? And is that market kind of the Northern New Jersey interest into you?

Yes. I mean, we tried to clarify as much as we could. Obviously, our policy in the past has been not to comment on public rumors. At the end of the day, we underwrite and look at into preliminary -- looks at a lot of different assets. And so if we think there's something that's going to go kind of within those gating items that we talked about earlier of can it be year 1 accretive, can we get longer-term cash flow growth, good ops upside, not put the balance sheet at risk. We talked in the past about development pipeline size and land pipeline size. We don't want to balloon that up with external acquisitions. So we tried to put a lot of gating items out there that we've laid out to The Street in the past, talked about kind of throughout in the last couple of quarters. As it relates to this one, obviously, the narrative in the public space ramped up with a couple of different releases. So we really just tried to clarify to The Street. We've never had discussions with Mack-Cali directly with their Board or management. In addition, we worked preliminarily with a group just to do some preliminary underwriting as we do on typical asset acquisitions and nothing came to fruition. So in terms of interest in New York, you've seen us acquire 2 assets there in the last year. It's a market that screens well. We're happy to have exposure to it. We're seeing operationally, start to pick up a little bit after a more difficult couple of years. So it's not a market that has been redline to the negative for us.

We've got a question from liveqa here. It goes back to, I guess, SmartHome infrastructure. Really trying to delineate between the benefits and where do you see more of the opportunity and benefit in terms of higher revenue that you can charge versus the expense benefits that you see?

Sure. So on average, right now we're seeing right around $25 as a premium, and that can range from $20 in Nashville to $35 in San Francisco. But again, on average, we are achieving that on the revenue side. On the expense side, it's still yet to be determined. It's definitely -- anecdotally, we've seen that it's saved us on some insurance claims, but that one is still out there to be seen.

Might add that Mike said, 33,000 will be at 40,000 installed by the end of the year. We've only had 3 residents who say they don't like it, out of that group. The other on the expense savings, you've done some savings with lockouts, overtime, it's easier for our service men to get in and out. And that provides a high level of security and comfort to our residents. So we've seen our satisfaction scores continue to improve with this product, checking all the boxes.

Maybe just one last thing to add, Nick, as it relates to the expense savings, we underwrite it on the revenue side. We do have some expense savings related to the insurance, the lockouts, the overtime. But all that is somewhat peanuts compared to the broader thing that we're trying to accomplish here in terms of, this is the base infrastructure to support the self-touring model. So when we talk about the platform and the phases we're going through there, that's really where a lot of benefit comes while we don't explicitly underwrite that $15 million to $20 million of platform upside and say, that's a sign to SmartHome. SmartHome can underwrite on its own. We think that $15 million to $20 million isn't really possible unless you commit to the SmartHome process.

Then maybe just quickly on external growth. Last year, you were very active, you had supportive cost of capital to do that. We've seen you pivot pretty quickly in the past depending on your cost of capital recognizing it's a volatile market. But where does the acquisition in DCP pipeline stand today, assuming that the cost of capital is supportive to execute?

Yes. Last year, we had a very active year. Very pleased with where we ended up. Obviously, added a couple of percent to FFO growth. So if we could follow last year's game plan again, we probably would, very much depended on, can we find the opportunities in those target markets or find assets next door, like we've done with the Brio deal that we tied up with a bridge loan within DCP, and we'll acquire it next year. So if we can find those opportunities and then turn around and figure out how to source the capital, be that well-priced equity that we had last year or dispositions which we said we had about $300 million in the market that we're evaluating at this point in time to help fund some of that growth, we'd be happy to continue to go out there and create more cash flow growth for shareholders. So it remains to be seen if we can get more. We announced one small DCP deal within the presentation, $20 million in Southern California, 9% yield with upside participation. So we're still working our way on DCP, still have capacity there as well, another $50 million to $100 million.

And then finally, just on development. I think you've talked about 2% to 3% of enterprise value. How do you get back to that level?

Yes. We have, call it, a $300 million pipeline today, that's 3 different assets compares to most of the cycle, where we ran at just over $1 billion on a smaller enterprise. We shrank that pipeline not because we are strategically trying to say it's time to shrink a platform. The idea was that we have to maintain discipline around 150, 200 basis points of spread. We couldn't find the opportunities for a number of years there. Now we are finding some opportunities. We've regrown that to 300. We have a Phase 3 Vitruvian West down in Dallas. We have a land parcel in DC that we acquired early last year. That combined, those will add another couple of hundred million. So that takes you to a $0.5 billion. We also have some densification opportunities that we're looking at. And of course, we're always looking at land in the background between both consolidated and looking at JV opportunities with different owners of land.

We have our 4 rapid-fire questions in the session. Will the apartment sector have more or fewer public companies a year from now?

Same.

What will same-store NOI growth be for the apartment sector overall next year in 2021, it's 3.1% this year?

In the low 3s.

What will the 10-year treasury yield be a year from now?

I'm not even sure I know what in the last 15 minutes, given it's 0.9 today. It's extraordinary. But probably, our guess, 1.5.

And finally, in what year will the U.S. enter a recession?

This is a long-running debate in this management team. So I got outvoted to '22.

Thank you very much.