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

Thank for joining us for UDR's presentation at our conference today. I'm joined by, to my right, Mike Lacy, Head of Operations; to his right, CEO, Tom Toomey; and to Tom's right, CFO, Joe Fisher, and you might recognize Trent Trujillo from every other apartment meeting we've been in today. With that, I'll pass it over to Tom for some opening remarks.

Well, welcome, and again, thank you for having us at this conference. It's been going very well for us, and I hope for you as well. So UDR at a glance, just quickly, 60,000 apartment homes diversified by product and markets, meaning AB as well as 21 markets. S&P 500 company, 51 years as a public company, not all of them mine so -- and it's a $20 billion enterprise. We really fashion ourselves about risk and reward, meaning we do well in all cycles, so a full cycle investment. Our primary strategy about creating value is around operations and operating margin where we lead the industry and continue to innovate around that supported by a very vibrant culture.

Appreciate those opening remarks, Tom. I remember we did a launch at NAREIT a couple of months ago. And one thing that stood out was just you got really excited when we talked about operations. Just curious if there's any kind of like new initiatives, anything you're kind of really zoning in on for kind of the next 12 months on the operations front?

Sure. Let me kick it off with an overview of maybe our strategy and then to Mike, who can fill you in with the long list of initiatives. First, if you ask yourself, the apartment business is really a necessity, but also commodity in a very fragmented industry. There are no concentrated key players in the space at all. So how do you win in that type of environment with a diversified portfolio? And the answer is, with 1 of 2 ways, cost of capital or operating acumen as measured by margin. So long term, we lead the industry, our cash flow margins, Joe will give you a little bit more detail about that, but how do we, in essence, increase margin in a commodity business? We view this and started in on it approximately in 2017, something we call the platform. And the platform is really in response to listening to our customer, which is, in essence, how you increase margin. Your customer usually tells you where to go. 2017, everyone in the world was basically transacting 100% on their phone in a complete self-service model. And we've seen it in other industries, whether that's the travel industry, car rental industry, hotel, all of it moving to a self-service model. We implemented such a model in 2018, resulting in, first, a reduction of the workforce by 40%. The good news is the 60% that went forward, actually got salary increases. But what was the response? We asked a customer in 2017, would you rather tour with our leasing agent or a self-guided tour? And this is all pre-COVID? The answer was 95% of our customers told us, I'd rather do a self-guided tour. Why fight your customer? They viewed it as that's the way they want to do business. And so that was Phase 1, was creating a self-service platform. Phase 2, and Mike can expand a lot more on it, is customer retention and service and why is that critical? And just a heads-up, Phase 3 is a redesigned pricing model. Phase 2, Mike?

Yes. I'd tell you, you talk about innovation and the things that we're most excited about, to Tom's point, the customer service side of the house. I mean from an operating standpoint, we feel like we're very good at a lot of things. One thing that we have found that we're not so good at is turnover. And as we've gone back over the last couple of years, we've noticed that our peers run turnover around 47%, 48%, where, at that time, we've been running closer to 50%. So we wanted to put more of a focus on our residents, how we can retain them at a much higher level. And we've done a pretty good job over the last probably 12 months or so to identify exactly what that will take. And I think the biggest thing when you think about it is, what's controllable, what's not controllable. And if you had the power to know exactly what your resident was going to do in terms of staying or going, what does that lead to? We think we are getting very close to understanding that, and I'll give you a couple of examples. But I think a lot of our peers and a lot of the operators out there, they have access to things like their texting, their phone calls, their surveys, their service requests, all this different data, but it's located in different silos, and it's hard to understand exactly what's going on. We've taken all of this information from all the different silos. We put it into one big hopper, and we have a much better understanding of our resident life cycle. What's happening at any given time through all these different avenues, are things positive? Are they negative? How can we be more proactive versus reactive? And this is allowing us to, again, look at that cycle, change the trajectory and become much better as it relates to turnover moving forward. Over the last 5 months, we've seen turnover come down on a year-over-year basis, about 100 move-outs per month, partially due to just putting a flashlight on this, understanding that it's a focus point. But where this is going to lead into next year as well as into 2025, we think it's endless. We think it helps on turnover, helps us with occupancy. And ultimately, we'll get to the point where it helps us on new lease growth and renewal growth.

Joe, anything you'd add?

Just a simple question [indiscernible].

It's shocking to feed you a couple of points. Mike said we were close to understanding. The answer is close as 97% of the time. We can predict your sentiment and the outcome of your lease. So if you knew someone signed today and in 3 months, I can tell you, am I improving my likelihood or am I not improving? What do I need to do to change the trajectory you know that you want to renew with us. Closing the back door leads to broad pricing power. Questions about what's the reason people leave us?

Jeff, it's a great point and something we found very fascinating is when you look at that turnover, 50% of it is actually controllable and it has nothing to do with price. Some of the biggest things you may surprise a lot of you, #1, it's noise; #2, dog waste; #3, just waste in general trash; and #4 I'd tell you, it's the move-in experience. So we've been spending a lot of time trying to bulletproof that. And we think if we can just improve on the margin in a lot of ways, this will improve our retention.

So you took downturn a little bit over the past year. Is that something like noticeable in the margin that you're getting across your properties? Or is it too early at this point?

It's early on. I will tell you again, for the last 5 months, it's been promising to see our turnover coming down on a year-over-year basis, but it's only 100 move-outs per month. It's helped us with occupancy, 100 move-outs equates to about 20 basis points of occupancy. It's marginal right now. We think that in the future, it should be significantly more.

Josh, just to quantify a little bit on the initiative front. Historically speaking, we've been able to outperform the peer average with a diversified portfolio by about 50 basis points a year. So that's the historical gauge that based off the innovative culture that Tom and Mike, we've been able to outperform. If you want to quantify the initiatives that you're kind of asking about, one of the biggest ones is our Wi-Fi rollout. So similar to what we did with SmartRent, we went big to enable the customer, rolled out with a partner early on and got a big bang for the buck. Wi-Fi, we probably have another $15 million, $20 million of incremental NOI left to do over the next couple of years, with another 60-plus smaller initiatives that we have in the hopper. We've got about another $10 million, and then you have this customer experience project where we're running 200, 300 basis points above peers on turnover. Every percent is worth about $2.5 million. So if we can just get back to average, we have $5-plus million of opportunity there. We think with the data that we're utilizing and shifting to more of a proactive customer experience, you're going to see more than that in terms of the turnover and economic benefit. So overall, I'd say we feel like we're in a pretty good place in terms of the foundation to continue producing at least 50 basis points of NOI relative to the markets and the peers that we compete against.

And beyond these 2 initiatives, you also have probably a list of 60 items that we see as opportunity in the business model to expand margin.

I don't know if we have enough time to go through all 60 right now, but it sounds promising. And then maybe just thinking about some of the comments you made on 2Q, you flagged that you're expecting a sequential same-store revenue growth to grow 2%, 2.5% from 2Q to 3Q. Is that still the expectation? Are you on track? And what's driving that?

Yes. So I'd say, we still remain on track. We put in the updated presentation plus or minus right around that 2% level. So we've lost a little bit on fees, but that fee expectation is really coming from transfers and relet fees. So we're seeing a few less people transfer at this time of the year than we typically do. Ultimately, that's a good thing because, typically, they're transferring down. But we lost a little bit there. But I'd say overall on pace. What you have to make up the 2% is about 70 basis points of that comes from blended lease rate growth, about 30% turnover here in the quarter, plus the earn-in from prior quarter. We're picking up occupancy, as you can see in the presentation, plus or minus 20 to 30 basis points. You've got a little bit of incremental bad debt benefit then that other income piece is big. A lot of that is coming from things like the fee income piece, you go into what we're doing with the rollout of Wi-Fi. You have utility reimbursements that come in. You have higher app fees in the third quarter as you have higher turnover expiration. So overall, on pace for that 2-plus percent takes you to about a 5% year-over-year number, ends up what we think will probably end up for the year, probably number 2 or 3 on revenue versus peers, which, given the diversified portfolio, you typically think we'd be in the middle, but 2 or 3 is a pretty good outcome for us.

On the Wi-Fi initiative, is that all hitting in 3Q? Or like how do we think about the cadence of like that hitting the P&L?

Yes. It really is a 3-year initiative. So the way it works is you do a full property install and day 1, you take on the expense load for that install. So if you have a 300-unit community, you're going to fund the expenses day 1. What you ultimately do is force place upon renewal or new lease at a plus or minus $50 premium. And so we're netting anywhere from $35 to $40 on each unit. And so that's what makes up your $15 million to $20 million. This year, it's about a $0 contribution to the bottom line because all of our installs are taking full expense with a little bit of revenue. Next year becomes additive, the year after more additive and then finishes out in '26. So it really is a 2- to 3-year initiative. So you have the financial implications of it. You have the customer benefit, as day 1, they have Wi-Fi in their unit. So you don't have to go schedule and install, go get the equipment, things of that nature. You also end up with full community Wi-Fi. So for the work-from-home crowd, you're not just confined to your unit anymore. You got to go out, walk around the community and have access everywhere. And then the longer-term benefit goes to our Scope 3 efforts where we're trying to reduce Scope 3. We're already doing a great job on Scope 1 and 2. We think eventually, there's going to be a sensor component within many of our units to give the individual to control over their own utilization, be it their washer dryer, their washing machine, the refrigerator, their AC. And so if you have sensors that run through all of that Wi-Fi, which we can control, we're going to empower that resident to be able to actually control their Scope 3 to a better degree.

[indiscernible] Scope 3?

Scope 3. So just CO2 emissions for the -- in the unit piece, 1 and 2 being the pieces that we control in common areas, Scope 3 being the resident controlled, which is about 70% of our total emissions.

Okay. Any questions from the field?

Just thinking about your comments on margins and are seeing some public-to-public M&A [indiscernible], could you be progressive on [indiscernible] public to public in apartments?

I think, to answer the question, which was do you see more -- given our margin advantage, more public to public opportunities. And my response is, we have a transaction, Joe can walk you through it, where we see greater opportunity in the private space, where some of our margin advantage over private operators because of the platform or anywhere from 800 to 1,000 basis points of margin and realize with the average community is $40 million of revenue, you're sitting on 10% expansion just by putting it on the platform. And generally, all of that gets to the bottom line. So that's the type of potential we're seeing. There's a transaction that's exhibited. With respect to the publics, publics are very well-run companies. All have a great platform. They're building it out. They're a little bit behind us, but they're certainly keeping us moving at a faster pace, but the private people are much easier. Joe, anything you'd say about...

Yes, I'd just say -- good question, Jeff. It does go to -- it's a little bit less splashy and it doesn't scale up as quickly, but don't know what we've been doing in the last 3 or 4 years of match funding incremental acquisitions from under-managed assets from the private market probably makes a lot more sense in terms of longer-term accretion, balancing risk rewards. So on Page 12, we do have just a recap of the portfolio acquisition that Tom referenced. So we did the OP unit transaction on a [indiscernible] asset, $400 million transaction that we just closed on a couple of weeks ago. The opportunity set there was about 2x what we typically see on a standard transaction. So you see 800 basis points of margin advantage. So we looked at our Dallas and Austin operating assets. They run about 84%. This portfolio runs about 76% controllable margin. We laid out kind of the different line items that we're going after here from an efficiency or upside perspective. But, ultimately, we really liked the ops upside on this asset. We like that it was self-funded in terms of assumable debt plus OP units where we name the price up at $47.50, a little bit above NAV. We like the fact that we got assumable debt, which was -- it's 3.8% for 6-plus years, which you can't get in this market today. So that has definite value. Plus you got a newer portfolio here that's 5 years old, so it's good high-quality assets with low CapEx profile. So we like going out and doing kind of things like this where you get the cash flow upside over time, but it's not a splash, I guess, is M&A.

That 800 basis points of accretion, like over what time of horizon is that supposed to work through the...

Yes. It's -- some of it, you can enact day 1. So Mike has given the example when we took over this portfolio, they had 35 associates on site. We've already reduced that by several. We expect that to go down to closer to 25 over time. So those individuals can disperse and go to other communities that we have as we have job openings in these asset -- in these markets because we do have a lot of exposure in these markets. But you'll be able to reduce the headcount. Some things like getting some of the amenities in place or in unit pricing, so the Wi-Fi, the smart homes, the package lockers, those take time. You got to order the equipment, get the installs and then rotate it through as leases turn in some cases. So it's a 2- to 3-year number to capture that by 800 basis points. But day 1, I think in 2024, we'll probably be cash flow neutral to positive. When you think about after CapEx on a levered basis, year 2 will be meaningfully accretive.

Just want to go over -- I think there was some confusion after the 2Q call on just like the dynamics of the second half of the year. Like it sounds like messaging occupancy is going to go up and blended rate is going to go up. Could you walk us through that dynamic and what's driving those thoughts?

There's a few things at play here. I think first and foremost, it goes back to how we're driving our occupancy for the remainder of the year. It goes back to a focus on turnover. So if we're able to reduce 100 people per month, we capture 20 more basis points of occupancy. That's how we're doing it. It's not necessarily trying to drive our rents down. So that's a function of it. The other thing that we talked a little bit about on the call is just what's happening with market rents today. I can tell you for the first time in about 7 months, we do have year-over-year market rent growth, and that is a function of 2 things. You have kind of normal seasonal patterns today on a sequential basis, market rents moving in the direction we would have expected. But what you're playing off of about this time last year when we left this conference, market rent started to come down with all the news about layoffs happening on the West Coast. So you had a drop in market rents. You have normal seasonal trends today. If you can maintain just normal seasonal patterns going through the rest of the year, that should translate into new lease growth. When and to how much, that's to be determined. But what I would tell you is we're sending out between 4.5% to 5% on renewals through November at this point. We typically achieve around 20 to 30 basis points of what we send out, and that's anchoring our blends. So if we can achieve those renewal rates, market rents maintain their level, we start to see a little bit of an uptick later in the year on new lease growth, we could see blends start to improve.

Any questions from the field? Maybe just what's causing that market rent growth acceleration that you flagged?

Well, if you go to Page 4, I think that lays out pretty clearly what we're seeing and what we're experiencing by region. Pretty normal in nature. What we are anchoring towards is 1/3 of our NOI in the Sunbelt. Obviously, that's where we've been under a little bit more supply pressure. That's been a little bit weaker than we would have expected. But as you can see on the West Coast, a little bit stronger. I mean, for example, Orange County, it's an 11% NOI market for us. No supply to speak of, actually seeing blends increase a little bit over 2Q. We don't have the exposure of downtown Seattle. We don't necessarily have anything in downtown L.A. We don't have anything in Oakland, and we don't really have much in San Diego. So we haven't been pressured as much as others just based on our geography and where we have exposure to supply. So overall, I'd say, West Coast, East Coast a little bit better, anchored by either Sunbelt bringing us down to some degree.

Is it actually a pretty interesting term for loss to lease. Can you go through the loss to lease across [indiscernible]?

Sure. East Coast, right now, right around 3% loss to lease. That is -- New York is probably driving that to the most part. We see around 5% to 6% loss to lease. Boston is probably closer to 4%. And then DC has been in that 3% to 3.5% range. West Coast, I tell you, it's been strong. And again, we don't have a lot of that exposure to the supply. Jobs have been healthy. Seattle has been probably one of the better performers for us as well as Orange County. So I'd say loss to lease in Northern California, you're looking at a 3.5% to 4% range. Loss to lease down in [indiscernible] today is slightly better. As it relates to the Sunbelt, this is where we are seeing a gain to lease today. I don't know if this comes as a surprise to anybody else. We've been seeing a little bit more pressure points where our exposure is in these markets over the last 6 months or so. And a lot of this has to do with where we're located. For example, Austin, we have a few assets located in the Cedar Park area. That's where about 1,000 units have been delivered over the last year. We expect another 1,000 coming over the course of the next 12 months or so, that's put a little bit of pressure point on rents. And then in Dallas, for us, it's mainly Frisco and it's been Addison, where we have 3,000 units in Addison, 1,000 units in Frisco. And you've seen around 2,000 units delivered to those submarkets. So where we saw a little bit of pressure early on, we're starting to see others feeling that pressure today. We expect this probably last for another 18 months or so, but that's put a little bit more, again, pressure on loss to lease, gain to lease in that region.

Josh, maybe one thing I'd add to that, too, just because we had some questions on it in some of our meetings. You look at here and see the portfolio level loss to lease of 2%. But when you look at our blends of 2%, they're really made up of 4.5% to 5% renewals, offset by a negative new lease growth. And the question came up of, how do you have negative news, but a loss to lease of 2%? That's really because of that comp issue you're going towards that year-over-year market rent growth coming up in fourth quarter. Most of our loss to lease right now resides in that 4Q lease expiration and 1Q lease expiration schedule, not in the current because remember, coming out of this conference last year was when ourselves and a lot of the industry saw a rollover in rents when you had all the headlines on tech layoffs taking place, traffic dried up a little bit just on the headline fears of major layoffs plus recession and demand philosophy. So we saw a much greater than seasonal swing in rents last year kind of September, October. So that's why we have the loss to lease, which is a really good thing, but news right now being slightly negative. That's why all else equal, if we see normal seasonal patterns as we move into 4Q, demand continues to hold up, we battle against supply, you come up on easier comps and see that news potentially start to move higher and start to capture some of that loss to lease. So I just want to clarify because we had a couple of questions like that in our meetings.

I appreciate that. It's good color. Just thinking about the supply dynamic. I have trackers that are more kind of macro than maybe what you guys would look at. Just kind of curious how you're thinking about like the supply impact on your portfolio and maybe how long that overhang could last?

Yes. Overall, I'd say we're kind of getting into the thick of it at this point. So when you look at overall supply in our markets as a percentage of stock, we're somewhere in that 2.5% to 2.75% range, and that applies to both '23 and '24. So we're going to come up on this plateau, if you will, as we go through 3Q, probably through the mid-part of next year. So we think it will be with us for at least another 6 quarters in terms of kind of elevated versus history supply level. Beyond that, we are seeing a pretty precipitous drop-off in starts, depend on what data source you're looking at, plus, anecdotally, I think all of us here that the letters have cut off lending to new construction. We're definitely seeing it within our traditional developer capital program book. The developers we talk to clearly aren't starting new transactions. So we think you'll see deliveries really start to fall off in '25. You're still dealing with some of the lease-ups from '24, but I think the picture really starts to tilt in our favor by the time you can get there. The other piece, of course, is relative affordability meaningfully in our favor. So you're seeing our backdoor close a little bit, less move-outs to buy because of that. New household formations as long as job growth holds up, probably bias towards rentership, either on the SFR side or our side. But I think you're going to capture a little bit from that. And then single-family side, you've seen starts drop-off very dramatically, which will actually bring total housing stock down next year, I think. So we're fighting through it, but you still have a lot of positives on that relative affordability. You got job growth. You've got wage growth. Still got positive GDP growth. So we're not seeing much stress within the consumer base. When you look at collection trends, doubling up utilization of concessions, the different move-out reasons, we're not seeing the stress on the consumer. We're just seeing an average to slightly below average trend right now when you look at the markets based on supply. You got East and West Coast pretty much in line with typical trends, Sunbelt a little bit below.

And to add some color about the absorption because what's critical about it is development is always going to happen, and it's going to be needed. I mean we need 4 million households formations a year, and we're building 2 million. So we're actually building in the wrong direction and not actually supplying it. So you're going to get these periods in markets that get supply waves. The question is, is this market capable of absorbing it? And so far, yes. Why lease-up volumes are running between 5% and 10% a month, which is natural. Second, the market's reaction to attract a new customer is generally at around a concession. Those are averaging 4 to 6 weeks, not a stress point. In fact, they could creep up to 8 weeks and still not have a great deal. The third is, we're generally a B operator where the supply is occurring. And most of the supply is an A product and the gap between the A product and ours generally somewhere between $200 and $500 a month. So not enough quite to entice people to move out of the Bs into the As. And so as long as that gap and that concessionary market remain in that, I think we'll have some degree of impact, but not that unmanageable.

[indiscernible] standpoint purposely want B in, say, Sunbelt markets where there is the [indiscernible].

I found over the years that the A, B argument, the Bs win about 70% of the time through cycles. And so it also represents an opportunity as the market increases, residents do in terms of income potential. I can always improve a B and move up the food chain, if you will. But once you start with an A, I only got one direction to go. And I just -- it's hard to always capture outsized growth margin expansion in an A product versus a B product.

Any questions from the field? One of the questions I get a lot from the field is on operating expenses. It's insurance, real estate taxes, in particular. Just kind of any early thoughts on your insurance renewal? I think it's up for renewal in end of December.

Yes. I guess, first off, just because we didn't address the expenses upfront, we communicated, I think previously, we expect a pretty big drop-off on year-over-year growth in expenses in the second half versus first half. we do see that occurring. So there's been questions of how do you expect to get there? It's a combination of ROI dollars a much easier comps. So I'll hit that on the expense side right off. As it relates to next year, next year kind of feels a lot like this year, to be honest, in terms of the kind of overall levels when you mash everything together. Specific to insurance renewal, it comes up in December, I'd say, while insurance is about a 5% line item for us, that's kind of a 50-50 premium and small claims activity. So the claims activity can be volatile. That's why you see our insurance expense year-to-date being down. We're coming off of 2 really elevated years of -- at the end of the day, our consumer is sitting home a lot more, not being in the office. And when they're home a lot more, they cause more fires and cause more damage. So you do have half of it that's a little bit more, I don't want to say, controllable, but not subject to the pressures of what we're seeing in the broader insurance premium market. I think, for our renewal, we'll see where it goes. But you're probably looking at another challenging year. Last year, we were at 20-plus percent. Wouldn't be surprised by the same type of levels this year. The thing we'll continue to do is slice and dice our stack and try to evaluate where are we getting hit for more premium relative to loss history, and then you evaluate do you want to take some self-insurance risk on that.

So Tom, we're getting close to the end of the time. And I just wanted to ask, like, do you think there's anything that's misunderstood about UDR, not fully appreciated by the markets right now?

No. One, I think I have an award-winning IR team. Trent's done a fabulous job. Always accessible. He really likes the 1 a.m. calls from wherever you are on the planet, he can field them. Second, you can see that we've always been transparent with our data and trying to always push more and more information because that helps you evaluate where you want to make your investments. So I don't really believe there's anything misunderstood about the enterprise.

Thinking about allocation of capital today, anything starting to get interest in the acquisition market, development front or just other uses?

Yes. We already talked a little bit on the OP unit transaction. So clearly, anytime the undermanaged assets can come up and be self-funded, we're going to be all ears on those type of transactions. The joint venture that we talked about that we got done in 2Q, we did the $500 million, 50-50 JV with LaSalle on behalf of a large institutional client. That was sourced in the low 5s effective yield. We're very focused on redeploying that dry powder with that partner. So we've got about $500 million of gross dry powder between them and us to deploy. We're looking at transactions. And I think that's one of the big things that we are focused on right now. I don't know if we'll have much to talk about this year, but I would say the fact that we source that in the low 5s have that capacity based off the type of asset we're looking at for that JV, generally a little bit more value-add, plus the combination of fees that go on to that on a recurring basis, we're probably going to capture a 50 to 75 basis point cash flow spread relative to where we source that capital. So very focused on that front. Development, we've delayed any starts that we had. We're going to build up optionality, be ready to go with a larger pipeline if and when all the numbers make sense and cost of capital makes sense. But nothing there near term. I mentioned the DCP pipeline, really nothing to speak of, given like a development today. We'll probably see more recap opportunities from developers that are now trying to go to more permanent structures. We'll probably see more of those in the next 12, 24 months that we'll take a look at. Aside from that, we're doing a little bit more redevelopment. But that's kind of it for right now.

Remind you, Fannie and Freddie represent an enormous asset for this industry, and with it lending through the government programs. Right now, 10-year paper is about [ 5.5 ] at about a 60%, 65% proceeds number. So represents a lot of stability with respect to capital transactions. Just our cost of capital and that don't equate to a lot of opportunities of the window.

So we're just about out of time. We've been asking 3 rapid fire questions to all the management teams. they're -- you probably already know these because Trent's heard them, I think, 10x already. But the first one was, do you believe the Fed has done hiking yes or no? And do you expect the Fed to cut rates in 2024, yes or no?

No, yes.

No, yes. Do you believe real estate transactions will meaningfully pick up by, a, the fourth quarter of 2023; b, the first half of 2024; or c, the second half of 2024?

C, second half of '24?

The last one is, are you using AI today to help you run your business? Yes or no? Do you plan to ramp up spending on AI initiatives over the next year, yes or no?

Yes, on the AI. And just as a data point, 97% of our leases today are assisted by ChatGBT or executed by our chat. Future, absolutely.

Awesome. Thank you, guys.

Thank you.