Hello, everyone, and welcome to the Centerspace Fourth Quarter 2022 Earnings Call. My name is Daisy, and I'll be coordinating the call today. I would now like to hand the call over to your host, Joe McComish, VP of Finance to begin. Joe, please go ahead.

Centerspace's Form 10-K for the year ended December 31, 2022 was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted to our website at centerspacehomes.com and filed on Form 8-K. It's important to note that today's remarks will include statements about our business outlook and other forward-looking statements that are based on management's current views and assumptions. These statements are subject to risks and uncertainties discussed in our filings under the section titled Risk Factors and in our other filings with the SEC. We cannot guarantee that any forward-looking statements will materialize and you are cautioned not to place undue reliance on these forward-looking statements. Please refer to our earnings release for reconciliations of any non-GAAP information, which may be discussed on today's call. I'll now turn it over to Mark Decker for the Company's prepared remarks.

Thanks, Joe. Good morning, everyone, and thank you for joining us. With me this morning is Anne Olson, our Chief Operating Officer, and Bhairav Patel, our Chief Financial Officer. 2022 was an ambitious year for Centerspace. We had several large forces at work, multiple large integrations of communities, people, and systems from late in 2021, meaningful labor pressures given that all of our communities are in highly employed markets, inflation, and the reset of the cost of capital. And yet, we did continue to grow the quality of our portfolio and we were able to grow core FFO per share by 11%. I'm confident we're on the right track as I listened to the many earnings calls and speak to private peers. We're in good company as it relates to strong fundamentals and expense challenges, though we are different in terms of our Midwest and Mountain West market exposure that's provided us with leading consistency in revenues and NOI growth since 2018. I get more excited when I consider that we've been able to find accretive ways to grow and our internal growth opportunity remains since we really are just a five-year-old owner-operator. I'm sure Anne will have some depth to the operating commentary, so I'll stop there. But before I move on, I want to say thank you to our teams in operations and support who continue to show incredible dedication to our residents and each other. Moving to capital allocation and balance sheet. We had a quiet first half as we pursued a large strategic portfolio that would have been funded with stocking units that didn't break our way. We got a little more active in the second half of the year and we deployed capital to continue to improve our portfolio, purchasing a newly built property in Denver, Lyra, for $95 million. And we also took advantage of the dislocation in public markets to buy back some of our own shares at a significant discount to intrinsic value. In all, we deployed about $125 million. Our plan was to fund those investments with the equity from sales of some of our least-efficient and most capital-intensive communities, as well as long-term fixed-rate debt, and that is what we expect will happen in the coming months, as we have 1,500 homes under contract today and we've rate locked a $90 million mortgage for 12 years at just over 5%. We delayed our financing plan to let the market settle, and in so doing, took more variable rate exposure. This proved to be the right long-term thing to do, but did cost us in the short-term and that's reflected in our results for Q4, and to some extent, our 2023 guidance where you can see that interest expense is eating into strong operating results. Asset sales may also hamper core FFO per share growth. However, in our analysis, our cash flow and quality of earnings has improved, and that's a trade-off we like and will continue to seek. I'm pleased to say that we expect, in the next 60 days, to have long-term financing in place and have our line nearly back to zero. So when it's all said and done, we'll have a robust and scalable operational system with numerous chances to improve resident and team experience while gaining efficiencies, a portfolio of communities with better long-term pricing power and ability to grow and distribute cash flow, and abundant liquidity with an untapped line, low blended rates, long maturities and a formidable unsecured asset base. Looking forward, considering our overall outlook, we believe that our portfolio provides a strong value proposition to our residents that our residents are economically strong and our portfolio of communities are among some of the least exposed to new supply in the public markets. We're excited about the opportunities to continue to improve the Company in 2023 and beyond. And with that, Anne, would you please provide a quick operations update.

Thank you, Mark, and good morning. I'm happy to say that 2022 was a great year, and like Mark, I'm extremely grateful for our team and their hard work. We ended the year with 9% growth in our same-store net operating income compared to 2021. Revenue was the highlight for the year with our same-store growing at 9.3% in the fourth quarter compared to the same period in 2021 and 10% for the full year. During the fourth quarter, our same-store new lease rates increased 1.8% on average over the prior leases, and same-store renewals achieved average increases of 7.2%. On a blended basis, this is fourth quarter rental rate growth of 4.2%. During 2022, overall, our same-store portfolio achieved an average new lease increase of 8% while renewals increased 8.4%. Renewals remain strong, given the significant growth in rates we saw earlier in the year and we are experiencing a return to normal seasonality in new lease pricing. During January, our new leases saw positive increases at 1.4%, while our renewal rents increased 6.5% over the prior lease. Our traffic has returned to pre-COVID trends and is currently up year-over-year. We feel good about the demand in our markets, the financial health of our residents is strong and we increased weighted average occupancy 40 basis points during the fourth quarter to 94.9% while maintaining collections of 99.8%. Expenses came on quickly in the second half of the year, and while we are experiencing our fair share of inflationary effects on labor and materials, utility increases contributed 26% of our overall same-store expense increase in 2022 over 2021. On a controllable expense basis, it was 32% of the total increase year-over-year. We are projecting utility expenses will remain relatively flat in 2023, and as we look forward, we believe that the bulk of the inflationary increases were realized in the second half of 2022, and thus our expense growth will moderate. Of note, we had an increase in eviction and similar activity in Q3 and Q4 with 10% of our expirations attributable to evictions in Q4. These drive expenses related to legal and administrative fees and often correlate to high return costs. We believe that activity, which was driven by the mid-year lifting of the rental assistance programs in Minnesota, will taper this year. As we start 2023, we're focused on systems and processes that will gain efficiencies and contain expense growth. Now, I'll turn it over to Bhairav to discuss our overall financial results and 2023 outlook.

Thanks, Anne, and good morning, everyone. Last night, we reported core FFO for the quarter ending December 31st, 2022 of $1.17 per diluted share, bringing our full year core FFO to $4.43 per diluted share, which represents an increase of 11% over the prior year. The key driver of the increase was strong growth in same-store net operating income. As Anne mentioned, although we felt expense pressure across the board during the second half of the year, same-store revenues established a strong foundation to sustain operating momentum as the impact of inflation and higher energy prices on expenses begins to moderate. I will discuss that in further detail when I cover our financial outlook for 2023. Turning to our financial position, we continue to take steps to further strengthen our balance sheet and broaden our capital options. During the fourth quarter, we repurchased 427,000 shares at an average purchase price of $67.25 per share, which we believe to be a significant discount to the value of our portfolio. Also, during the fourth quarter, we closed on an unsecured $100 million term loan facility with an initial term of one year with a one-year extension option. The loan bears interest at SOFR plus a spread of 120 to 175 basis points based on our leverage ratio. The current spread on the loan is 130 basis points, which is roughly in line with the current spread on our unsecured line of credit. The term loan augmented capacity and provided balance sheet flexibility during a period of extreme volatility and uncertainty in the capital markets as we embarked on a plan to prune the portfolio, as Mark discussed in his remarks. As of December 31st, 2022, we had total debt of $1 billion with a weighted average maturity of 5.8 years and a weighted average interest rate of 3.62%. Now, I will discuss our financial outlook for 2023, which is presented on Page S-17 of the supplemental. At the midpoint, we expect same-store NOI growth to be 8% in 2023, driven by continued top line growth coupled with a moderation in expense growth. The key components of revenue growth are earn-in of approximately 4% at year-end, projected blended rate growth of 4.5%, driven in part by value-add spend and the expansion of what we collect in RUBS across our portfolio. We expect total expenses to grow by 5.5% at the midpoint compared to 11.6% during 2022, as we anticipate key drivers of higher growth in 2022, such as utilities and R&M to remain relatively flat in 2023. Almost two-thirds of the increase in expenses is driven by higher real estate taxes and insurance costs as assessed values and premiums continue to rise. We expect core FFO for 2023 at the midpoint to be roughly flat compared to 2022 at $4.42 per share as the impact of higher interest expenses and the planned dispositions is expected to offset strong operating results. Approximately, 21% of our total debt as of December 31st, 2022 was variable rate debt with short-term rates projected to be significantly higher in 2023. However, we expect to refinance approximately $90 million of our current floating rate debt to fixed-rate secured debt at a coupon of 5.04% and a maturity of 12 years as we were able to rate lock during a brief window of time when the 10-year yield dipped slightly below 3.6%. We are pleased to have locked in those savings as treasury yields have since risen by approximately 35 basis points. Lastly, as Mark mentioned in his remarks, our guidance assumes disposition proceeds of approximately $155 million to $165 million from the planned sale of 11 assets or approximately 1,900 units. We expect to close nine assets for approximately $140 million by the end of the first quarter with a balanced plan to be completed by the end of the third quarter. The proceeds from the dispositions will be used to pay down outstanding balances on the term loan and the line of credit. Pro forma for the refinancing and asset sales, our weighted average interest rate as of year-end would have been 3.5%, our weighted average maturity would have increased by over a year and a half to 7.5 years and our variable rate exposure would decline to approximately 1% of the total debt balance post the paydown. Additionally, our leverage would decline by about 1.1 times and our capacity would be fully restored, further strengthening our balance sheet. To conclude, I would like to thank our entire team at Centerspace for their contribution in making 2022 one of the strongest years in the history of the company. While there are challenges ahead, we are extremely confident in our team's ability to execute our operating strategy and propel Centerspace to newer heights. And with that, I will turn it over to the operator to open it up for questions.

Thank you. Our first question today comes from Brad Heffern from RBC Capital Markets. Brad, please go ahead, your line is open.

Yeah, thank you. Good morning, everyone. On the dispositions, can you walk through exactly where those assets are, the cap rate you expect, and what the dilutive impact was on the guide?

Sure. Good morning, Brad. This is Mark. I'll start by saying that two of the assets are in Nebraska, one is in Lincoln and the other in Omaha. There are five in St. Cloud and three in the Greater Twin Cities area, specifically Minneapolis. So that’s where they are located. The dilutive impact is estimated to be between $0.08 and $0.10. What was the other part of your question, sorry?

Just cap rate.

Oh, cap rate. Yeah, low sixes on a trailing basis. It's probably higher than that on a forward basis. But on an AFFO, contribution below the line, I think it's actually going to be a net accretive or slick.

Okay, got it. And then on the utility front, can you give an update on the progress that you're making in having the residents be responsible for their own utilities, and I guess is that contributing at all to your expectation that utility expenses will be flat year-over-year?

Anne, do you want to take that?

Good morning, Brad. Regarding the rollout of gas and key utilities into the RUBS, we began that project in May and June, and it typically takes just over a year to complete all lease transitions. We're slightly less than halfway through because we encountered some months with lower lease expirations. This affects our revenue growth, as it will reflect positively in our revenue line. Our expectation that utility costs will remain relatively stable is based on a thorough analysis of utility expenses and future projections, especially considering the sharp increases experienced last year. We anticipate that these increases will moderate, which will significantly reduce the year-over-year figures. However, the recovery reflected in our revenue does not influence the expense side.

Okay, got it. And are you seeing price sensitivity around that? I know you sort of expected that as you make people responsible for their own utilities that they will become more rate sensitive and there potentially be an offset. I guess, are you seeing a full offset to that or are you still sort of recapturing some uplift from it?

Yeah, we've had very little pushback. In fact, I check with the team pretty regularly to make sure that that isn't happening. When you have renters looking at their full chunk rent, they take into account the utilities. So we haven't had much pushback on it at all. And in fact, we still feel really good about where our overall rental rate growth is, both from a new lease and renewal given where we are right now in the season.

Okay, thank you.

Thanks, Brad.

Thank you. Our next question today comes from John Kim from BMO Capital Markets. John, your line is open, please go ahead.

Thank you. Good morning. Your same-store revenue guidance is noticeably higher than most of your peers. I guess, you have a few weeks of additional data, given the timing when you report. But I wanted to focus on the 4.5% blended lease growth rate that's in your assumption. Can you break that down between market rental growth and renewal rate growth that you expect?

Sure, John. This is Bhairav. With respect to the blended rate growth, I would say, about 3% to 3.5% is projected market rent growth. The remainder comes from projected value-add spend in 2023, plus some of the value-add spend we've put into the portfolio in the second half of 2022, which will enable us to capture some of the premium as we go through the lease roll.

Okay. You had a significant delta between renewal and new lease I think in January that Anne had mentioned. Do you think that's going to continue throughout the year?

I believe it will take some time to equalize the rates. Our new lease rates are still much higher than our renewal rates, and there were months last year when our new lease rates grew significantly, which means it will take time to catch up. I expect to see some moderation in these rates. They tend to lag behind the new lease rates by a couple of months, so we should see them decline slightly as the year goes on. However, as new lease rates are expected to rise to between 3.5% to 4.5% during the prime leasing season, we may see an increase overall.

Have you disclosed your bad debt in 2022? If not, can you say what that is? And also, what you're expecting as far as bad debt in 2023 as well as your occupancy assumptions for the year?

Yeah, so for bad debt in 2023, our projections incorporate about 40 basis points of bad debt. With respect to 2022, you're right about that mark, I think we had about 30 basis points of bad debt for 2022. With respect to occupancy, we expect to stay around 95%. As we go through 2023, obviously, there is going to be some volatility as we go through peak leasing season. But overall, we expect to maintain occupancy around the 95% mark.

Okay. Last question from me. How do you feel about your dividend levels these days? On our numbers, your payout ratio is above 90, I know consensus is below that. But given the cost of debt and maybe some attractive use of proceeds, are you satisfied with your dividend level where it is today or is there a possibility that you can resize it?

It seems you are factoring in all types of capital, including value-add capital, to arrive at that payout number, which is quite high.

Correct.

How do you get to that number, John?

Revenue enhancing CapEx, we typically do that.

Got it. Our perspective is that revenue-enhancing capital is discretionary. We estimate our payout ratio to be in the high 70s, and our objective is to gradually reduce that ratio to around the mid-60s. While we aim to continue growing at a modest pace, we feel that current compensation isn't adequate. Nevertheless, part of our mission is to generate cash flow and increase returns to our shareholders. The decision lies with the Board, of which I am a member. In my opinion, the dividend is secure. We have around 50 assets with approximately 25% leverage when considering our unencumbered base against our unsecured debt, which provides us with considerable financial stability. The Board shares a similar outlook.

Okay, I appreciate it. Thank you.

Thanks, John.

Thank you. Our next question comes from Alexander Goldfarb from Piper Sandler. Alexander, please go ahead, your line is open.

Good morning. For the first question regarding the dilution from the asset sales, Mark, you mentioned it would be $0.08 to $0.10. Is that figure including the debt repayment, or is it just based on the asset side? If debt repayment is considered, the dilutive effect would obviously be lower.

Yeah, so this is Bhairav.

Hey, Bhairav.

That $0.08 number is inclusive of the impact of the debt pay down. With respect to 2023, we had some growth from a core FFO perspective program for those assets. So when you kind of consider that and then net it down with the impact of the pay down, that's the number that Mark was referencing.

Okay. So the $0.08 to $0.10 is inclusive of the associated debt pay down?

That's correct.

Okay. Then the next question is, Anne, you mentioned that you started implementing RUBS around the middle of last year, which takes about a year to fully implement. Is this for the entire portfolio, or are there specific assets that cannot implement RUBS, meaning you will still be exposed to utility costs in those assets?

No, this is the entire portfolio.

Okay. So there won't be any assets that are free-floating, correct?

There may be a few unique situations, but we don't have any geography where regulations would limit our ability to proceed. So as long as it makes sense, we're implementing it.

Okay. And then just the final question. You guys put out a Nareit FFO, you put out core FFO. But in looking at your core FFO, it seems to be a lot of recurring items that seem to be just part of running the business. So just sort of curious, why not merge just to Nareit FFO, especially as these don't seem like one-off items they seem to happen every year?

I mean, fair comment. We'll take it under consideration.

Okay. Thank you, Mark.

Thanks, Alex.

Thank you. Our next question is from Rob Stevenson from Janney. Rob, please go ahead, your line is open.

Good morning, guys. Mark, what's the acquisition pipeline looking like today? Lots of talk in the sector about merchant developer stress coming and positioning to step in as a capital source. Are you guys seeing any of that yet? Are you guys seeing any attractive acquisition opportunities to redeploy capital into, how would you characterize that today?

Good morning, Rob. Thank you. I would say we are noticing opportunities. I believe that by the end of the year, some merchant developers will be exiting the market and will likely take profits, though probably less than they anticipated. We are engaged in discussions about these situations and have a few ongoing conversations regarding OP units, as is our usual practice. However, I would mention that volume has not really materialized yet. I noticed that around $40 billion was transacted in the fourth quarter, which is decent compared to most periods, but it's certainly lower than the levels we’ve seen in recent years. At the NAHC, there was a sentiment among people that they are looking ahead to the second half of the year. On the buy side, there is still a noticeable disconnect, and the fluctuations in treasuries are, to some extent, dampening enthusiasm. We do expect some activity, likely more in the latter half of the year, especially with our stock currently in the mid-60s and secured debt around mid-5s, while unsecured debt is probably around six for the quarter. As it stands, we aren't very active participants unless there’s a structured opportunity.

How would you assess your current approach to initiating new revenue-generating capital expenditure projects, considering the market conditions and your internal forecasts for this year and next? Is your stance similar to what it was a year ago, or are you feeling slightly more cautious? How would you describe your willingness to approve funding for these projects at this time, along with the associated hurdle rates?

A year ago was definitely more enjoyable, Rob, with the era of free money coming to an end. However, our perspective hasn't shifted significantly. The capital we invest is crucial for securing returns in the coming years, and we proceed with these investments only if they enhance the product for our residents. Currently, our renewal rents fall within the $1.50 to $1.60 per foot range on a portfolio basis, and there remains a substantial difference between these rents and those for new properties, as people are drawn to high-quality offerings. As long as there's a valid business case, we will continue to invest. That said, we are now applying more scrutiny to the business case because the initial costs or funding requirements have increased. This situation does encourage a bit more discipline, but it doesn't suggest a lack of discipline in the past, which is not accurate.

Okay. And then last one to me, you guys talked about the utilities and the natural gas. Are you guys hedging any of that at this point? And how big is the dollar value sort of tied to natural gas?

Yeah, Bhairav.

Yeah, from a hedging standpoint, no, I think, as Anne mentioned, we are with the RUBS program being rolled out, we would be able to capture most of that back through the revenue line item. So it's going to dramatically reduce our exposure to the fluctuation in prices from a utility standpoint. I believe overall that accounts for about 40% of the total utilities expense, the gas prices. But again, with the rollout, the exposure on a net basis would be a lot lower going forward once it's fully implemented.

Okay. So once this is fully out, there's not going to be that much of a delta between, if you're talking about natural gas prices that average out to six-something per million BTUs like last year or the $2 to $3 that you saw from basically 2015 to 2020?

That's correct. After accounting for collections and common area deductions, we would cover approximately 80% to 85% of the exposure.

Okay. And same in terms of water and other utility costs or is that de minimis compared to natural gas?

Yeah. In terms of water and sewer, I mean, we capture back a lot of that. So overall, that's already factored into the numbers. So the exposure was on the gas side.

Thanks, guys. Appreciate the time.

Thank you. Our next question is from Wes Golladay from Baird. Wes, please go ahead, your line is open.

Hey, good morning, everyone. I just have a quick one. For the casualty loss, is that just a general placeholder for the guide or is that a known event at this point?

I mean, are you talking about the 2023 guide? That's just

Yeah, I think there’s a $1 million impact.

Yeah, so that's an estimate at this point in time.

Okay. Thanks, everyone.

Thanks, Wes.

Thank you. We have no further questions. So I'd like to hand back to the team for any closing remarks.

Thanks very much, Daisy. Well, thanks, everyone. We appreciate your continued interest, and we look forward to seeing you next quarter.

Thank you, everyone, for joining today's call. You may now disconnect your lines, and have a lovely day.