Welcome to the Elme Communities Second Quarter 2023 Earnings Conference Call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Amy Hopkins, Vice President, Investor Relations. Amy, please go ahead.

Good morning, and thank you for joining our second quarter earnings call. Today’s event is being webcast with the slide presentation that is available on the Investors section of our website and will also be available on our webcast replay. Before we begin our prepared remarks, I would like to remind everyone that this conference call contains forward-looking statements that involve known and unknown risks and uncertainties which may cause actual results to differ materially, and we undertake no duty to update them as actual events unfold. We refer to certain of these risks in our SEC filings. Reconciliations of the GAAP and non-GAAP financial measures discussed on this call are available in our most recent earnings press release and financial supplement, which was distributed yesterday and can be found on the Investors page of our website. And with that, I’d like to turn the call over to our CEO, Paul McDermott.

Thanks, Amy. We delivered a very strong second quarter with same-store multifamily NOI growth of 10.9% and core FFO per share growth of 14.3% year-over-year. I am very pleased to share that we have officially completed the transition of community-level operations to Elme management. We kicked off this strategy in 2021, and I want to thank all of the team members that contributed countless hours designing and implementing our new operating model. I would also like to welcome our newest community team members and thank them for their hard work and dedication to customer service that they’ve shown throughout this transition. We launched our new platform with minimal disruption to our existing residents and very high community team retention. We are thrilled to have this transition behind us, and we look forward to turning our full attention to our operating initiatives. On that note, we welcomed our new Chief Operating Officer to our executive team in July. Tiffany Butcher brings extensive experience in multifamily operations that aligns well with our goals for our operating platform. I expect her leadership to enhance our ability to drive NOI growth and look forward to her participation on future earnings calls. Before I turn to our operating trends, I’d like to address our multifamily NOI guidance reduction. We had expected to see a more pronounced seasonal upswing into the spring and summer leasing seasons than we experienced in our markets. Additionally, our rebranding and transition activities had a greater impact on our ability to generate leads and push rents during the summer months than we had anticipated. These two impacts resulted in lower-than-expected new lease rate growth achieved during the second quarter and lower assumed new lease rate growth in the third quarter compared to our original expectations. As communities have transitioned, we have been closely monitoring community-level performance and have seen a rebound in our ability to drive rent growth as communities have restabilized under Elme management. Additionally, our renewal rates and occupancy trends remain in line with our expectations. Therefore, we feel good about our outlook for high single-digit same-store multifamily NOI growth this year, which represents strong performance for our core business during a period when we were executing significant changes to our internal systems. With the execution risk related to the onboarding process now behind us, we are shifting our focus to realizing the full benefits of our new multifamily platform. Turning to operating trends. We generated effective blended lease rate growth of 3.7% during the quarter for our same-store portfolio, comprised of renewal lease rate growth of 6.4% and new lease rate growth of 0.4%. Renewal rates remained very strong throughout the summer months, and we signed renewal offers for July and August lease expirations of 5% on average in line with our expectations for continued moderation in renewal rates over the course of the year. Our focus on occupancy continues to deliver good results, and we have driven occupancy gains across our entire portfolio since the end of last year. Same-store occupancy averaged 95.6% during the quarter, up 10 basis points compared to the prior quarter, and ending occupancy was 95.9%, up 30 basis points year-over-year. Retention remains strong at 63% during the quarter, up 200 basis points compared to the prior year and above our historical average in the mid-50% range due to lower move-outs of tenants and our focus on maintaining strong retention throughout the portfolio transition to Elme management. Our geographic expansion strategy has yielded solid results thus far, and our Atlanta communities are contributing very good growth. Revenue for our same-store Atlanta portfolio increased 15% year-to-date compared to the prior year period, and NOI grew 24%. Occupancy for our entire Atlanta portfolio averaged 94.2% during the second quarter, 120 basis points above the market average due to our focus on driving occupancy. Same-store multifamily revenue increased 9.6% in the second quarter compared to the prior year, comprised of approximately 9.5% growth from our DC Metro portfolio and over 12% growth from our Atlanta portfolio. Our current rent levels translate to rental growth of approximately 5.6% year-over-year, which represents 90% of the rental rate growth we need to achieve the midpoint of our guidance. Turning to renovations, our price points provide the opportunity to offer like-new interiors at several hundred dollars below the monthly costs of Class A apartments, which allows us to generate cash-on-cash renovation premiums in the mid-teens. We have completed over 141 renovations year-to-date at an average ROI of approximately 14%. This return does not include the market rent growth that we achieved. By executing renovations on turn, we have the flexibility to increase or pull back the pace of renovations as revenue maximization opportunities shift. Given the very strong renewal rates we are seeing, we are strategically keeping turnover low and have, therefore, slowed down the pace of renovations as fewer homes have become available to renovate. While our total pipeline and value creation opportunity has not changed, we now expect to complete 300 to 350 renovations this year. With a 2,900-unit pipeline, we have more than enough runway to drive renovation-led value creation over the next several years. The rent-to-income ratio for new leases signed in the second quarter was in the mid-20s, consistent with our historical average, and the average income for those leases increased nearly 9% year-over-year as we continue to see that income growth is keeping up with the pace of rent growth in our markets. For the first time since early 2021, the affordability outlook is improving nationwide as middle-class wages grew faster than the rate of inflation in May and June. Despite improving affordability, the cost of owning a home or living in recently built apartment communities remains unaffordable for mid-market renters in our markets. Near our communities, recent deliveries are priced $440 to $680 or 28% to 32% more than our rents. The cost of owning a home is even higher compared to our mid-market rent levels. In addition to the relative insulation provided by our price points, most of our communities are not located in the path of new supply next year. While at the market level, annual supply will peak for Washington, D.C. and Atlanta in the third quarter of 2024, over 40% of Elme’s communities are located in submarkets where supply is expected to peak this year. Overall, as we look towards 2024 and beyond, we see favorable demand dynamics for our price points, supported by the financial health of our residents and the improving outlook for wage growth versus inflation and the affordability of our rent levels for the deepest section of the rental market. With that, I’d like to turn the call over to Steve Freishtat, our CFO, to discuss our transition to Elme management, balance sheet, and guidance updates.

Thanks, Paul. I’ll start by reiterating how pleased we are to have achieved our goal of having the full transition of community operations behind us by the end of July. Our focus on making this transition as seamless as possible for our residents supported very strong resident retention and renewal rate growth throughout the onboarding process. Thanks to the extensive amount of planning and relationship building done by our teams, 93% of our community-level staff chose to transition to Elme, which provided continuity for our residents during the transition. With the transition behind us, our teams now have significantly more capacity to focus on driving operational improvements and leveraging our new technology to increase our profitability. These operational upside initiatives include smart home packages that will drive higher rents and reduce operating expenses, reducing vacant days by implementing revised scheduling, policy and process adjustments to manage our occupancy levels more effectively, fee income opportunities, cash management, and expense initiatives, and centralizing resident accounts management, which represents Phase 1 of our multi-year centralization initiative. We estimate the additional FFO that we expect to generate from these initiatives above what we would have otherwise generated from 2023 through 2025 to be between $4.25 million and $4.75 million. Furthermore, we have the opportunity to drive additional upside by centralizing renewal negotiations, leasing, and maintenance, and we look forward to providing more detail as we continue to make progress on our centralization plan. Moving on to our balance sheet. We are well positioned with limited exposure to interest rates and no debt maturities until 2025 with options to extend our 2025 term loan maturity another two years. Our annualized second quarter net debt-to-EBITDA was 4.8x, and we have over $680 million of availability on our line of credit as of the quarter-end. We are running below our targeted leverage level with about $100 million to $150 million of investment capacity. We will continue to evaluate acquisition opportunities in our target markets as owners come to terms with the reality of an ongoing higher interest rate environment and will pursue further acquisitions when they create additional value for shareholders. Now turning to our outlook for the balance of the year. We lowered the top end of our core FFO guidance range to $0.96 to $1 per fully diluted share. As Paul mentioned, the reduction in our same-store and non-same-store multifamily NOI growth guidance ranges are the result of lower-than-expected new lease rate growth expectations for the year. We have seen a sequential improvement in new lease rates in July and are seeing a favorable trend in August. Given our year-to-date growth achieved and the trends we are seeing heading into the fall, we feel good about our ability to achieve high single-digit same-store NOI growth for the year. We lowered our guidance for G&A by $750,000 at the midpoint, interest expense by $500,000 at the midpoint, and reiterated our guidance for Watergate 600. Watergate is approximately 88% occupied. We have no remaining lease expirations this year and limited lease rollover over the next few years. We continue to expect our core AFFO payout ratio for this year to be at or below our mid-70s target, and we are managing to an AFFO growth profile that should provide us with additional flexibility to grow the dividend over time. And with that, I will now turn the call back to Paul.

Thank you, Steve. To conclude, we remain on track to achieve very strong growth this year despite some friction related to our community onboarding process. The onboarding process is now complete, and the execution risk related to transitioning our systems is behind us. We have been doing all our pricing and asset management in-house since 2017. But for the first time, we have the team and technology in place to take our platform to the next level. Ninety-three percent of our community teams transitioned from our third-party managers to Elme. Our regional managers have over 20 years of experience in our markets, and we have a new COO with an extensive background in residential asset management. Given where we are today and the opportunity set ahead of us, we believe our value proposition is compelling, and we expect to earn a lower implied cap rate as we deliver the operational upside embedded in our platform. And now, operator, I’d like to open it up for questions.

At this time, we are opening the floor for questions. Your first question is coming from Jamie Feldman from Wells Fargo.

I know you provided some insight on the guidance cut, but could we explore this in more detail? Can you explain your initial guidance, the first revision, and this latest adjustment? Specifically, what was the process of gathering information, what did you learn, and what led to the decision to cut it again? We would like clarity on whether this will be the final adjustment.

Yes, Jamie, this is Steve. Looking back to the start of the year, we initially discussed our guidance when we released it in September and reaffirmed it in February. We experienced more demand during the spring leasing season, which helped us achieve better rental growth on new lease rates. However, by April, we did not see the anticipated early spring leasing activity that would have allowed us to reach the upper end of our guidance. To be transparent, we adjusted our guidance in April to better reflect the situation. Now, as of August 1, we have observed demand trends that have influenced our lease rates, prompting us to make further adjustments based on current market conditions. Our data from July and August shows improvement, but it still falls short of what we needed to meet our initial guidance. This updated guidance reflects our current market observations and early lease information for September as well. Regarding our outlook, we mentioned in our prepared remarks that most of our rental rate growth was secured by the end of June. With the onboarding process now complete, we believe the risks associated with it are behind us, although we will see some impact from recent onboardings in Q3. On the expense side, we have seen stability, and we feel confident in our ability to adhere to this revised guidance.

Okay. And just to confirm, how much of the change is due to kind of bad information because pre-internalization and how much of it is purely fundamentals. It sounds like it’s mostly fundamentals from your answer. I just want to confirm that.

Yes. I mean we’ve looked into it. It’s hard to quantify which of it is kind of the market growth versus the friction from onboarding. So it’s both happened during at the same time during the spring leasing season. We certainly felt the impact of both. With the transition behind us, as I said, we’re now poised to drive growth with everything under our own management. And our revised guidance reflects the more modest expectations for new lease rates kind of trending throughout the rest of the year.

Okay. And then what are your assumptions on rent growth in the third quarter and fourth quarter?

Yes. So looking at as far as our renewals and new lease rate growth, when we talk about renewals, it’s really the renewals have stayed in line with how we saw them coming into the year that high single digits at the beginning of the year, by the middle of the year mid-single digits, and really trending down to the lower single digits towards the end of the year. And that’s really been following that pattern. As far as new lease rate growth, we’ve seen now July and August tick up a bit from where the new lease rate growth has been around 1% to 1.5%. But we’ve got it then kind of coming down towards the end of the year and finishing the year just above flat.

And do you think supply has an impact on that moderation?

This is Grant. So we definitely think that supply is having an effect on the overall market performance. But as we’ve messaged for a while, we’ve remained really disciplined in deploying our capital and really looking to stay below 95% of market median rents on the capital we have put out, and we do think that’s blunting the most direct impact of new supply. But we have seen that the share of product that’s in lease-up or that is delivered since 2021, that’s below that 95% threshold has increased this year from around 3% to around 12%. But even so, when you look at the submarkets immediately surrounding our properties, there’s still a significant gap. So for Washington, that gap is around 450 or 24% versus Class A product. And in Atlanta, that’s around 470 or 30%. So we really don’t see a lot of cross-shopping on our product within our Class B resident base.

Okay. And then just one more for me. You cut your G&A guidance. How does that impact your ability to grow the platform? I think in the past, you said you can expand by 80% without adding more G&A. Does that lower that number?

No, Jamie, I think that our movement in guidance this quarter for G&A is more impactful to just 2023 and not really ongoing that what we’ve said before about the ability to nearly double the unit count of the company and keep G&A materially still the same, still applies here that we’re still focused on growing the company and this guidance adjustment hasn’t changed that.

Okay. So can I assume from your answer that it ramps back up in 2024 if it’s just a 2023 G&A cut?

We are not giving ‘24 guidance right now, but like I said, the impact that we just adjusted for this quarter for G&A is related primarily just to ‘23.

What exactly is the cut?

It’s just a compensation adjustment for ‘23.

Our next question is coming from Alan Peterson from Green Street.

Steve, within the NOI guidance change, I appreciate the comments on expenses. Is the 6% to 6.5% expense range that you shared last quarter still intact? Or is there any idiosyncratic headwinds or tailwinds to expense growth this year that you’re not expecting to repeat?

No. Alan, I think the 6% to 6.5% still applies. That’s where we’re forecasting expenses to finish out the end of the year. Maybe there are some slight movements within some of those line items. But overall, that 6% to 6.5% still applies.

Understood. And then maybe as you guys are setting out renewals today, I appreciate the comments on 5% renewals in July and August. Can you give us a sense of where renewals are being sent out within September and October renewal negotiations?

Yes, we’re still sending them out at 5%, 6%. We are seeing some negotiating. So that number could come down from what we’re sending it out at. But again, like I said, we’re really still seeing renewals trending in line with what we expected as the year progressed and still seeing it trending down to the low single digits by the end of the year.

Understood. And then as you guys round out the summer leasing season here, are you offering concessions across any of your properties on any specific floor plans or any specific communities?

Yes, Alan. So concessions overall remain low. However, we are seeing a slight uptick in the concessionary environment in some of our submarkets that we’re needing to do that in order to maintain our favorable occupancy trend. But year-to-date, we’re seeing concessions on about 11% of leases. When you look across all new leases, that concession is less than half a week.

I appreciate that. And last one for me, maybe for Paul. I know that there’s an asset right now that’s being marketed in some media outlets reported on the office market on Eye Street being now marketed at a low double-digit nominal cap rate. I understand that Watergate has a better WALT and better occupancy today. But could we see a scenario where Watergate could be marketed if it were today at a double-digit nominal cap rate versus inside 10%?

Alan, I know the asset, I think I would say that, that is really an apples and oranges comparison in terms of asset quality location. The amount of CapEx that we’ve put back into our building and as you highlighted, a different WALT structure. And also, I would add a different credit profile with ours probably being superior to that. That is a bank-led note auction, which should say a lot about those cap rates we continue to see. And quite frankly, the only fact pattern we do have here in Washington, D.C. has really been driven by bank auctions and note auctions at significant discounts. I don’t think there is a comparison between the Watergate and the asset on Eye Street that you’re referencing. Obviously, we’ll have to wait and see. Number one, if that asset even clears the market, and number two, we will take that information and probably interpolate the cap rate. But beyond that, it’s really just speculation at this point, Alan.

Your next question is coming from Tony Paolone from JPMorgan.

You have a question for Tony this morning. I guess, firstly, congratulations to Tiffany on joining the Elme team as COO. Just curious if you could speak to any near-term focus as you guys will have on the operations front.

Sure. I’d be more than happy to speak to that. I think a lot of the things that we were focusing on and we’ll be focusing on going forward were outlined in our prepared remarks and in our slides, but we’re obviously focused on finishing the year strong from an operations standpoint from both rent and occupancy and that we’re very excited. Now that we have the Elme management in place to be able to start driving our operational upside. So we’re really going to be focusing on ways to bring down our average day occupancy through changes to our policies and procedures and how we’re addressing move-outs, which we think will be a very strong help as we move into 2024. We’re also focusing on our smart home technology rolling that out, which obviously will help drive revenue and also help on the expense side with some of the leak detectors and some of the other smart thermostats that are part of that rollout. We’re also testing managed WiFi at one of our communities, which is a fee income opportunity. So there’s lots of operational upside that we’re working on right now that we’re very excited about. It is part of that $4.25 million to $4.75 million that Steve talked about in his remarks.

Got it. I have one more question for you. Regarding the transaction market, your guidance has indicated that acquisitions will be paused for the remainder of the year, but I'm interested in your insights on cap rates in the market. Could you provide a breakdown specifically for the Washington, D.C. area and then for Atlanta?

Sure, Nam. This is Paul. There hasn't been much change since our comments in the first quarter. However, we expect to see more opportunities in September and towards the end of the year, based on feedback from brokers and operators in D.C. and Atlanta. Two brokers mentioned that their broker opinion of value activity has doubled in the last month. Regarding cap rates, for Class A value-added properties, we've seen trades in the low 4% range, and other Class A properties are around 4.5% to 4.75%. For Class B, I'd estimate an increase of 25 to 50 basis points on top of that. The initial yields have remained stable, but we're observing higher cap rate trends and lower growth in some external markets, which can vary by submarket and property age. We track every deal and find that about 80% of sellers are institutional. There's an increase in closed-end fund activity as they seek to support other business aspects, especially to address redemption queues. On the buying side, around 80% is coming from private entities with financing contingencies, primarily high-net-worth private syndicators, family offices, and 1031 exchanges. The market's sweet spot appears to be deals between $40 million and $75 million, attracting a premium due to their scarcity. The dividing line seems to be deals at $100 million and above. We've noticed that $100 million to $120 million all-cash offers represent significant opportunities, as they provide clarity of execution without financing contingencies. Large syndicators struggle to raise equity for deals of that size quickly. The lender market is becoming a bit more aggressive, with lenders reviewing current cash flows and adjusting for taxes and insurance. Fannie and Freddie are not leading the market right now, focusing instead on higher quality and affordable components. Debt funds are stepping up for 3-year deals in the 7% to 7.25% range. We're also seeing private buyers either buy down rates or seek higher loan-to-value ratios, with expected internal rates of return shifting from 7% to 18% to about 12% to 13%.

Your next question is coming from Michael Gorman from BTIG.

Maybe if you could just kind of synthesize a few different things here. Paul, it sounds like you’re starting to see some movement on the transaction side, which is obviously a potential positive as we get into the back half of the year. As you think about that, especially some of the potentially larger transactions where maybe you have a competitive advantage. Obviously, there’s some capacity on the balance sheet side. But as you think about the cost of equity versus the potential proceeds from a sale of Watergate even in a challenged market. How do you balance that out if you found a transaction where you needed some more equity funding? How do you think about the current value of the stock versus selling out of the Watergate?

Let me begin by discussing the entering cap rate, and then Steve can address potential funding sources or other equity options. It's important to note that we don’t solely focus on the initial cap rate; we invest with a long-term perspective. Our strategy targets the most underserved renter segments in markets where we have strong connections to industries poised for job and productivity growth. Recently, we've observed cap rates that could start in the mid-5% range but quickly rise above 6% within the first 9 to 12 months. As we've mentioned to some of our investors at NAREIT, our approach is not strictly quarter-by-quarter. If a value creation opportunity arises with some straightforward enhancements, we pursue it. For example, just last month, we evaluated an asset lacking a daily pricing model that we could elevate above 6% cap rate within the first 9 months. These types of assets deserve thorough underwriting to explore acceleration opportunities. Our goal is to create long-term value for our shareholders. Regarding the transaction market, we observe that for deals over $100 million, the pool of buyers and lenders has substantially decreased. We see this as a chance to take advantage of, though we must identify the right transactions that align with our strategy. Steve, perhaps you can elaborate on sources...

I will discuss the balance sheet and our funding sources. Currently, we are operating below our targeted leverage level, which allows us to tap into the $680 million available on our line of credit. As for the equity markets, they have been somewhat disrupted lately. Our primary focus, as Tiffany mentioned, is to execute our 2023 plan and leverage the opportunities ahead to decrease the implied cap rate and potentially secure equity, which may not be feasible at the moment but could change in the future. While Watergate is a factor, we also have other properties in the D.C. area, including some multifamily assets that may have limited growth or require capital expenditures, which we could consider selling to free up capital as we aim for higher growth investments in the Sunbelt region. We have consistently stated that we will utilize the appropriate capital for each opportunity, and that approach will not change as we assess the prospects Paul highlighted, choosing the most suitable funding source for each situation.

We appear to have reached the end of our Q&A session. I’d now like to turn the floor back over to the management for any closing comments.

Thank you. Again, I would like to thank everyone for your time and interest today, and we look forward to speaking with many of you over the next several weeks. Please enjoy the rest of your summer. Thank you.

Thank you very much. This does conclude today’s call.