Earnings Call Transcript - IRT Q4 2020

Operator, Operator

Thank you for standing by, and welcome to the Independence Realty Trust Fourth Quarter and Full Year 2020 Earnings Release call. Please be advised that today's conference is being recorded. Thank you. I would now like to hand the conference over to Lauren Torres. Ms. Torres, please go ahead.

Lauren Torres, IR Manager

Thank you, and good morning, everyone. Thank you for joining us to review Independence Realty Trust's Fourth Quarter and Full Year 2020 Financial Results. On the call today with me are Scott Schaeffer, our Chief Executive Officer; Jim Sebra, our Chief Financial Officer; and Farrell Ender, President of IRT. Today's call is being webcast on our website at www.irtliving.com. There will be a replay of the call available via webcast on our Investor Relations website and telephonically beginning approximately 12:00 p.m. Eastern Time today.

Scott Schaeffer, CEO

Thank you, Lauren, and thank you all for joining us this morning. 2020 was a year like no other for our company, our industry, and our country. We were faced with unexpected challenges brought on by the global pandemic. But due to the perseverance of our team and focus on accomplishing our objectives, we were able to deliver strong fourth quarter and full year results and better position our company for long-term success. We prioritized the needs of our people, which included protecting the health and well-being of our residents and employees, while providing flexibility to those residents demonstrating financial hardship. We focused on growing occupancy and driving leasing traffic while sustaining our financial flexibility and lowering leverage, thereby strengthening our balance sheet. As a result of successfully executing against these priorities, our same-store average occupancy increased 250 basis points to 94.9% in the fourth quarter on a year-over-year basis, with average effective monthly rent per unit growing 2.6% in the quarter. We have collected 98.7% of fourth quarter rents. Our same-store NOI increased 4.4% in the fourth quarter and 3.1% for the full year compared to a year ago. Our core FFO improved more than 10% in the quarter and for the full year 2020. We notably reduced our leverage this past quarter, having normalized net debt to adjusted EBITDA of 8.2 times at year-end. Reducing our overall leverage has been a long-term objective of ours, and I'm very pleased that we were able to make meaningful progress against this commitment during the year when we faced unprecedented market conditions.

Farrell Ender, President

Thanks, Scott, and good morning, everyone. We are pleased to report that IRT closed out 2020 with strong fourth quarter results, led by the diligence of our on-site teams. Due to our ongoing effort to support resident retention and build occupancy during the pandemic, our occupancy grew substantially in 2020 and was 95.3% at year-end. We continued these efforts into 2021 and have sought to support occupancy, ending January at 95.4%. On a lease-over-lease basis for the same-store portfolio during the fourth quarter, new lease rates increased 4.5% and renewals were up 1.6%, yielding a combined lease-over-lease rental rate increase of 3.3%. Strong trends continued in the first quarter-to-date, with new leases having increased 7.7%, led by our value-add communities, while renewed leases are up 4.4% with a blended lease-over-lease rental rate increase of 5.4% for our same-store portfolio. While we are encouraged by these trends, we are also cautious as we continue to manage through the pandemic, and therefore remain focused on maintaining occupancy. Given our occupancy in the fourth quarter of 2020 and into the first quarter of this year, we've taken a targeted approach to renewal rates at communities where we have high occupancy and very little exposure. We remain optimistic about our initiatives behind our value-add and capital recycling programs, which both experienced a pickup in activity in the second half of last year. First, on our value-add program, we completed renovations on 230 units in the fourth quarter and 1,004 units in the full year, realizing average rent premiums of 21% in the quarter and 18.8% in 2020 as compared to un-renovated units.

James Sebra, CFO

Thanks, Farrell, and good morning, everyone. Today, I'd like to begin with an overview of our fourth quarter and full year 2020 results, then provide a brief review of our balance sheet and capital structure, and wrap up with a discussion of our 2021 guidance. Beginning with our 2020 performance update. For the fourth quarter of 2020, net income allocable to common shareholders was $13.3 million, down from $23.8 million in the fourth quarter of 2019. The decrease was due to $9.4 million of gains on the sale of real estate assets in the fourth quarter of 2020 as compared to $20.7 million of gains on the sale of real estate assets in the fourth quarter of 2019. For the full year 2020, net income allocable to common shareholders was $14.8 million, down from $45.9 million for the full year 2019. Similarly, the decrease was due to the gain on sale of real estate assets of $7.6 million in the full year 2020 and $35.2 million in the full year 2019. During the fourth quarter, core FFO grew to $20.8 million, up 11.7% from $18.6 million in the fourth quarter of 2019. Core FFO per share during Q4 was $0.22, 10% higher than Q4 last year, at $0.20 per share. For the full year, core FFO grew to $75.9 million, up 10.8% from $68.5 million in 2019. Core FFO for the full year was $0.80 per share in 2020, up from $0.76 per share for the full year of 2019. Turning to our same-store property operating results. NOI growth in the fourth quarter was 4.4%, driven by revenue growth of 5.4%. Rental rates increased year-over-year with an average monthly rent of $1,117 this quarter, up 2.6% since the fourth quarter of last year, and has accelerated to an annualized 4% growth rate sequentially from the third quarter. While this included value-add communities, we did see rental rate growth at our non-value add same-store communities, with rental rates in Q4 increasing 120 basis points over the prior year. For the full year 2020, same-store revenue grew 3.6%, almost entirely driven by the 3.4% increase in average rental rates. We have collected 98.7% of our fourth quarter billings, and we have collected 99.3% of our 2020 billings. As a result, we have evaluated our outstanding receivables for collectability to increase our reserve for bad debt by $124,000 during the fourth quarter to a total of $927,000. The $927,000 reserve for bad debt recorded as of December 31st reduces the future risk of any billed revenue that we have not yet collected.

Scott Schaeffer, CEO

Thanks, Jim. In closing, I would like to highlight that our strong full year results reflect IRT's commitment to retain residents, maintain high occupancy levels and provide quality homes and communities during a time of uncertainty. We're proud of the efforts of our team and thank them for their dedication. Looking ahead, we remain confident in our operating and investment model that was built not only to weather near-term volatility, but also to grow and strengthen over time. We thank you for joining us today and look forward to speaking with many of you at Citi's Global Property Conference in early March. Now, operator, we would now like to open the call for questions.

Operator, Operator

Certainly Neil Malkin with Capital One Securities. Your line is open.

Neil Malkin, Analyst

Hi, good morning. Thank you for taking the question and congratulations on a strong quarter. First, you mentioned joint ventures and the possibility of exploring other structures to pursue acquisitions more aggressively. Could you elaborate on that? Why does that seem like a suitable approach considering your favorable stock price, particularly in relation to issuing equity to reduce debt and grow, as opposed to complicated joint venture structures?

Scott Schaeffer, CEO

Well, thanks, Neil. Well, first, we don't look at it as being overly complicated, and we do look at it as an additional avenue to grow. I'm comfortable looking at it at this time relative to looking at it in the past when we were able to just go out and acquire properties directly because I think I've mentioned this in prior calls that some of the values and cap rates and pricing of our historical type asset, B plus, A minus, some of the prices are, we think, getting a little bit sloppy. So you look at the situation where you can buy brand new at very similar cost to what people are paying for 12- to 15- to 20-year old product. And we think there's a real opportunity now to have some new construction within the portfolio. So not only do we see this as being a benefit pricing-wise, but we also see it as a way to build pipeline for future growth. It's a situation where the company is now, with the de-levered balance sheet, I think, in a stronger position, and we're willing to take on some limited risk at this time.

Neil Malkin, Analyst

Yes, that makes sense. Just to clarify, is it mainly focused on development or more on newer properties that are five years old or younger? I understand you mentioned a preference, so how does that impact your priority?

Scott Schaeffer, CEO

It's both. I mean we're looking at both. I mean, we're going to look at what is giving us the best risk-adjusted returns. But we haven't done any transaction yet, and that's why we said we're exploring.

Neil Malkin, Analyst

Got it. Okay. Other one for me. Just in terms of guidance, it seems to be pretty conservative, especially with your already strong levels of blended leasing spreads. Congratulations on achieving the lowest leverage in your history. However, what is your approach to reach that current range? Considering everything you've mentioned about strength and growth opportunities, as well as the favorable stock price, why not aim for a slightly higher range?

Scott Schaeffer, CEO

So I'm going to let Jim answer the question completely. But I just want to start out with saying that we feel that we're in a very, very good place right now. Our portfolio is well positioned. We're in the area of the country that's growing, jobs and population with limited regulations, but there is still some uncertainty, so the eviction moratorium is still out there. We don't know how long it will be. We don't know how it will end. We've done a very good job of collecting rents, and we continue to collect rents from last year and from January still to this day, as people are able to catch up. So again, we feel we are in good shape, but there is some uncertainty, and the guidance we put out, I think, reflects a little bit of that. Jim, do you want to expand on this?

James Sebra, CFO

Yes, I believe that's completely accurate. We've managed to maintain and grow our occupancy levels, and we feel confident about our current position. However, the upcoming months hold some uncertainties that we're aware of, and only time will tell how it unfolds. As Scott pointed out, our collections remain strong, the pace is good, and we have seen solid rent growth in January and the first quarter. That said, we're proceeding with caution regarding the unknown factors. We've successfully collected rents for January so far, and our collection rate today is actually about 30 basis points better than it was yesterday. Things are looking up, and we will keep monitoring the market conditions and adjust our guidance as the year progresses.

Neil Malkin, Analyst

Okay. Thank you, guys.

Operator, Operator

Austin Wurschmidt with KeyBanc. Your line is open.

Austin Wurschmidt, Analyst

Hey, good morning. Thanks, guys. Yes, I just wanted to hit again on some of the new news around the preferred equity and joint ventures. And just hope you could talk a little bit more about how you're underwriting these deals? And how large this investment or platform could become as a percent of enterprise value or however you're thinking about it? And then you also mentioned that this is a source of potential future acquisitions and help building that pipeline. But how much would you guys be willing to expand into kind of more Class A type assets, as this really hasn't been the focus historically?

Scott Schaeffer, CEO

Thank you, Austin. We've currently targeted no more than $100 million for this program. We believe it will ultimately be very beneficial in terms of new construction and aligns with our previous efforts. Our focus has been on a portfolio of fee assets because we see it as a better long-term investment with greater potential for share growth. However, this becomes more complex when considering older products trading in some of our markets. We view this as a solid alternative to allocate capital for higher returns while continuing to grow in preferred markets. In terms of competition, the sunbelt region where we operate is experiencing significant growth, with reports predicting a population increase of 19 million people over the next decade in that area. This translates to a need for approximately 19 million new homes. We see this as a significant opportunity, although somewhat limited. As I mentioned, we are in the exploratory phase and haven't made any commitments yet, but we believe this could be an effective way to invest capital strategically, always considering risk-adjusted returns. Our approach will be cautious and measured to ensure we make the right decisions for our company.

Austin Wurschmidt, Analyst

Got it. And I certainly think it could make a lot of sense. I appreciate the thoughts there. So as we think about kind of funding this investment, you guys did issue some shares under the ATM, some additional shares under the forward program. And curious what your thought is on how much appetite you have to do anything additional there on that front? And kind of related to, I guess, funding these initial preferred equity investments, either through the ATM or just capital recycling?

Scott Schaeffer, CEO

So we're looking at it really as part of the capital recycling initiative, that we're not going to go out and issue equity in order to fund this, but it would be part of the capital recycling. But again, money is fungible. So we do think there's opportunity for growth, notwithstanding the sloppy cap rate environment. We have very good relationships. We continue to monitor them. We have the ability to execute and transact quickly, which some sellers want. And we will continue to take advantage of those opportunities as we have in the past. But this is just an alternative use of capital and nothing different, and quite early as it will come from the recycling program.

Austin Wurschmidt, Analyst

Got it. Thank you for the time.

Scott Schaeffer, CEO

Thank you.

Operator, Operator

Nick Joseph with Citi. Your line is open.

Nick Joseph, Analyst

Thanks. Maybe just following up on that. It's obviously nice to see the leverage progress that we've made so far. But when do you expect to get to the target of mid-7 and given guidance and the new announcement this morning, where do you expect leverage to be at the end of 2021?

James Sebra, CFO

Nick, thanks. Regarding our target of low to mid-7s, we are still on track to achieve that by the end of 2022. I believe we will continue to make progress on this front between now and the end of 2021. We will also work diligently to grow our earnings and reduce the net debt-to-EBITDA ratio through normal growth. While there are elements of future growth that remain uncertain, we will keep moderating and updating guidance throughout the year as new information becomes available.

Nick Joseph, Analyst

And so what is the current guidance for the end of the year?

James Sebra, CFO

It's a slight downtick to the kind of upper 7s from where we are today, about 8.2%.

Nick Joseph, Analyst

Following up on the joint venture or the new external growth opportunity, why is this the right time to move forward considering the ongoing uncertainty from COVID and the eviction moratorium? With the progress made on leverage, why not wait a bit longer for more clarity and stability before executing?

Scott Schaeffer, CEO

Thanks, Nick. It's Scott. One of the reasons we're taking our time is due to the uncertainties you mentioned. We believe that COVID will eventually come to an end, and there is an opportunity because some lenders have pulled back, making capital more necessary for developers, which allows for better pricing at this moment. We are looking into it and are aware of the uncertainties, which is why we are proceeding cautiously. However, with leverage down where it is, and as Jim pointed out, it could reach the 7s by the end of this year. I feel more comfortable taking on those different risks when considering the potential rewards.

Nick Joseph, Analyst

Thank you.

Operator, Operator

Amanda Sweitzer with Baird. Your line is open.

Amanda Sweitzer, Analyst

Thanks. Good morning, guys. I wanted to start with your value-add pipeline and the two projects that are still on hold. Can you go through the fundamental triggers you're looking for to become more comfortable with restarting those projects? And then as we think further out, do you see opportunities in the existing portfolio to add properties to that pipeline beyond the six that you've outlined?

Farrell Ender, President

Sure, Amanda. It's Farrell. Out of the six properties we've identified, two have not yet started. One is our Asheville community, which relies heavily on tourism and services. In that market, we've seen a decline, and we expect an 18% to 20% return on any renovation project. Currently, we believe that given the state of the market, we won't achieve those returns. The other property is located in Raleigh, facing similar challenges due to the submarket. While we lack confidence at this moment, we believe we may include it in the value-add pipeline in the future. As you know, we're expanding our teams in all the markets where we're implementing value-add strategies—Columbus, Memphis, Tampa, and Raleigh. This allows us to perform all the work ourselves, significantly reducing costs compared to hiring a general contractor. There are still several markets where we haven't applied this approach, including ND, Indianapolis, Oklahoma City, and Dallas, which we think will eventually join the value-add pipeline. It's about carefully building those teams.

Amanda Sweitzer, Analyst

That's helpful. And then following up on the most recent forward sale. Can you talk more about how you thought about your cost of capital at the $14 per share issuance price, I guess, relative to your NAV likely increasing sort of recent decline in private market cap rates?

Scott Schaeffer, CEO

Yes, when we consider raising equity capital, we assess how we can deploy it in assets, evaluating the cap rates and ensuring that it is beneficial from both an earnings and net asset value perspective. This shapes our understanding of the cost of capital. We also view it as a means of incremental deleveraging. While we may not allocate those proceeds to fund something that is leverage-neutral, we focus on improving leverage over time, ensuring it is advantageous for both earnings and net asset value.

Amanda Sweitzer, Analyst

That’s helpful. Thanks for the time.

Operator, Operator

John Massocca with Ladenburg Thalmann. Your line is open.

John Massocca, Analyst

Good morning. So you mentioned that the Class B market appeared kind of frothy. But I mean how has that trended recently? Just curious if you've seen any impact on competition for assets from kind of some of the recent changes in interest rate expectations?

Farrell Ender, President

Yes, John, it's Farrell. Yes, we've definitely seen some pressure on cap rates in our market. I mean, it's a pretty favorable asset class right now and the markets we're in are desirable. So we're seeing cap rates at 4.5% and trending down to, as Scott mentioned, even sub-4 in certain circumstances where people are underwriting significant value add. So it's gotten pretty competitive.

John Massocca, Analyst

But has it become more competitive since around November or December, perhaps due to some expectations of a slight increase in long-term interest rates?

Farrell Ender, President

I would say that even before the summer ended, there was significant pent-up demand because many deals fell through due to market conditions. Therefore, I believe the fourth quarter and the beginning of this year have shown a surge in people becoming more aggressive with investments, as they have been unable to deploy capital for the past six months.

John Massocca, Analyst

Okay. And then I know we've talked about the JVs kind of ad nauseam at this point. But in light of the discussions around JV, what is your view on kind of supply dynamics for Class A assets in your markets? I mean historically, there's been some headwinds to those assets from new supply that doesn't exist in Class B. And has the pandemic just kind of extinguished all that concern, given kind of population movement and some of the growth in some of your core markets?

Scott Schaeffer, CEO

I don't think it's distinguished that concern. But I think that we're going to come at this in a very targeted way and make sure that we are in locations and markets that will be able to absorb any new supply, and that you're well-located and appropriately managed. So it doesn't eliminate the concern, but we expect that we'll be doing it in a way that we take all of that into consideration.

John Massocca, Analyst

Okay. And then one last detail one on the balance sheet. As some of these kind of mortgage bullets come due, should we expect those to be refinanced as mortgage debt? Or are you kind of moving to a completely unsecured balance sheet?

James Sebra, CFO

Yes. This is Jim. Yes, we'll be moving to an unsecured balance sheet. So we will not be refinancing those with mortgages.

John Massocca, Analyst

Okay. Well, that’s it from me. Thank you all very much.

James Sebra, CFO

Thanks, John.

Operator, Operator

There are no further questions at this time. It's now my pleasure to turn the call back over to Scott Schaeffer for closing remarks.

Scott Schaeffer, CEO

Well, thank you all for joining us today. We are excited for 2021 and look forward to speaking with you and giving you an update on our next call. Have a good day.

Operator, Operator

This concludes today's call. We thank you for your participation. You may now disconnect.