Earnings Call Transcript - KW Q2 2024

Operator, Operator

Good day, and welcome to the Kennedy-Wilson Second Quarter of 2024 Earnings Call. Please note that this event is being recorded. I would like to now turn the call over to Daven Bhavsar, Head of Investor Relations. Please go ahead.

Daven Bhavsar, Head of Investor Relations

Thank you, and good morning. Thank you for joining us today. Today's call will be webcast live and will be archived for replay. The replay will be available by phone for one week and by webcast for three months. Please see the Investor Relations website for more information. With me today are William McMorrow, CEO; Matthew Windisch, President; Justin Enbody, CFO; and Mike Pegler, President of Europe. On this call, we will refer to certain non-GAAP financial measures, including adjusted EBITDA and adjusted net income. You can find a description of these items, along with the reconciliation of the most directly comparable GAAP financial measure and our second quarter 2024 earnings release, which is posted on the Investor Relations section of our website. Statements made during this call may include forward-looking statements. Actual results may materially differ from forward-looking information discussed on this call due to the number of risks, uncertainties and other factors indicated in reports and filings with the Securities and Exchange Commission. I would now like to turn the call over to our Chairman and CEO, William McMorrow.

William McMorrow, CEO

Thank you, Daven. Good morning, everybody. Thank you for joining our call. Yesterday, we reported our results in the second quarter and the first half of 2024, which highlighted improving operating fundamentals on our multifamily portfolio and solid progress on our key initiatives during what has been a challenging 24-month period for real estate, given that inflation rates were at a 40-year high and interest rates at a 22-year high. We saw continued momentum in Q2 within our investment management business and deployed $2 billion of new capital throughout the first half of the year. The deployment includes $1.7 billion through our credit platform, which fully related to the construction of new high-quality market rate multifamily and student housing made to best-in-class sponsors and $300 million on multifamily and industrial acquisitions. We also continue to finish and stabilize our development and lease-up portfolio and in the quarter, stabilized five multifamily communities, which added $16 million to our estimated annual NOI. We have only two remaining active market rate developments. In total, our development and lease-up portfolio is expected to add $70 million in estimated annual NOI upon stabilization. With our developments largely finishing, our capital spend on development has dropped from averaging $150 million per year in 2022 and 2023 to only $10 million remaining to be spent in the second half of 2024. As a result of our Q2 activity, our estimated annual NOI grew by 5% to $485 million, assets under management grew to $27 billion and is annualizing at a 16% growth rate and fee bearing capital grew to a record $8.7 billion with the ability to grow to $15 billion including $2.9 billion of future fundings from previously originated and closed construction loans and the investment of non-discretionary capital that is available to invest. Turning to market conditions, we have seen improving liquidity throughout the year, including several large portfolio transactions within the U.S. apartment sector, which were recently completed or announced, highlighting the strong institutional demand for high-quality multifamily assets. While interest rates have been a headwind for real estate over the last few years, we've begun to see significant beneficial shifts. In the U.S., the 10-year bond has declined by 100 basis points and touched 5% in October 2023. In Europe, the Bank of England cut rates last week for the first time in four years and the 10-year bond in Ireland today sits at 2.7%, versus, I might add, it was close to 16% when we first went there in 2010. Further anticipated decreases in rates by the Fed also provide a supportive backdrop for our valuations and increases of our portfolio. A lower cost of capital and lower base rates should help increase transaction volumes and improve our ability to find opportunities to deploy capital and realize additional cash monetizations. This bodes well for our business, where we have created a unique platform that can scale through investing in both real estate equity and debt. I'm excited about our current positioning and the numerous opportunities we have to expand our assets under management with a focus on the following areas. First, growing our investment management platform. Our track record spans over three decades, in which we have navigated many different cycles and at the same time, grown our relationship network, which expands from the U.S. to Canada, Europe and across Asia to include some of the largest sovereign wealth funds, insurance companies and other large institutional investors around the world. This includes our partners in Japan, where we recently reopened our office and our history dates back to when we established Kennedy-Wilson Japan back in 1994. We continue to see a strong desire from our partners to invest with KW in real estate debt and equity in the U.S., United Kingdom and Ireland. I am very confident in our ability to continue raising further third-party capital to grow our investment management business. We're currently focused on three key products. First is rental housing, where our portfolio of approximately 60,000 units includes 22,000 units being financed through our construction loan platform and over 38,000 multifamily units in which we have an approximate 56% ownership interest. Renter fundamentals remain very healthy as there remains a shortage of housing throughout the U.S., U.K. and Ireland. In the U.S., multifamily demand for largely suburban portfolio has remained strong, while supply starts have dropped significantly. We also have a very successful track record of investing in and building high-quality rental housing in Dublin and the U.K., and we continue to evaluate opportunities in those regions. Second, we look to continue growing our credit platform where we are generating solid risk-adjusted returns for our shareholders. Q2 marked the one-year anniversary of our acquisition of a $4.1 billion construction loan portfolio from PacWest Bank. Since then, the PacWest construction lending team that joined KW has integrated seamlessly within our KW culture, while completing $1.9 billion of multifamily and student housing construction originations with very high-quality institutional sponsors. We have a strong pipeline of $600 million to $700 million that is signed up and is currently in the process of closing, which will take our closings to $2.7 billion since the acquisition, and third, we look to continue building on our existing 12 million square feet of logistics. We acquired two industrial platforms in the quarter, totaling $180 million, one in the U.S. and one in the United Kingdom and we are evaluating several new opportunities in our pipeline in both regions. Our second key initiative relates to our asset sale plan. In July, we sold a retail center in Spain, which was our last wholly owned asset in the country, generating $35 million of cash to KW. This brings our year-to-date total through the end of July to $330 million of cash generated from asset sales, non-core assets and loan repayments. We have a strong disposition pipeline for the second half of the year with proceeds to be used for reducing our unsecured debt and for future co-investment opportunities. I want to thank our entire organization for their hard work as we've continued working as one team across all geographies and business lines, which has set up a firm foundation for the next phase of growth at Kennedy-Wilson. With that, I'd like to turn the call over to our CFO, Justin Enbody, to discuss our financial results.

Justin Enbody, CFO

Thanks, Bill. I'll start by reviewing our financial results and then discuss our balance sheet. Investment management revenue grew by 37% to $26 million in Q2, driven by completing nearly $1 billion in new originations in our credit platform as well as higher levels of de-bearing capital. Baseline EBITDA grew by 5% to $105 million. We saw minor changes in the values of our unconsolidated portfolio in the quarter and we saw overhead costs go down by 9% year-to-date. Additionally, post quarter end, as Bill mentioned, we divested in the largest asset we held in Spain and with that, we'll be closing our Spanish office. In summary, our GAAP net loss totaled $0.43 per share in Q2, which includes $0.46 per share of non-cash items including depreciation and amortization, fair value and share-based compensation. Adjusted EBITDA totaled $79 million for Q2 and $283 million for the year. Now turning to our balance sheet and debt profile. At quarter end, we had $367 million of consolidated cash. We paid down our line of credit by $67 million in Q2 and today we have $172 million drawn on our $500 million line of credit. Our share of total debt is 98% fixed or hedged with a weighted average maturity of five years. We continue to collect cash as a result of our interest rate hedging activities, which is not reflected in our financial statements as an offset to interest expense. In Q2, we collected $11 million of cash bringing our year-to-date total to $23 million. Our effective interest rate of 4.6% reflects a 50 basis point saving over our contractual rate as a result of our hedging strategy. Our remaining 2024 debt maturities total $181 million, which are all non-recourse at the property level. In Q3, we refinanced the construction loan at one of our recently completed multifamily projects in Dublin, where the effective rate improved from 6.2% to 4.5% fixed for five years. We also continued to repurchase stock in the quarter, buying another 600,000 shares, which brought our year-to-date total through July to 1.7 million shares, or approximately 1.2% of our outstanding share count. We have $110 million remaining on our $500 million share repurchase authorization. With that, I'd now like to turn the call over to our President, Matthew Windisch, to discuss our investment portfolio.

Matthew Windisch, President

Thanks, Justin. We continue to strengthen the quality of our portfolio as we work through disposing of non-core assets, while at the same time stabilizing brand-new communities. Our stabilized portfolio totals $485 million in estimated annual NOI, which grew by 5% in the quarter. Over the last five years, our portfolio has continued to shift towards multifamily credit and industrial, which have increased from 50% to roughly 70% of our NOI. We have also sold down our retail office and hotel portfolios, which five years ago accounted for 50% of our portfolio versus approximately 30% today. In total, our 38,000-unit multifamily business has grown to 61% of our stabilized portfolio, producing $525 million of estimated annual NOI at the property level, of which KW share is $294 million. We have 2,700 units in our lease-up and development pipeline, which we expect to add $29 million to estimated annual NOI at stabilization. Our U.S. multifamily portfolio has benefited as a result of our asset management initiatives, where we are focused on driving operational efficiencies and enhancing our assets, as well as strong demand from an overall shortage of homes for sale and the high cost of homeownership. These drivers resulted in same property occupancy growth of 1.9%, revenue growth of 3.6% and NOI growth of approximately 3%. Overall, portfolio occupancy stood at 94%. On the expense side, rising insurance costs reduced our same-store NOI results in Q2 by approximately 50 basis points. However, we expect that our insurance premiums will be flat to down in the second half of the year based on our July renewals. Our market rate apartment portfolio in the U.S., which is over 90% suburban, saw blended leasing spreads of 2.6%, similar to what we are seeing in July, and we ended the quarter with a loss to lease totaling 4%. Turning to our regional highlights. In our California portfolio, we continue to make great progress working through delinquencies and releasing units. In Q2, we saw occupancy increases, lower bad debt, and stable operating expenses, leading to NOI growth of 5% across our California portfolio. In Northern California, bad debt dropped to the lowest level in two years. The Pacific Northwest also delivered an impressive 4% NOI growth, as occupancy grew by 1.4%, while our value add initiatives in this region continued to positively impact our results. In the Mountain West region, we saw occupancy improve by 2%, leading to revenue growth of 3% and NOI growth of 1%. Our portfolio here is well diversified across six states. Nevada and New Mexico were the strongest in our portfolio with 9% and 6% NOI growth respectively. Our Arizona properties produced NOI growth of 6% and in Utah, we saw NOI growth of 3%. In Idaho, we have seen supply impact our rental growth, although we anticipate much less new supply coming online in the years ahead. We continue to have conviction in these markets where our portfolio offers an attractive, lower-cost alternative to higher rent units and higher tax and more densely populated cities. Our Mountain West portfolio's average rents are roughly $1,600 per month, and we believe these markets are set up for solid growth as supply pressures subside. Moving over to Dublin, our portfolio there remains in strong demand. In Q2, we stabilized two multifamily projects in Dublin, Cooper's Cross Residential and The Grange, which totaled 758 units. These two properties added approximately $10 million to estimated annual NOI. We have a further 232 units undergoing lease-up at Cornerstone, which we anticipate stabilizing in early 2025. Renter fundamentals remain healthy in Ireland as labor market conditions are tight and there remains a large structural shortage of housing. With regards to our global office portfolio, we saw improving occupancies and lower operating costs lead to 6.5% NOI growth. It is worth noting that U.S. office represents only 6% of our stabilized portfolio, where we have completed approximately 0.5 million square feet of leasing in 2024 with an average term of almost six years. The majority of our office portfolio is located in Dublin and in the U.K., where the overall leasing market environment has improved in 2024. In Q2, same property NOI increased by 2.2% in our European office portfolio, driven by slight increases in occupancy and lower operating expenses. Stabilized occupancy in Europe remains healthy at 94% with a weighted average lease term of seven years to expiration and five years to break. In Dublin, our nine stabilized properties have less than 5% vacancy, with five of the properties 100% leased. We continue to see a slight upgrade to quality, which we believe will benefit our portfolio. Fundamentals in our industrial portfolio remain very strong with our portfolio 98% occupied. In Europe, leasing completed in the quarter delivered a 44% increase in rents. Demand from our existing tenants to remain in our properties remained strong, with tenants regularly engaging in early discussions ahead of their lease expiration. In-place rents in Europe remain 19% below market, which allows for us to continue enhancing value as leases mature. Switching gears to our investment management business. As we continue to simplify our balance sheet through non-core asset sales, investment management growth is an important focus as it allows us to generate attractive returns in a capital-light manner. We have successfully grown our fee-bearing capital by 93% over the past three years to a record $8.7 billion. A large portion of our investment management growth has been driven by our credit business, which includes $5.1 billion in outstanding loans and $2.9 billion in future fundings. Our capital raising efforts span across the globe with the majority of our capital coming from large institutional insurance companies, sovereign wealth funds and pensions. Combining these important relationships with an improving interest rate backdrop should strengthen liquidity and improve our ability to deploy capital at scale. In summary, we are emerging from a challenging period of time as a much stronger company positioned for growth. We greatly increased the strength of our lending capabilities in the last year. We continue to finish and stabilize our developments, while recycling capital from our non-core asset sales, strengthening our overall portfolio, and most importantly, we have a well-seasoned and invigorated team on the field, which looks forward to growing the business over the years ahead. So with that, we can open it up to Q&A.

Operator, Operator

Thank you. Please proceed with the question-and-answer session. The first question comes from Anthony Paolone with J.P. Morgan. Please go ahead.

Anthony Paolone, Analyst

Okay, thanks and good morning. I guess, first question as it relates to the debt platform. It seems like the origination thus far has been mostly on the construction loan side or maybe all of it has been, if I recall, but just wondering what the prospects are for doing other types of maybe longer duration type debt deals or taking advantage of some of the repayments to be the vehicle that terms out some of that debt to add some just broader duration to that book?

Matthew Windisch, President

Anthony, this is Matt. It's a great question. We see a great opportunity in the construction lending space within the residential sector, and so that's where our primary focus has been, but the team that we both bought and built within KW is a seasoned team of people with expertise not only in construction lending, but in permanent lending, bridge lending, you name it. So we definitely have plans to increase the duration in the portfolio and look at longer-term solutions for our customers and we've got capital partners that are interested in doing that with us. So it's a good question. I think you'll see over the next several quarters an expansion of our business beyond just construction lending.

Anthony Paolone, Analyst

Okay. And then with regards to development, the program there seems to be winding down and it's simplifying the story overall for you guys. Do you think there are incremental starts on the horizon or do you think this continues to wind down for a while here?

William McMorrow, CEO

No, we're really looking at that business in a different way than we have in the past, where we were a sizable equity partner in all of these deals and so we have several new projects that we're looking at right now. We're taking both of our really experienced teams here in the United States and in Europe and for lack of a better word, really repurposing them into a construction management business, where similar to what we've been doing with the investment management platform, where we will be 5% to 10% investors in these properties that manage and run all the construction and earn the normal development fees that you would earn in developing any property. So we've been doing this now for 10 years. And we've developed a very, very outstanding team of people in both Europe and here in the United States and so we don't want to slow the development down where it makes sense. But what we do want to do is do it more in the format of an investment management platform where we're the construction manager.

Anthony Paolone, Analyst

Okay, thanks. And then just if I could ask one last one, it seems like you're making progress towards your disposition goals. Just wondering if you can put some brackets around what all you have in the market, if we should expect anything more sizable coming or any exits of other markets or property types or anything?

Matthew Windisch, President

Yes. So you saw that we did sell our Spanish retail center in Q3, so that's obviously done, but we have a substantial pipeline of dispositions that we're in various stages of selling. So it's in line with the plan that we announced late last year and we're confident we can still hit those numbers and for us in particular, you've seen the shift of the majority of the assets on the balance sheet being U.S. multifamily. So I think with this disposition program, you'll continue to see that shift continue.

William McMorrow, CEO

Yes. I think, Tony, just to add to what Matt said, it's very clear that one of our core strengths is, whether it's in the credit business or the equity side, is the multifamily business where we now are involved in almost 60,000 units and so our view of the housing market is that there are going to be significant opportunities to continue to grow that business over time and so we have very clearly identified the other non-core assets that we want to get out of and I think to simplify the company in terms of geography, we're only focused on those three markets, the United States, the United Kingdom and Ireland, and the other side of the equation is the capital that we're raising in various parts of the world and as we said earlier in the call, we're very, very focused on raising capital now out of Asia, Canada and Europe. And so we're making really, really good progress in all of those markets.

Anthony Paolone, Analyst

Got it. Thank you.

Operator, Operator

The next question comes from Joshua Dennerlein with Bank of America. Please go ahead.

Joshua Dennerlein, Analyst

Hey, guys. Just wanted to explore what you guys include in the fair value adjustment and adjusted EBITDA. I guess what's the rationale on that because I feel like it adds a lot of noise to just the overall earnings power of the company. So just why do you guys feel it's important to include that?

William McMorrow, CEO

I mean, I think historically, as you mentioned, it's been a little bit volatile and we typically are including everything in that metric and that's why we introduced baseline EBITDA to be a more recurring operating metric for the users. So now you can choose which one you'd like to look at.

Joshua Dennerlein, Analyst

Okay. Sorry, I missed that. So that was new for this quarter, the baseline EBITDA?

William McMorrow, CEO

I think second quarter or third quarterwe've had it, but that was the genesis of it. So it's a good question and hopefully we're just giving you more information.

Joshua Dennerlein, Analyst

Okay. And then, you guys mentioned opening a Japan office. I guess, one, I guess what's the rationale behind that? And then can you help us reconcile that with like the cost-cutting progress? It just seems like maybe that's a yeah, anyway. Thank you.

William McMorrow, CEO

We began our operations in Japan in 1994 without any employees, and by 2002, we had become one of the first U.S. real estate companies to go public in Japan with Kennedy-Wilson Japan. After going public, we sold nearly all of our shares in that company over the following years, but it continued to thrive and is now privately owned by a significant Japanese financial institution. In addition, we owned nearly 50 apartment units mainly located in Tokyo and Osaka, which turned out to be a very successful investment that we sold in 2015. We used the proceeds from that sale to acquire a 50% stake in vintage housing in the U.S., which initially had 5,000 units and has now grown to 12,000. Throughout the years, we have maintained strong relationships with numerous large Japanese financial institutions and companies, including an existing joint venture with a major construction company in the Bay Area. Earlier this year, we completed our first multifamily equity investment with a large Japanese development company in Vancouver, Washington. This has prompted us to reevaluate the deep relationships we have built over the past 30 years, especially considering the global nature of Japanese institutions. As Japan faces a declining population, these companies, regardless of the yen's status, have a long-term investment perspective outside of Japan. Earlier this year, we decided to strengthen our capital-raising efforts in Japan, which requires a physical presence, so we have reopened our office there. We've also attracted several Japanese companies into our discretionary fund business, including one significant company that joined just a couple of weeks ago, leading to real success in raising capital.

Matthew Windisch, President

I would like to mention that the team we have in that region is already part of the company. We didn't hire any new employees for this, so there hasn't been a significant change in general and administrative costs related to opening this office.

Operator, Operator

The next question comes from Tayo Okusanya with Deutsche Bank. Please go ahead.

Tayo Okusanya, Analyst

Hello, can you hear me?

William McMorrow, CEO

Yes, we got you. Hi, I can hear you.

Tayo Okusanya, Analyst

Okay, good morning. I wanted to ask about the credit platform and how we think about the growth outlook for the business, just given again if rates are coming down going forward, do you think that results in more construction loans, or do people all of a sudden want to start borrowing? Or do you think about it as they become other sources of there'll be more attractive funding for potential developers and they kind of move towards a different product? Like just how do we kind of think of how the business evolves in a world that we have declining interest rates?

William McMorrow, CEO

That's a good question. We've noticed a significant slowdown in apartment construction starts. Currently, fewer developers are active, and there are also many fewer financial institutions and lenders in the market. This has led to a substantial reduction in the overall size of the construction lending market compared to three or four years ago. However, we've managed to capture a considerable market share, largely because many traditional lenders are not active right now. With the potential for interest rates to decrease, we believe that more people will begin to build, as lower interest costs will reduce construction expenses. Additionally, the value of completed assets should increase, making subsequent financing more appealing. Consequently, we expect a rise in new apartment building starts, along with new entrants entering the market due to these conditions. We are optimistic that the market will continue to expand and that we will sustain our strong market share. Overall, the growth opportunities appear promising, and we have a competitive capital cost along with an excellent team that has effectively partnered with these borrowers while others have not.

Tayo Okusanya, Analyst

Got you. Does it change profitability of the business because you're probably now going to be making loans at lower rates?

Matthew Windisch, President

It's not a significant change for Kennedy-Wilson because we're putting up a relatively small amount of capital into the loans themselves and we're earning fees based on the origination and asset management and servicing of the loan. So for Kennedy-Wilson, it won't be a significant change in the return.

Tayo Okusanya, Analyst

Okay. That’s helpful. I guess that’s it for me. Thank you.

Operator, Operator

The next question comes from Alan Parsow with Elkhorn Partners. Please go ahead.

Alan Parsow, Analyst

Hi guys. I have two quick follow-up questions. One is on Japan and that area and if there is a way for you to elaborate on the amount of funds you've been able to this point get into your fund development and different fund issues? And then two, if you could quantify your sale of the Spanish property and give us an idea of what you made lost or whatever on that property and how much you should save from closing eventually that Spain office?

William McMorrow, CEO

As for Japan, we're in the early stages of raising capital and are having meaningful discussions with about a dozen major Japanese companies. We've secured $100 million in capital from Japan related to our fund seven discretionary. In the past year, we haven't placed much capital in equity investments; instead, we believed that focusing on growing the credit business was a better use of resources due to higher returns. However, with decreasing rates, this will positively impact the equity side of our business, improving both asset valuations and our ability to leverage acquisitions. This is why we haven't made significant moves regarding new equity-oriented investments in the last year. On the overhead front, we've effectively reassessed our costs over the past nine months, reorganizing staff and locations for better efficiency. We've identified another 5% reduction in overhead that is nearly complete, resulting in annual cost savings of approximately $1 million to $1.5 million.

Matthew Windisch, President

Yes. So the third quarter impact from the sale itself is going to be negligible in terms of the gain.

Operator, Operator

This concludes our question and answer session. I would like to turn the conference back over to William McMorrow, CEO, for any closing remarks. Please go ahead.

William McMorrow, CEO

Well, thank you everybody for listening in today. We're very pleased with where we're at and as always, if there are any other questions that you've got, any of us are available to talk with you at any time. So thank you.

Operator, Operator

The conference has now concluded.