Rmr Group Inc. Q4 FY2020 Earnings Call

Good morning, and welcome to The RMR Group Fourth Quarter and Fiscal Year 2020 Earnings Call. All participants will be in listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Michael Kodesch, Director of Investor Relations. Please go ahead.

Good morning and thank you for joining us today. With me on today's call are President and CEO, Adam Portnoy; and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and performance for the fourth quarter and full year of fiscal 2020, followed by a question-and-answer session. I would like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company. Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR's beliefs and expectations as of today, November 20, 2020 and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, or SEC, which can be found on our website at www.rmrgroup.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we may discuss non-GAAP numbers during this call, including adjusted net income, adjusted earnings per share, adjusted EBITDA and adjusted EBITDA margin. A reconciliation of net income determined in accordance with U.S. generally accepted accounting principles to adjusted net income, adjusted earnings per share, adjusted EBITDA and the calculation of adjusted EBITDA margin can be found in the news release we issued this morning. And now, I would like to turn the call over to Adam.

Thanks, Michael, and good morning, everyone. For the fiscal fourth quarter, we are pleased to report sequential increases in adjusted EBITDA, adjusted EBITDA margin and adjusted net income per share. These improvements were driven by increases in stock prices of some of our Managed Equity REITs, stabilized operations at our managed operators, and successful cost mitigation efforts at RMR. Moving into fiscal year 2021, we remain focused on ensuring our client companies have adequate liquidity to weather a prolonged economic downturn, while at the same time being prepared to take advantage of strategic opportunities that may present themselves. As we end fiscal year 2020, I believe our efforts have resulted in each of our client companies being well-positioned for the future. Over time, I'm hopeful these efforts should help us earn back a portion of the over $55 million in lost revenues we are currently experiencing as the majority of our Managed Equity REITs continue paying base business management fees on an enterprise value basis versus the higher historical gross investment basis. Turning to some of the more significant highlights across our client companies. We are very proud to have announced this week the formation of our inaugural private capital investment vehicle, which is led by an investment from a large top-tier global sovereign wealth fund. This global sovereign wealth fund represents a new relationship for RMR. This new investment vehicle has initial investments of $680 million in 12 industrial properties. Our existing client company, ILPT, sold the initial properties into the vehicle and maintains a 22% ownership stake in the venture. ILPT also expects that its leverage will be substantially reduced as a result of this transaction, and we plan to grow this vehicle with additional industrial properties in the future. We also hope this new investment vehicle marks the beginning of a new line of business for RMR, which includes managing large pools of private capital on behalf of institutional clients for investments in core real estate assets. From an operations perspective, ILPT same-property cash basis NOI during the quarter increased 1.9% on a year-over-year basis. Tenant leasing demand at ILPT has also displayed continued strength as it entered into almost 800,000 square feet of leases during the quarter. Finally, ILPT continues to collect over 98% of rents. Moving to our office REIT. OPI continues to benefit from its high credit quality tenant base, including a large number of government tenants and its limited exposure to gateway city markets, which has tended to be more negatively affected by the pandemic. Consolidated occupancy remains above 91%, and OPI continues to experience robust rent collections at close to 99%. As a result of its stable tenant base, OPI’s same-property cash basis NOI increased 1.7% over the prior year. We were further encouraged by the quarter's strong leasing activity as OPI executed almost 600,000 square feet of leases for a 31% roll-up in rent and a weighted average lease term of more than 10 years. In 2020, OPI has issued over $400 million in senior notes with proceeds used to repay all amounts outstanding on their $750 million unsecured revolving credit facility. As a result, OPI’s balance sheet remains investment-grade rated, its leverage stands at the low end of its target range, and its dividend remains well covered. Switching gears to our Healthcare REIT. While DHC continues to experience pandemic-related headwinds at its senior living communities, the company remains well capitalized with over $1 billion of liquidity and no near-term debt maturities. Additionally, it’s important to remember that approximately 77% of DHC’s NOI now comes from its office segment, which continues to benefit from a healthy life science real estate market. During the quarter, leasing activity in DHC’s office segment more than doubled sequentially as DHC executed over 200,000 square feet of leases with a 4.1% roll-up in rents and a weighted average lease term of seven years. On the senior living side of the business, 97% of DHC’s communities are now open for new admissions, while the majority of residents currently moving into communities are generally needs-based. We believe there’s currently significant pent-up demand in the market from seniors deferring move-in decisions. DHC’s primary operator, Five Star, is currently working with additional referral sources to attract new residents without undermining rate or profitability. New resident leads were up 35% in the quarter with conversion rates getting back to pre-pandemic levels, and move-ins increased 31% over the prior quarter, both positive trends for DHC’s senior living portfolio. Finally, our busiest REIT continues to be SVC. SVC continues to face the most significant pandemic-related challenges among all our client companies, as hotels, restaurants, and other service retail businesses are facing a difficult environment. Operationally, SVC has seen steady hotel occupancy advances in most markets as suburban extended-stay hotels and select service hotels continue to outperform urban full-service hotels. All but two of SVC’s 329 hotels are now open and overall occupancy has steadily increased to 46% in September from a low of 21% in April. The biggest news this quarter at SVC involved its inability to reach resolution with IHG and Marriott, after each failed to make their minimum required payments to the company. SVC’s Board decided to terminate these operators and transition management of these operators’ hotels to Sonesta. RMR is dedicating significant time and effort currently to assist Sonesta in preparing for a successful transition, which is expected to begin at the end of November. In addition, measures taken to improve liquidity further include the recently announced issuance of $450 million of senior unsecured notes due in 2027 and successfully securing waivers for all financial covenants through July 2022 on its $1 billion revolving credit facility. It’s also important to note that over 25% of SVC’s rents come from TravelCenters of America, which continues to perform well during the pandemic. TA reported yet another strong quarter of increased adjusted EBITDA and net income. TA also closed on its $85 million public stock offering in early July, which provided important liquidity to the company. Turning to our efforts to expand and grow the RMR platform. As capital markets and fundamentals began to recover from the lows of the pandemic, conversations with sources of private capital—both existing and possible new relationships—have gained momentum. While we have nothing specific to announce at this time, we remain confident that our private capital management business will continue to expand either externally through an acquisition of a third-party platform or organically via relationships we establish on our own, such as the new investment vehicle with a global sovereign wealth fund that we recently announced that involves one of our client companies. Before I turn it over to Matt, I’d like to reaffirm our confidence in the strategic actions we have taken in reaction to the ongoing pandemic on our client companies and reinforce the fact that RMR remains well fortified by our 20-year evergreen contracts with the Managed Equity REITs and our healthy operating cash flows. As I’ve said in prior calls, given the current economic environment, I continue to believe that over the next 12 to 18 months, there may likely be unique opportunities to take advantage of in the market that will benefit our platform for years to come. I’ll now turn the call over to Matt Jordan, our Chief Financial Officer.

Thanks, Adam, and good morning, everyone. I'd like to start by acknowledging the continued effort and dedication we've seen across our organization in light of the ongoing pandemic. While the last seven months have been challenging, all our managed office and industrial assets remained operational and available to our tenants. At our corporate office, which reopened in June, we have invested significantly in ensuring compliance with both federal and state safety mandates, with the majority of our personnel coming into the office on a regular basis. Turning to our results for the quarter, for the fourth quarter of fiscal 2020, we reported adjusted net income of $6.4 million or $0.39 per share. In addition to recurring adjustments to separation costs and unrealized gains on our investment in TA, this quarter includes an add-back of $0.03 per share for a full-year bonus accrual true-up. Adjusted EBITDA in this quarter was $20.8 million, a sequential quarter increase of 6.1%, and adjusted EBITDA margin was 48.8%, a sequential quarter increase of 170 basis points. Both of these improvements reflect stability in many of our client companies' operations and our efforts to mitigate expenses where possible. Management and advisory services revenues of $40.2 million were in line with our guidance of $39 million to $41 million and represented an increase of almost $1 million on a sequential quarter basis. This sequential quarter increase is due to growth in fee-paying AUM across the majority of our Managed Equity REITs and modest operating improvements at TA and Sonesta. Across our client companies, rent deferral activity has slowed considerably and construction activity has seen limited delays from the pandemic. This quarter, RMR directly supervised almost $44 million in capital improvements and increased on a year-over-year and sequential basis. Based on current trends, both of these possible headwinds to our property management fees should continue to have limited adverse impact on our revenues. Using October average share prices, coupled with an assumption that there is not another COVID-related shutdown in significant parts of the country, we are projecting total management and advisory services revenues to remain flat in the next quarter. With that said, looking ahead to the full fiscal year, our revenues will be favorably impacted by the following client company activities. First, as it relates to the upcoming transition of IHG and Marriott branded hotels, just enough that Adam discussed earlier, we expect these transitions will result in $2.7 million of incremental revenues for fiscal year 2021 and approximately $4 million on a run rate basis. These projections are based on current operating estimates, all of which are subject to change based on the uncertainty surrounding the ongoing pandemic impact on the hospitality sector and assumes an IHG transition on December 1, and the Marriott transition occurring in the first quarter of calendar 2021. Secondly, we expect to begin collecting fees again from TRMT, our mortgage REIT effective January 1. These fees present approximately $325,000 per quarter or $1.3 million annually. Turning to expenses for the quarter, cash compensation of $31.5 million was up approximately $1.9 million on a sequential quarter basis primarily driven by the $2.2 million bonus true-up I discussed earlier. Without this bonus adjustment, cash compensation was down sequentially, as we have restricted new hiring, and many employees reached statutory limits on payroll taxes and 401(k) contributions during the quarter. After considering annual merit increases that were effective October 1, projected bonus inflation, and recent executive retirement, we expect cash compensation to be approximately $30.5 million per quarter in fiscal 2021. We also expect this cash compensation to be reimbursed by our client companies at a rate of approximately 45% in fiscal 2021. Regarding recently announced executive retirement, next quarter, we expect record separation costs of approximately $4.5 million. G&A expenses in this quarter were $5.8 million, a decrease of $500,000 on a sequential quarter basis. We expect G&A costs to remain at approximately $6 million per quarter for the foreseeable future as we look to continue minimizing discretionary spending. In closing, our balance sheet remains strong, as we ended the quarter with $370 million in cash and no debt. In addition, our adjusted EBITDA levels continue to ensure our dividend remains well covered. That concludes our formal remarks. Operator, would you please open the line to questions?

Our first question today will come from Bryan Maher with B. Riley FBR. Please go ahead.

Good morning Adam and Matt. Let's start just with a question on the ILPT and the new investment vehicle. Wanted to figure out how those fees worked in a little bit more granularity. So what used to go to ILPT will now go to the new RMR investment vehicle and should we be deconsolidating that from our ILPT model in the fourth calendar quarter of this year?

Hi Bryan, yes. The short answer to your question is yes. It is going to be deconsolidated from the ILPT financial statements in the fourth quarter. The fees that the new vehicle has directly engaged in management agreements with RMR, agreements are substantially similar to the agreements that we have with the existing REITs. For example, we have a property management agreement that is almost identical to the property management agreement that exists with our Managed REITs today, both in terms of economics and the services provided. We also have an asset management agreement similar to the business management agreement. There is a slight difference in the economics there, it’s in the way it's calculated. The end result is about the same dollars. In the REITs, as you know, we get paid 50 basis points based on the lower of either historical cost or market value or total market value. In the new vehicle, we're earning 100 basis points on the equity book equity contributed to the vehicle. So depending on how much leverage you have, you can do the math; it’s roughly equivalent dollars that we’re receiving.

Okay. And then as we think about those 12 assets and whatever else is added later, the day-to-day kind of overseeing of those properties will now shift to RMR, not that theoretically it wasn't really RMR before, but ILPT as an entity really won't have anything to do with that. Is that correct?

With the entity itself, well, it's essentially the same people who are going to be managing those properties that were managing before, before those properties were held in ILPT. Remember, ILPT has no employees, it outsources its entire management to RMR. So the people managing the assets across all of our offices, across the country here in Newton are the same people who are going to be managing those assets now that it's in a new vehicle, but the vehicle itself hasn't had separate contracts with RMR versus the contract that ILPT has with RMR. ILPT will continue to have a 22% ownership in the vehicle. You can think of it in simple form as almost like a passive limited partner interest in the vehicle; it's the best way to think about it. Now in terms of growing the vehicle, it's important to note that there's no requirement that ILPT must contribute any additional properties into the vehicle. That being said, we anticipate that there will be additional properties that ILPT’s Board will likely sell into the vehicle. We also know that the partners in that vehicle are very keen to grow it, and they are hopeful that ILPT will contribute additional properties into the vehicle. We see this as one of the rare times you have a true win-win in the sense that ILPT is looking at this as an efficient way for it to raise effectively equity capital down at the asset level versus raising very diluted equity capital up at the corporate level by issuing stock in what we believe to be a low price. Again, it’s ILPT's option whether it wants to show any properties into the JV; there's no requirement to it, there's no first rights, there's no call rights by the vehicle into ILPT; it’s a truly one-way option if they want to sell anything into the vehicle. So we think it's a very fortuitous opportunity—it's a great source of growth for RMR and it's a great source of liquidity for ILPT if they choose to use it.

Got it. Thanks for that. And considering your conversations with the partners in the fund, what would you anticipate the growth in that fund to be either in a percentage basis or an absolute dollar basis over the next year or two? And is there any change in the parameters of cap rate expectations that the fund has versus what ILPT may have had prior?

I'll take your second point first, which is no, we don't anticipate significant change in the type of assets that ILPT will seek out nor the type of assets that the venture would be interested in. One of the reasons that the partners in the venture entered into this partnership was that they very much liked the strategy and the type of assets that ILPT seeks out. Those are the types of assets that those partners are also interested in investing in. In terms of the size, our partners, our large capital providers, they have an appetite for up to several billion dollars to invest in this type of asset class. I think all parties that went into this are hopeful that we can add significant assets to this vehicle going forward, and the appetite is in the billions of dollars.

Great. And just last for me on Sonesta. This is kind of a big deal for Sonesta, this calendar quarter coming up and even next quarter. What is RMR doing to help facilitate the growth of that? Do you expect it to really ramp—grow a lot in 2021? We're getting a lot of calls from people in the industry who are surprised; their comment is, and that's growing from kind of nothing to kind of a big deal very fast. What are your thoughts there? Thanks. And that's all.

Yes. Great question. From Sonesta's standpoint, it is growing; it’s growing very rapidly. They are hiring a lot of folks in the corporate office. I will tell you, this is an incredibly great environment to be out trying to hire people with hotel experience. We have been getting very high-caliber folks interested in joining Sonesta. We haven't even really been using headhunting firms to find people; they’ve been finding us. We've been getting inundated, in some sense, with the number of resumes. So it's really a fantastic time to be hiring folks, and we are hiring folks, and Sonesta has been hiring folks. From RMR's perspective, we're really getting involved in the transition of taking over the hotels here in the short term. What do we mean by that? We're lending some efforts on the HR side; some folks on the other asset management side of the business are devoting some energy and time, what I would call on a temporary basis. Some folks in the accounting group on a temporary basis are lending their time to help Sonesta. And this is really covered as part of the business management agreement between RMR and Sonesta and with the other companies. This is not a permanent shift to folks at RMR; it's sort of just helping them over the next several, call it several weeks and months, as they gear up and take over these hotels. There are several large, for example, 99 hotels that are coming over in less than about 10 days that are coming over. And we seem to be very much on track to take those hotels. Nothing will be flawless, but I think it's going to be very well executed. A lot of energy has been put into taking over these hotels. A lot of planning has been carried out to take over these hotels, and I think we're well positioned, and I think it will be successful. I think the transition will be successful.

Thank you.

Our next question will come from Owen Lau with Oppenheimer. Please go ahead.

Yes. Thank you. Good morning, and thank you for taking my questions. First of all, congratulations on the closing of the private capital. I have a couple of questions related to this investment vehicle, and I think Adam, you may have answered some of these, but let me see whether you have additional color on that. So could you please talk about what attracted that top-tier global sovereign wealth fund to invest in this vehicle and then how do you plan to grow this vehicle? Lastly, what are the verticals outside the industrial properties where you see potential to attract external capital? Thank you.

Sure. I think the partners were attracted to this opportunity twofold. One, I think they were attracted to the assets themselves and the quality of the real estate that is held at ILPT and the type of real estate that the RMR Group, helping ILPT, seeks out in the industrial space. I think they're also very attracted to the fact that RMR is a vertically integrated, nationwide operator that can touch many different asset classes. There was a tremendous amount of diligence done on us in our asset management capabilities, specifically our property management capabilities, specifically our ability to produce reports on an accounting basis. I think the fact that we are fiduciaries now in managing large pools of publicly traded vehicles is a plus to these partners. These partners are also fairly large in size, and I think what they attracted them to this opportunity was—it's very hard for large institutional investors that need to put large amounts of money out to specifically invest in, let's say mid-sized real estate investments. So let's say a $40 million industrial building, $30 million, $60 million investment building. They are capable of investing in portfolios. They are capable of investing even in one-off very large assets. But I think what they liked about the opportunity was this idea that they could sort of piggyback off of ILPT and they could sit in ILPT's business plan along with RMR, which is able to go out and meaningfully acquire properties—mid-market $30 million building, $40 million building, $50 million building, aggregate a pool of properties. Then if ILPT chooses to, and again, I can help emphasize this, there's no call; the fund doesn't have a right to call properties; it doesn't have a first right to first refusal, first offer; it has no rights to pull the properties. This is truly a one-way option that ILPT has to present them to the fund. ILPT and its board will have the ability to decide; I think and this has been discussed at the board level. It's likely that we will likely sell additional properties into the vehicle going forward because the cost of capital for ILPT to grow by issuing equity up at the corporate level is too dilutive. Now that calculus could change if the cost of our capital at the corporate level to issue equity changes, let's say the stock price at ILPT increases significantly. That would be wonderful for everybody involved if that were to happen, and we hope it does, but absent that happening, this is a way for ILPT to raise equity at the asset level. So that’s how we see the vehicle growing; ILPT can go out and acquire properties very efficiently and sort of mid-sized properties and then sell them into the vehicle at its option. With regards to the last part of the question, are there opportunities to do similar types of structures with other asset classes with our vehicles? The short answer is yes. I think there are. We are in preliminary conversations regarding other asset classes within our realm that are managed and owned by some of our REITs, with other capital partners as well as some of these existing capital partners around additional asset types that we could do a similar structure around. The conversations are early, but I think it’s very much something that we could think about replicating in other vehicles.

That’s great. That’s very helpful. So now you have established a relationship with a sovereign wealth fund, and building the track record, does it change the way you think about how to use your cash and balance sheet for acquisition? Do you need a transformative acquisition to get where you want to be? Thank you.

We don’t need a transformative acquisition to get where we want to go. I think an acquisition, strategically, could help accelerate us to get where we want to go. We can continue to have conversations with parties around those types of transactions. I continue to remain cautiously optimistic that one of those conversations will eventually bear fruit and that we will perhaps enter into an M&A agreement to acquire another party. I hope that were to happen in the coming months, but I will tell you the pandemic has really slowed a lot of things down. To give you an example, this vehicle that we just entered into, absent the pandemic, I think we would have been announcing this in the summer or spring. The pandemic really slowed the conversations down for multiple reasons, and it had sort of the same effect on some of our M&A discussions as well. I continue to believe that in order to accelerate our growth into private capital, M&A is a way that we could do that. If we were to do that, there are going to continue to be, I think, opportunities to seed investment vehicles with some of the RMR cash. I continue to want in this environment that we're in today; I believe that there are opportunities that may present themselves in the next 12 months to 18 months. I can’t even identify them yet. I just believe that this is the type of environment where those that are liquid can really do some amazing things and do transformational things because this is when there’s a lot of dislocation. When there’s a lot of dislocation, that’s when a lot of wealth can be created. I just want RMR strategically to be in a position that it could execute on something like that in the coming months because I really do believe we’re in an environment that it’s right for that.

Thank you, Adam. That’s it for me.

Our next question will come from Ronald Kamdem with Morgan Stanley. Please go ahead.

Hey, good morning. Couple from me. Congrats on the announcement of a private vehicle. Some of the client questions that we’ve received, just on number one for ILPT and dropping the assets in the vehicle. Can you just remind us why is it better for them to do that rather than potentially just sell those assets in the market and reinvest in their portfolio and other assets? So, what’s the advantage for ILPT to drop the assets down in this vehicle? Thanks.

Sure. The advantage is that it gets a market price for those assets and gets to continue to participate in a minority portion of the equity. Remember, if we’re buying the assets, we’ve liked their long-term prospects at ILPT. It doesn’t preclude us, by the way, from also outright selling assets if that’s something we would like to do. I think the way the ILPT Board is looking at this is it’s just another lever that it can pull to raise capital and do it efficiently. It doesn’t have to do it; it’s a one-way option for ILPT. It does have the option to sell outright.

Got it helpful. And then the second one, maybe this one will be quick. So, I heard the 100 basis points on—I think you said equity—are there any other sensitivities or promote structures with this private vehicle or just any other fees that we should think about as you’ve mentioned already, but I don’t think I caught it.

No. There’s no other fees associated with the vehicle other than what we outlined: the property management fee and in the business or asset management fee.

Right. And then the other one I had was in backing on one of the questions before, which is, does this open up an avenue potentially for some of the other public manager REITs? Could this, clearly the vehicles are only looking at the industrial sub-sector, but is this something that down the line could be done in some of the other sub-sectors and segments, if there’s appetite for it? How are you guys thinking about that?

The short answer is yes. It is something that we could explore for other asset types in other vehicles. We are having preliminary discussions around those types of vehicles with other asset classes, with other vehicles, with existing partners and with new partners. Those conversations are preliminary, and it’s unsure whether they will actually ever come to fruition, but we are exploring it because, again, we see this as a pretty interesting way for our client companies. It’s a lever to pull to raise capital and help it grow without having to issue what would be very dilutive equity in today’s markets for some of our vehicles where they trade. We think there are a lot of advantages to the structure, and we are exploring it with some of the other vehicles.

Got it. And my last question, if I may. This is a big picture question related to the hotel space. I think with the vaccine announcement that we’ve seen over the last week or two, there’s a lot more investor conversation, a lot more interest about sort of what the recovery is like for the hotel space overall. I’d love to hear your comments and how you guys are thinking about it: just again, big picture whether it’s a high-end CBD hotel versus extended stay or limited service, how do you guys think that plays out over the next couple of years? And the corollary to that is: has Sonesta positioned in that view and how do you think about that? Hopefully that makes sense.

Yes. That does make sense. From a big picture perspective, we’ve been—ever since the pandemic began, we pretty quickly had to derive what is big picture? How did we think the next couple of years was going to play out? The view we had six months ago hasn’t changed much, even as we get to where we are today. That view has been that we anticipate that things will be very tough for the hospitality industry and many industries probably to the second half of 2021. That generally continues to be our view, especially around the hospitality industry. I do think that in the hospitality industry specifically, once the vaccine is generally available and widespread to the general population—which I think by mid-year 2021 is a reasonable estimate, given everything we know—that may be the improvement in the travel and leisure industry could be more accelerated than the current sort of industry projections. There are a lot of folks that think that you’re not going to get back to where we were in 2019 to 2024 or 2025. I’m a little bit more optimistic that once things really do open up, it may take a while, but it may not take until 2024 or 2025 for us to be back to 2019 levels in the hospitality industry. With regards to Sonesta specifically, I think that one of the advantages that the big brands—the Marriotts, the IHGs, the Hiltons, the Hyatts—have traditionally had to drive a lot of their business has been their rewards programs. Those rewards programs are largely driven by business travel. I do think that there is going to be some permanent reduction in business travel as a result of coming out of this pandemic. I just can’t help but think that there’s going to be less need to travel because I think we’ve all learned how to do a lot of work with video conferences. I think a lot of CFOs in Corporate America have noticed that their travel and entertainment budgets are way down in the last few quarters, and it’s an interesting way to save costs. So, I don’t—I can’t tell you how much it’s going down, whether it’s 5% or 30%, but I do think it’s going to be a meaningful reduction. When that happens, the power that those big brands have and the advantages that they have will be less significant, and I think Sonesta, in that type of environment where the rewards programs are typically driven by business customers, will be in a strong position. As for the domino effect, as the business customer doesn’t come back 100%, those rewards programs become less valuable. It becomes harder for the Marriotts, the IHGs, the Hiltons, and the Hyatts to charge the fees they charge and to justify the fees they charge to their owners. I think Sonesta is going to be very well positioned in that environment to do very well. More specifically with Sonesta, I can’t help but say this: SVC owns 34% of Sonesta, and any benefit that Sonesta has will directly benefit SVC because of that ownership. The only other thing I’ll say about the vaccine, quickly, big picture is that we anticipate, and I generally think that in the second half of 2021, there will be opportunities for recovery. However, for the senior living industry, it's becoming top of mind in my view over the last few weeks because it’s going to be the first industry to get the vaccine for its workers and residents. If that happens, the senior living industry could actually lead the recovery and could begin to see a turnaround starting maybe in Q2 rather than Q3 or Q4. That’s my big picture view.

Really helpful. Thanks so much.

Our next question will come from Kenneth Lee with RBC Capital Markets. Please go ahead.

Hi, thanks for taking my question. Just another one on follow-up on the private vehicle with ILPT. I’m wondering if you could just, perhaps outline some of the key drivers for potential fee growth longer term. Realized that you mentioned that the initial fees are going to be similar to what they were when the properties were owned by ILPT, but just want to see how the potential trajectory of the fees could differ potentially over the longer term. Thanks.

Sure. I think the biggest driver of the fee growth would likely come from growing the vehicle itself. The best landmark I can point to, say that how you can think about it is, I can tell you the partners in the vehicle have deep pockets and very much would like to grow the vehicle; their aspirations are that it could be many billions of dollars is what they would like it to be. It’s really how many assets that ILPT acquires, what is ILPT's cost of capital look like going forward, and how many assets based on that does it decide that it would like to sell into the vehicle going forward? I think we will sell additional assets into it. The rate of how many assets we sell into it, the speed at which we do it, how big it gets—it's hard to put an exact pin into, but I can tell you that all parties involved anticipate that the vehicle will grow and that the appetite again is many billions of dollars.

And Ken, from a modeling perspective, the way we’re thinking about it is that every $100 million in new capital is about $1.5 million annually new revenues to RMR when you think of the asset management and property management fees together.

Got you. Got you. That’s very helpful. And just one more follow-up, if I may. You mentioned briefly about the management fee expectations for Tremont. Just wondering more broadly whether you could just give us an update as to just the overall growth opportunity within the commercial mortgage REIT side, as well as Center Street Finance.

Sure. Generally speaking, we have another vehicle to the RMR Mortgage Trust, which is the conversion of our old mutual fund into a mortgage REIT. That conversion is mid-processed right now. We are actively—we have one loan that we’ve actually closed on in that vehicle. We have several loans under application that are pending. We have publicly announced that we’ve been redeeming some of our auction rate preferred in that vehicle. We have also publicly announced that we’re moving along with good pace with the SEC to be in a position to be a D-40 Act compliant organization. I tell you all that because that is the principal vehicle that the organization is using its energy to put new mortgage investments into. Center Street specifically is basically dormant, and it’s dormant because I’m the principal capital provider there. I’m the only capital provider there. It just—it’s not right. I can’t front-run the public markets. So I’m basically forgoing all opportunities to invest in mortgages at the moment and allowing the public vehicle to have first right and first dibs on all those opportunities until that gets fully invested. Ballpark mid-2021, give or take, is when I think that vehicle should be fully converted and fully invested. We actually have quite a bit of capital to put to work, and it’s really a pretty opportunistic time to be putting capital to work in mortgages. We’re able to get very good returns on what I say on lower-risk basis. We don’t have to go as far up the risk curve as we were, let’s say, a year ago, and maybe get the same return because there are very few capital providers in the market today willing to make short-term bridge loans into what I’ve called light-value-add situations. There are a few, but not many. We’re one of a handful that are in the market, so it’s a pretty interesting time for that vehicle. I can tell you all of its loans are current; none of its loans have gone into default; and they’ve made all payments every month since the pandemic began, which is a pretty good testament to the quality of the portfolio that we’ve put together over the last couple of years because this is a real stress test for that portfolio. It’s actually performing quite well.

Great. Very helpful. Thank you very much.

Our next question will come from Mike Carrier with Bank of America. Please go ahead.

Hey, good morning. This is Dean Stephan on for Mike. Most of my questions have been answered, but I was wondering if you could provide some additional detail on some of the cost containment measures you’ve implemented, either at the parent company or any of the affiliates recently. And if we get any type of sustained market or macro downturn moving forward, what capacity you may have for additional cost measures moving forward? Thanks.

Yes, let me talk about RMR specifically. So on the G&A line, you’ve seen a sizable decline over time. A lot of that is tied, as Adam mentioned, to travel and expense reductions. It’s also significantly tied to hiring restraints, which have kept recruiting fees in check. Then there are some variable costs, whether it’s IT professional or operating-related costs that—with reduced headcounts and reduced volumes of activity in the office itself—we are able to manage. Some of which will become permanent, some of which will come back over time, which is why we’ve increased our forward-looking guidance to get back towards $6 million in the progressive quarters. And then on the people side, we’re still operating in a very competitive environment here in Greater Boston. I do continue to expect some wage inflation and bonus inflation, and we’ll just look to be thoughtful over time in terms of growing our headcount. Otherwise, we have an obligation to support our client companies and need to continue doing so.

Helpful. That’s all for me. Thanks.

Our next question will come from William Katz with Citi. Please go ahead.

Hi. This is actually Millie Wu on for William Katz. Yes, most of my questions have been answered, and I appreciate all the colors on the private capital. I guess just one more follow-up on the cost measures. Just would appreciate any update on your expectation of the separation costs going into fiscal 2021, given all your initiatives to improve cost efficiencies.

So, as we highlighted, we have some retirements that’ll hit next quarter. There’ll be about $4.5 million in separation costs. Those were decisions made by individuals to retire on their own. We are not actively reducing headcount and don’t expect to. I think we’ve always had a history of running pretty efficiently and leveraging technology to avoid letting headcount get out of control. So we don’t expect to go any further on reductions around people. After next quarter’s separation costs, I would not model any going forward. We’ll just continue to be very thoughtful around recurring cash compensation. And one thing I should’ve highlighted earlier is that in this past year, while there was some inflation in salary and bonuses, we kept all our executive compensation flat for the senior leaders, and that’s something we may explore continuing based on how the pandemic plays out.

Okay. Thank you. That’s helpful.

Our next question will come from Brent Dilts with UBS. Please go ahead.

Hey, guys. Just starting with the inaugural private fund, could you provide a little more color on just around the kinds of investments that fund’s going to be targeting in the industrial space outside of adding properties from ILPT? Specifically, what geographies and tenant industries are you going to be focused on?

I think the type of investments that it will be targeting is similar to what ILPT invests in today. E-commerce, logistics—primarily type investments. I think we are focused on the top 50 markets, with probably a highlighted focus on the top 50 industrial markets, with probably our sweet spot somewhere between markets 5 to 25. We tend to buy longer-leased single-tenant industrial properties or logistics properties, not only, but that tends to be the type of property that ILPT invests in, which I think would also go into that. So that gives you a sense. I mean, I’m trying to think typically our buildings are a little larger—sort of the bulk distribution. If it’s an Amazon facility, it’s typically a regional distribution hub rather than a last-mile hub, which tends to be what we have.

Okay. And then given your diverse exposure across different real estate markets, could you talk about how active transactions have been in the main sub-sectors? Just where you’ve seen cap rates recently?

Yes, it’s a good question. Overall, in the acquisitions market and transaction market, I would say the most robust area continues to be industrial that we participate in. I would say in office—there are lots of segments of office. I would say MOBs or medical office buildings are also very did, very attractive to investors today. Life science buildings—that’s a very niche sub-sector of office that I think is extremely attractive to investors. Cap rates have compressed there. The other sectors we play in, general office, if it’s long-term lease to credit tenants, still attracts a decent bid; anything that’s multi-tenant or anything that has got a lot of loose role generally has a bid for it but not a very aggressive cap rate. In the retail sector, there are parts of the retail sector that there is no bid forward, if anything, to deal with, let’s say, a B mall that’s heavily focused on apparel. You may not even find a bid. The hotel sector, there’s not a lot of transaction activity occurring. The transaction activity is people trying to buy pieces of debt—hotel debt that has been the most activity. Generally speaking, there’s been a little bit of shyness away from, call it, what has been traditionally the top four or five gateway city markets, the urban core assets; unless they are well leased to long-term tenants, you don’t see a lot of those assets coming to market, you don’t see a lot of parties that are interested in investing in those types of assets in those locations. That gives you a sense, but the areas that we are deploying capital on and are active in the marketplace have been principally the industrial side and the office side. We’re not active in the multi-family side, but my understanding is that is also a sector that is staying relatively intact and cap rates are remaining consistent with where they were prior to the pandemic.

Okay, great. Thanks for those insights, Adam. Have a great Thanksgiving, everyone.

There being no further questions at this time, this will conclude our question-and-answer session. The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.