Earnings Call Transcript - RMR Q3 2025

Operator, Operator

Good afternoon, and welcome to the RMR Group Fiscal Third Quarter 2025 Earnings Conference Call. Please note that this event is being recorded. I would now like to turn the conference over to Matt Murphy, Manager of Investor Relations. Please go ahead, sir.

Matthew Murphy, Manager of Investor Relations

Good afternoon, and thank you for joining RMR's Third Quarter Fiscal 2025 Conference Call. 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 quarterly results, followed by a question-and-answer session. I would also 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, August 6, 2025, 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, which can be found on our website at 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, distributable earnings and adjusted EBITDA. A reconciliation of net income determined in accordance with U.S. generally accepted accounting principles to these non-GAAP figures can be found in our financial results. I will now turn the call over to Adam.

Adam David Portnoy, President and CEO

Thanks, Matt, and thank you all for joining us this afternoon. Yesterday, we reported third quarter results that were in line with our expectations, highlighted by adjusted net income of $0.28 per share, distributable earnings of $0.43 per share and adjusted EBITDA of $20.1 million. Despite ongoing economic uncertainty, we have remained focused on the strategic initiatives of our managed REITs and RMR's private capital business. For the managed REITs, these initiatives have included deleveraging actions through a combination of asset sales and accretive refinancings. We have been pleased with the public market reactions to these initiatives as the share prices of certain of our REITs, most notably DHC and ILPT, have increased substantially year-to-date. Further, as a demonstration of the alignment of interest we have with our clients, these share price improvements have also resulted in our client companies accruing potential incentive fees this past quarter which could result in a payment to RMR at year-end that is in excess of $17 million. While potential incentive fees are subject to change, this is encouraging for RMR and its shareholders at this point in the calendar year. As it relates to our private capital initiatives, this aspect of our platform now totals over $12 billion. We continue to engage with investors regarding our platform's capabilities and the real estate strategies we are fundraising for and/or investing in, which includes retail, residential, credit, and select development opportunities. Within the retail sector, a sector in which we have continued conviction, we are sourcing opportunities to accumulate a portfolio of value-add multi-tenant retail assets of approximately $100 million in gross asset value as a means to build a track record in this sector. Our first investment, a $21 million community shopping center located outside of Chicago, closed this past quarter. We plan to leverage our in-house retail team to execute the value-add business plan at this property, which is primarily focused on capital improvements to enhance the curb appeal of the center and strategic leasing. Upon execution of this value-add business plan, we expect to generate mid-teen returns. In terms of our residential and credit platforms, each of these sectors continues to benefit from market tailwinds which is illustrated by each having robust pipelines of approximately $1 billion in possible deals. On the residential side, we anticipate closing 2 value-add acquisitions in August for an all-in cost of $147 million. One is a 266-unit property near Raleigh, North Carolina, and the other is a 275-unit property near Orlando, Florida. These 2 properties, along with the 2 properties we acquired in the joint venture earlier this year in Florida, as well as our currently owned multifamily asset in Denver, will be the seed properties for our recently launched RMR Residential enhanced growth venture. While it is early in the fundraising process, our conviction around the residential sector remains supported by decelerating supply growth and favorable migration trends, both of which will drive rent growth and occupancy gains for well-positioned assets, particularly across the Sun Belt. This venture is targeting returns in the mid-teens to high teens. The investments we've made using our balance sheet, such as our value-added retail and residential acquisitions, are part of our continued strategy to diversify our client base and grow our private capital AUM. While the fundraising environment remains challenging, we are confident in our ability to grow private capital AUM over the long term. To that end, this past quarter, Mary Smendzuik joined RMR as a Senior Vice President and Head of Capital Formation. Mary has a successful track record of raising institutional capital, and we believe she will expand the sources of capital available to our various strategies. Turning to a few notable updates on our public capital clients. DHC posted solid second quarter results with almost all financial measures beating consensus estimates. DHC's strong results continue to be led by the SHOP segment, which saw same-property cash basis NOI increase by 18.5% year-over-year. This growth was a direct result of strong sector fundamentals, the strategic capital deployed across the portfolio over the last several years and our active asset management. DHC has also been successful in selling assets at attractive valuations in an effort to deleverage. At SVC, results were in line with consensus expectations with RevPAR across SVC's hotel portfolio increasing 40 basis points year-over-year and outpacing the industry by 90 basis points. Despite meaningful revenue displacement from renovation activity during the quarter, SVC continues to benefit from the stable cash flows of its triple-net lease assets, which are anchored by SVC's $3.3 billion investment in travel centers, which are leased to investment-grade BP through 2033. SVC has also made significant progress with its hotel sales with 114 hotels now earmarked for sale in the second half of 2025, with over $900 million currently under binding agreement. ILPT's results were highlighted by continued strong operating results and ILPT's refinancing of $1.2 billion of floating rate debt with new 5-year fixed rate debt at a weighted average interest rate of 6.4%. The refinancing and continued strength of ILPT's industrial portfolio helps support the decision of ILPT's Board to increase its dividend to $0.05 per share per quarter. Lastly, OPI continues to face headwinds associated with its nationwide portfolio of office properties. OPI, along with its advisers, continues to explore all options to address its upcoming debt obligations. To conclude, we are pleased with the progress the company has made over the past quarter, assisting our clients with their financial and strategic objectives. We continue to believe RMR operates a durable business model supported by clients with a nationwide portfolio of real estate, spanning multiple commercial real estate sectors. Our perpetual capital clients provide RMR with stability while also allowing us to pursue new growth initiatives to drive revenue and earnings growth. We look forward to updating you on our progress in the coming quarters. With that, I'll now turn the call over to Matt Jordan, Executive Vice President and our Chief Financial Officer.

Matthew Paul Jordan, Chief Financial Officer

Thanks, Adam. Good afternoon, everyone. As Adam highlighted earlier, this quarter, we reported adjusted net income of $0.28 per share, adjusted EBITDA of $20.1 million and distributable earnings of $0.43 per share, all of which were in line with our expectations. Recurring service revenues were approximately $44 million, a sequential quarter decrease of approximately $1.5 million, driven primarily by lower property management fees at RMR Residential as managed assets realized their respective business plans, which was partially offset by seasonal improvements in Sonesta-related management fees. Next quarter, we expect service revenues to increase to approximately $45 million based on favorable trends in the enterprise values of our managed REITs as well as construction and property management fees that are expected to remain consistent with this past quarter. Turning to expenses. Recurring cash compensation was $38.6 million this quarter, a decline of approximately $3.5 million sequentially, which reflects the impact of recent cost containment measures. Looking ahead to next quarter, we expect cash compensation to remain at this level. As it relates to equity-based compensation with our fiscal year-end approaching, RMR share awards to employees are expected to occur in September. Based on historical grants, we expect approximately $600,000 in incremental equity compensation next quarter. Recurring G&A this quarter was $9.5 million, a sequential quarter decrease of $1.2 million as we continue to minimize discretionary spending. We expect recurring G&A to remain at these levels. As it relates to the upcoming Sun Belt residential acquisitions, we expect these assets to generate incremental adjusted EBITDA of approximately $900,000 next quarter. In aggregate, our owned real estate is expected to generate adjusted EBITDA of approximately $2.2 million next quarter. Interest expense this past quarter was $1.1 million. Given that our 2 pending residential acquisitions will each use leverage to fund their respective purchases, interest expense next quarter is expected to increase to $1.7 million. It is worth noting that as RMR uses its balance sheet to acquire real estate as part of our strategic growth initiatives, certain financial metrics like adjusted earnings per share will be adversely impacted by expenses RMR has not historically incurred, such as depreciation and interest expense. Accordingly, we believe cash flow measures such as adjusted EBITDA and distributable earnings are becoming more relevant when comparing our results to prior periods and/or other alternative asset managers. Aggregating the collective assumptions I've outlined, next quarter, we expect adjusted EBITDA to be approximately $20.5 million, distributable earnings to be between $0.44 and $0.46 per share and adjusted earnings per share to be between $0.21 and $0.23 per share. In closing, after giving consideration to the cash outlay for our upcoming residential acquisitions and annual bonuses that are paid each September, we expect to end the fiscal year with approximately $60 million of cash and no borrowings on our $100 million line of credit. That concludes our prepared remarks. Operator, please open the line for questions.

Operator, Operator

Our first question today will come from Tyler Batory with Oppenheimer.

Tyler Anton Batory, Analyst

Mostly big picture questions from me. And my first one on the fundraising environment, specifically on the private capital side. It sounds like it's still a bit challenging out there. Conditions are maybe a little bit tough, but I'm not sure if you're seeing any green shoots more recently. I'm not sure if there's some optimism around lower interest rates, and perhaps that can contribute to a more constructive backdrop for raising capital on that side?

Adam David Portnoy, President and CEO

Thank you for your question, Tyler. You're right that the fundraising environment remains quite challenging, particularly for private capital. However, I believe there are signs of improvement. We've noticed an increase in meetings with potential capital providers this year compared to last year, and I anticipate this trend will continue over the next six months. It seems we are beginning to see some thawing in the market. While it's speculative, the prospect of lower interest rates may encourage some investors to become more active. Additionally, we are engaging with various groups, including pension plans and insurance companies, which have capital tied up and have yet to receive returns. We are witnessing some improvement in the transaction market as well. As more funds are returned to these direct capital providers, they may find it easier to allocate additional resources. Overall, the situation remains difficult and will likely take longer to resolve than we would prefer, but there are positive developments taking place.

Tyler Anton Batory, Analyst

Okay. Perfect. Then a couple of questions on the residential side and the RMR residential enhanced growth feature that you just discussed. Can you expand on that a little bit more in terms of the mechanics, the rationale, how that's going to work? I'm assuming all of the residential properties that you've done so far and then the 2 deals that are still upcoming. I'm assuming that all of those are going to fold into that feature. But I just want to be clear just kind of what's going on with that.

Adam David Portnoy, President and CEO

Yes, you have it right, Tyler. Our goal is to combine five assets in total—three of which we fully own and two that are part of joint ventures. We plan to include our general partner interests in these ventures along with the three wholly owned assets, creating a comprehensive portfolio of five assets to market. Overall, we have invested nearly $100 million in equity across these five direct assets, which includes both fully owned and joint venture interests. We aim to present this collection of assets as a seeded portfolio. This strategy helps us differentiate ourselves in the current market, as we’ve noticed that investors are generally less willing to invest in a blind pool. They prefer to commit capital that can be deployed immediately. Investors want to ensure their funds are put to work right away, especially considering the significant amount of capital that remains unutilized. By seeding this portfolio with $100 million in equity investments, we enable investors to essentially take over most of our previous investments while retaining a small interest as the general partner, likely between 5% and 10%. This portfolio is intended to serve as a foundation for a future venture that could potentially attract an additional $300 million in equity, bringing our total buying power to around $1 billion. Once we effectively deploy this capital, it could transition into a subsequent fund. Ultimately, our goal is to create fully discretionary closed-end funds focusing on residential investments. We are applying a similar model to our credit activities, where we currently hold a couple of loans, and we're also expanding in the retail sector, especially in value-add multi-tenant retail, to generate seed investments for a future venture that would lead to a larger pool of capital. I hope this clarifies our strategy and answers your question.

Operator, Operator

Our next question will come from Mitch Germain with Citizens.