Apartment Income REIT Corp. (NYSE:AIRC) Q3 2023 Earnings Call Transcript

Apartment Income REIT Corp. (NYSE:AIRC) Q3 2023 Earnings Call Transcript November 3, 2023

Operator: Welcome and thank you for attending today’s AIR Communities Third Quarter 2023 Earnings Conference Call. My name is John and I’ll be your moderator for today’s call. All lines have been placed on mute to prevent any background noise. [Operator Instructions] I would now like to pass the conference over to Lisa Cohn, President and General Counsel of AIR Communities. You may proceed.

Lisa Cohn: Thank you, John, and good day everyone. My name is Lisa Cohn and I am President and General Counsel of AIR Communities. During this conference call, the forward-looking statements we make are based on management’s judgments, including projections related to 2023 expectations. These statements are subject to certain risks and uncertainties, a description of which can be found in our SEC filings. Actual results may differ materially from what may be discussed today. We’ll also discuss certain non-GAAP financial measures such as FFO. These are defined and are reconciled to the most comparable GAAP measures in the supplemental information that is part of the full earnings release published on AIR’s website. Prepared remarks today come from Terry Considine, our CEO; Keith Kimmel, President of Property Operations; Josh Minix, our Chief Investment Officer; and Paul Beldin, our CFO.

Other members of management are also present and all of us will be available during the question-and-answer session, will follow our prepared remarks. I will now turn the call to Terry Considine. Terry?

Terry Considine: Thank you, Lisa, and my thanks to everyone on this call for your interest in AIR. AIR had a solid third quarter and business is good. I start with three observations. The first operations matter. Keith and his talented team continue to outperform. Second, portfolio composition matters. At a national level, there’s a tremendous amount of competitive new supply but there is no national market for apartment renters, only local markets, submarkets and neighborhoods. AIR is diversified by markets and price points. And as we look to 2024, our regular review of new supply property-by-property shows a range that’s been typical over the past several years. Third, interest rates matter. The increase in the 10-year rate has disrupted property pricing and created opportunities for profitable acquisitions.

In the third quarter, AIR made successful paired trades that upgraded our portfolio and increased the expected growth rate in recurring cash flow. In the quarter, Keith and his team again confirmed our decision to organize AIR around comparative advantage in operations. In the third quarter, AIR enjoyed the highest customer retention, lease rate growth, same-store net operating income growth, free cash flow growth and operating margins. AIR’s emphasis on customer selection results in more stable communities with residents who are more financially capable and stay with us longer. AIR operations and the deep pockets of our venture partners make possible accretive acquisitions. Over the past three years, we’ve invested more than $2 billion of AIR capital in properties whose financial results are improving at rates well above AIR’s peer-leading same-store portfolio.

Speaking of transactions, I want to introduce Joshua Minix, our Chief Investment Officer, to the call. Many of you will have met Josh who had been co-CIO at AIR for more than two decades. His transition to CIO was seamless. And I also want to tip my hat to John McGrath, a dear friend, for his many contributions to AIR and wish him well in his entrepreneurial pursuits. Through joint ventures and a property sale, AIR raised more than $600 million of new capital, and as Josh will report, reinvested the proceeds and property purchases, share buybacks and debt reduction, both accretive to FFO and AFFO, and improving the quality and growth rate of the portfolio. Paul kept the balance sheet bulletproof. AIR will end the year with leverage below 6 times EBITDA, abundant liquidity and limited exposure to higher interest rates.

We prize the AIR culture, it’s the foundation for all we do and is well described in the corporate responsibility report published last month by our colleague Patti Shwayder, and posted on our website. Now I’ll turn the call to Keith Kimmel, President of Property Operations. Keith?

Keith Kimmel: Thanks, Terry. The third quarter was good. As expected, with strong demand and leasing pace, 25% ahead of 2022, high retention with only 38% turnover in the past year, accelerating occupancy as we put peak season frictional vacancy behind us. Slower rent growth as inflation ebbs, impactful supply in pockets muted overall by AIR’s diversified portfolio and significant gains from acquisitions whose growth rate outpaces our same-store communities. The third quarter solid leasing translated into good financial results. AIR transacted new lease rates up 3.6%, renewals up 6% and blended lease-to-lease rates up 4.7%. Occupancy increased throughout the quarter from 94.6% in July to 96% in September. Revenue was up 6.8% year-over-year.

Expenses were up 8%, largely due to timing. And for the full year, expenses are on plan with controllable expenses up less than 1%. Net operating income increased 6.3% and AIR’s operating margin was 73.4%. Growth was even stronger in our acquisition portfolio, now 20% of our business, thanks to Josh and his team. Our five acquisitions from 2021 now owned for approximately two years and included in our same-store portfolio and revenue up 10.3%, net operating income up 15.2% and added 40 basis points to same-store revenue growth and 80 basis points to same-store net operating income growth. Our Class of 2022 acquisitions not yet included in same-store had revenue up 9.9%, expenses down 6% and net operating income up 20.1%. Their rate of increase in profitability is more than triple our same-store result.

Southgate, bought earlier this year, had sequential revenue growth in the third quarter that also outpaced our same-store communities. We see a steady close to the year and setting us up for a solid start to 2024. October average daily occupancy was 96.9%, up 1.6% from the third quarter. Physical occupancy is in the mid-97% range today, which we expect to hold throughout the rest of the year. These rates are easing seasonally with October transacted new lease rates up 1.3%, renewals up 3.8% and blended lease rates up 2.1%. We are well positioned for further revenue growth in 2024 with earn-in the low 2% range, occupancy that will start the year in a strong position, bad debt that continues to show improvement and a diversified portfolio in which strong markets are expected to offset those pressured by new supply.

We talk regularly about the AIR Edge, a distinct approach that delivers consistent results. The AIR Edge begins with quality residents with an average 725 FICO score and rent to income below 20%. Our residents stay longer, thanks to world-class customer service delivered by our experienced and stable on-site teams who build communities and relationships, differentiating AIR in a commoditized marketplace. We add technology selectively where it improves team productivity or the resident experience. These factors combined to reduce AIR’s controllable operating expenses to nearly flat for the past 13 years. We approach our business differently. We use analytics to fundamentally rethink operations, delivering results in lease-to-lease metrics, turnover, occupancy, bad debt income growth and margin.

My thanks to all AIR team members for your ongoing passion to provide world-class customer service and create communities our residents value. You are the foundation of the AIR Edge. I’ll now turn the call over to Josh Minix, our Chief Investment Officer. Josh?

Josh Minix: Thank you, Keith. We are open for business and closed five transactions this quarter. We increased our allocation to faster-growing acquisition properties and further improved the portfolio. The core JV, announced on the Q2 call, provided AIR with $505 million of capital and grew by over $100 million with the acquisition of The Elm in Bethesda, Maryland. The sale of Tempo [ph] provided $21 million, finishing our planned exit from New York City. These fund our share of The Elm and our entry to the North Carolina market where we bought Brizo in the Research Triangle and Olde Towne in Raleigh. The balance was used to delever and buy back stock. Taken together, these parent trades are expected to be neutral to 24 NOI and accretive to free cash flow by $0.02 per share.

Our investment philosophy remains the same. We focus on generating a positive spread to our cost of capital and on improving portfolio quality. The properties acquired this quarter compared to the properties sold halve average ages of less than two years versus effective ages of over 26 years, resulting in a reduction of capital replacement spending of $4 million per year. Expected stabilized free cash flow that is cash flow after capital replacement is 20% higher, rents 11% higher, better locations and expected 10-year IRRs 230 basis points higher, driven by the combination of the AIR Edge and higher growth markets. We also used retained cash flow to fund property upgrades of $24 million in Q3 and $64 million year-to-date with double-digit yields in IRRs. The result, a portfolio with a 20% allocation to acquisitions where the implementation of the AIR Edge is driving NOI growth rates of around 17%, lifting the total portfolio NOI growth by 170 basis points to 7.2%.

Higher recurring cash flow from these and economies of scale generated by our JVs with AUM of over $2.2 billion. Organic growth from property upgrades, exceptional high credit quality customers and broad diversification with roughly equal weighting across the following three categories: East and West Coast, Class A and Class B apartments, and urban and suburban locations. This portfolio has proven resilient, even during periods of elevated national supply. The impact of supply depends upon price point and micro location. We track the percent of NOI from properties facing new supply pressure which historically has ranged from 20% to 30%. We estimated at 26% for ‘24. More details can be found in the appendix to our release. At the moment, the transactions market is chilled with national volume down to reported 72% due to the high cost of debt, limited available equity and supply concerns.

However, AIR benefits from access to capital via our partnerships with some of the largest and most sophisticated global investors and sovereign wealth funds, superior operations from the AIR Edge and the ability to source acquisitions accretive to both financial results and portfolio quality. I note, it is a great advantage as an investor to be able to count on Keith and his talented team to improve our returns. With that, I’ll turn the call over to Paul Beldin, our Chief Financial Officer. Paul?

Paul Beldin: Thank you, Josh. Today, I will discuss AIR’s balance sheet, report third quarter results and our expectations for the full year, highlight three enhancements made to our earnings supplement and conclude with a brief comment on our dividend. The AIR balance sheet is well positioned. During the quarter, AIR refinanced $154 million of borrowings on our revolving credit facility and $325 million in 2023 and 2024 term loans with new fixed rate property debt with a weighted average life of 5.3 years and a weighted average interest rate of 5.2%, 30 basis points above the short-term debt repaid, but happily about 100 basis points below borrowing costs today. As a result, AIR has near-term exposure to rising interest rates that is limited to $79 million in our share of the Virginia joint venture debt plus $26 million on our revolving credit facility.

We have no debt maturities until the second quarter of 2025 and abundant liquidity with $2.1 billion available, sufficient to refinance all maturing debt through 2027. Leveraged EBITDA is anticipated to be below 6.0:1 at year-end. It is temporarily elevated today due to the timing, $365 million of NOI and free cash flow accretive acquisitions and share repurchases. Turning to third quarter results. FFO of $0.64 per share was $0.01 above the midpoint of guidance. As previously discussed, 2022 and 2023 FFO include income not expected to recur in future periods. In the third quarter, we had $0.05 of such nonrecurring income compared to $0.03 in the third quarter of 2022. Run rate FFO, which excludes this nonrecurring income was $0.59 per share in the third quarter, up 7.3% year-over-year and up 8.2% year-to-date.

Run rate AFFO was $0.52 per share, up 4% year-over-year and up 6.3% year-to-date. AIR AFFO has been calculable from our disclosures. We publish it now to provide greater visibility of the capital spending required to maintain our properties, a proxy for depreciation, which we call capital replacements. AFFO in excess of dividends about $56 million year-to-date and expected to be about $80 million for the full year is retained to fund organic growth, such as investment in property upgrades, which we call capital enhancements. Looking forward to the fourth quarter, we have narrowed our guidance for full year pro forma FFO to be between $2.39 and $2.43 per share. For the quarter, we anticipate pro forma FFO between $0.63 and $0.67 per share, with $0.05 higher property NOI, offsetting the sequential decline in nonrecurring income.

The fourth quarter is usually AIR’s most profitable due to the earn-in of peak leasing season rents and seasonally lower expenses. Next, I’d like to discuss three enhancements made to our earnings release. The close of the Core joint venture increased the percentage of FFO and AFFO derived from unconsolidated properties and from services provided to third parties. To allow for more efficient and effective modeling, we enhanced Supplemental Schedule 2. We’ve separately disclosed third-party services subject to long-term contract and those generally in support of transaction activities, a walk of consolidated drivers of FFO to AIR’s proportionate share, and additionally, we added to our glossary a walk of our GAAP income statement to this schedule.

We trust these changes will be beneficial, please reach out with any questions. Last, the AIR Board of Directors declared a quarterly cash dividend of $0.45 per share. On an annualized basis, the dividend reflects a yield of approximately 5.8% based on the current share price. With that, we will now open the call for questions. Please limit your questions to two per time in the queue. John, I’ll turn over to you for the first question.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Eric Wolfe from Citigroup.

Eric Wolfe: On page 6 of your sup, you gave a breakdown of your NOI growth by properties based on when you acquired them. Just curious, can I take from that disclosure that 89% of your GAV will be in the same-store pool next year? So basically just excluding the other real estate in Class of 2023 and so that remaining 11%, any early sense for the growth potential for those properties?

Paul Beldin: Hey Eric, this is Paul. Thank you for the question. I hope you’re well. Thank you for pointing out the additional disclosure we provided in our supplement. And to answer your particular question, next year in same store, we will be adding — we’ll be adding the Class of 2022 to same-store. But also what’s included in other real estate, those four properties are the properties that we reacquired from Aimco, a little less than a year ago now. And then so that will be part of our same-store pool in 2024 as well. And so, the only items that will be outside of same-store will be our acquisitions made in 2023.

Eric Wolfe: Got it. And then, this quarter, you saw a 120-bp contribution to your same-store revenue from other residential income, which has been growing over the last couple of quarters, presumably as you receive more late fees. Can we see that be a little bit of a headwind to growth next year, just given that your bad debt has come down substantially? So, I would think you’d see less late fees, or are there other initiatives to offset that?

Keith Kimmel: Eric, it’s Keith. There’s some other initiatives to offset that. We have lots of focus on parking and storage and other resident type of very particular amenity opportunities. So, while I acknowledge your point about whether late fees or other things that could come with previous delinquencies, we have other ideas and things that are in play that actually we’ve been working on a lot of the year, and will start earning into next year.

Operator: Your next question comes from the line of Rich Anderson from Wedbush.

Rich Anderson: So, on the deployment of joint venture funds and sort of bringing in partners and so on, I understand the line of thinking behind it. What concerns me is sort of a return to more complicated sort of structures, the very thing that you sold AIR on is simplified strategy and all that sort of stuff. So, do you expect to expand joint venture activities from here, formation of new ones, or do you feel like what you’ve got is enough to feed your growth needs for the coming few years? Thanks.

Terry Considine: Rich, it’s Terry. And good afternoon where you may be, I think, and it’s good to hear your voice. You’re absolutely correct that the addition of joint ventures adds an element of complexity to the AIR plan. I would note that it was included in the AIR separation. At that point, we had a single joint venture. But there’s been a change in facts since then, a dramatic change in the capital markets. And when the facts change, we need to incorporate that in our thinking. And we want very much for AIR to be transparent. And that’s why Paul and his team spent so much time on same store Schedule 2 to provide a walk so that analysts and the market would be able to track the proportionate contribution and not be too undone by the increased complexity.

Rich Anderson: And as far as the opportunity set that may lie ahead, you sort of — you and your peers are kind of teeing yourself up for some dislocation related to debt maturities and all that. Do you have an idea of how this could look? Do you have a sort of a pipeline number in mind today? And would it be mostly one-off deals in your paired trade scenario. Could you see yourself doing something larger portfolio-wise or even some sort of entity level type situations? Like, what’s out there that you see now and how might it grow as we go? Thanks.