Elme Communities (NYSE:ELME) Q3 2023 Earnings Call Transcript

Elme Communities (NYSE:ELME) Q3 2023 Earnings Call Transcript October 27, 2023

Operator: Hello, and welcome to the Elme Communities Third Quarter 2023 Earnings Conference Call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Amy Hopkins, Vice President Investor Relations. Amy, please go ahead.

Amy Hopkins: Good morning, and thank you for joining our third quarter earnings call. Today’s event is being webcast with a slide presentation that is available on the Investors section of our website and will also be available on our webcast replay. Before we begin our prepared remarks, I would like to remind everyone that this conference call contains forward-looking statements that involve known and unknown risks and uncertainties which may cause actual results to differ materially, and we undertake no duty to update them as actual events unfold. We refer to statements of these risks in our SEC filings. Reconciliations of the GAAP and non-GAAP financial measures discussed on this call are available in our most recent earnings press release and financial supplement, which was distributed yesterday and can be found on the Investors page of our website. And with that, I’d like to turn the call over to our CEO, Paul McDermott.

Paul McDermott: Thanks, Amy. We delivered solid third quarter operating performance and the operating trends that we are seeing today align with our expectations and guidance for the remainder of the year. Therefore, we are maintaining the midpoint and tightening our FFO guidance. In terms of our recent company updates, we closed on the acquisition of a 500 home apartment complex in the inner suburbs of Atlanta for $108 million on September 29. This acquisition rounds out our Atlanta footprint and improves our future growth profile. I’ll talk more about this acquisition in a minute. Additionally, we welcomed a new member to our Board of Trustees. Susan Caris is an accomplished leader in the real estate industry who brings extensive multifamily transaction experience and a deep network of relationships.

We look forward to the valuable insights that he will bring to our Board. I’ll focus my prepared remarks today on our recent acquisition and future external growth expectations. Tiffany will cover our operating trends and growth initiatives, and Steve will discuss our balance sheet and guidance updates. Turning to our recent acquisition, we acquired Elme Druid Hills at a forward yield above 6%, including the impact of leveraging our existing expense base. We were awarded the deal for a competitive bidding process where our ability to provide certainty of execution as an all-cash buyer work to our advantage. We expect the acquisition to become accretive over the next 12 months. This is an attractive real estate deal for Elme for the following reasons.

First, it fits squarely into our Class B value-add strategy, which targets communities with rent levels that are 85% to 95% of the market median with renovation potential. This provides the opportunity to grow rents and create value over time without directly competing with new supply. Elme Druid Hills offers the opportunity to renovate all 500 homes as Class A homes in the surrounding area are priced about at a 21% premium above our in-place rents, leaving more than enough room to renovate and capture our targeted return. Furthermore, the area is somewhat insulated by new supply with only 1 new delivery since 2021 and limited new supply under construction within a 3-mile radius. Second, it’s located in an affluent area with a growing job base.

North Threwood Hills offers seamless accessibility to over 550,000 jobs within a 3-mile radius and is close to Atlanta’s most important new medical developments. Children’s Healthcare of Atlanta, and Emory Healthcare’s Executive Park expansion, which has generated over $3 billion in investments. Employment in our targeted income band grew more than 17% over the past 5 years in the Brier Cliff submarket, where average household income is $98,000 supporting an average rent-to-income ratio for Elme Druid Hill residents of 20%. Third, rent growth at Elme Druid Hills has outperformed the submarket and broader Atlanta market average on a trailing 5-year and 10-year basis. Fourth, it is an expansive property that sits on nearly 50 acres. Elme Druid Hills is the second largest multifamily property acreage within a 3-mile radius, yielding a ratio of approximately 10 homes per acre, which is a significantly more land per unit than the average for new deliveries over the past 5 years and offers longer-term redevelopment options.

This community is a rare find in a mature a fluid inside the perimeter location. Finally, this is an exceptional price representing a deep discount to replacement costs of over 30%, and we believe that this acquisition will perform very well over time and drive long-term shareholder value. We onboarded Elme Druid Hills onto our operating platform and retain the entire community team, providing continuity for existing residents. The Elme Druid Hills team joins us with extensive local community management and leasing experience, and we could not be more pleased to welcome them to our company. And with that, I’ll turn it to Tiffany to discuss our operating trends and growth initiatives.

Tiffany Butcher: Thanks, Paul. I’ll start by reiterating that our outlook for the same-store multifamily NOI growth remains in the high single digits which represents very strong performance during a year of transition. We generated effective blended lease rate growth of 3% during the quarter for our same-store portfolio comprised of renewal lease rate growth of 5.1% and new lease rate growth of 0.1%. Renewal rates remained strong throughout the fall, and we continue to experience very strong resident retention, averaging 61% during the quarter. Thus far, we assigned renewal offers for October and November lease expirations of 5.5% on average, representing a stable trend compared to the third quarter average. We expect blended lease rates to moderate over the remainder of the year towards the low single digits.

Our focus on building occupancy earlier this year put us in good position heading into the winter and we continue to experience the pricing power needed to maintain occupancy within our targeted range. Same-store occupancy averaged 95.6% during the quarter, up 20 basis points compared to the prior year. Same-store multifamily average effective rent per home increased 4.9% in the third quarter compared to the prior year. Turning to renovations. We achieved an average renovation ROI of approximately 14% year-to-date, and we’re on pace to complete over 300 renovations this year. Including the renovations we expect to complete at Druid Hills starting in late 2024. Our pipeline now stands at approximately 3,300 homes, which represents more than enough runway to drive renovation-led value creation for the foreseeable future.

Turning to rent to income. The rent-to-income ratio for new residents remains in line with our historical average. The average rent to income ratio for new leases signed in the third quarter was 24% and indicating that our rent levels are affordable to our new residents. Furthermore, our communities continue to offer a compelling value proposition versus Class A product, a cornerstone of our strategy. Even as new supply has caused rent compression between Class A and Class B communities in our market, particularly in high supply areas, the affordability gap between our communities and new lease-ups in their submarkets remains greater than 30%. The durability of these gaps exist due to our acquisition discipline, targeting communities well below market median price points and allocating capital to submarkets that are not as impacted by new supply.

Only one quarter of our submarkets currently have a community in lease-up. Moving on to our growth initiatives. We have completed the transition of community-level operations while retaining 93% of our community teams which has positioned us to now focus on driving operational improvements to increase profitability. Thus far, we have achieved interest expense savings by accessing rent payments earlier, began capitalizing on new fee income opportunities revised our vendor payment process to take advantage of rebates, identified opportunities to share resources and team members amongst communities that are located in close proximity, and we are 75% of the way through our smart home technology rollout. We are pleased with these initial accomplishments and the progress we have made thus far, and we are excited about the opportunity to make continued progress next year.

We continue to expect to generate between $4.25 million $4.75 million of FFO from these initiatives above what we would have otherwise generated through 2025 with additional opportunity beyond that based on centralizing components of the leasing and maintenance process. We look forward to providing more details as we continue to make progress on our centralization plans. And with that, I’ll turn it over to Steve to cover our balance sheet and outlook.

Steven Freishtat: Thanks, Tiffany. Our balance sheet is in very good shape with no secured debt and no debt maturities until 2025, with options to extend our 2025 term loan maturity another 2 years. Our annualized adjusted net debt-to-EBITDA remains in line with our targeted range and is expected to trend to the mid-5s by year-end. Following the acquisition of Elme Druid Hills, our liquidity position remains strong with approximately $550 million or 80% of the total capacity available on our line of credit. In terms of our capital allocation strategy going forward, we are focused on finding opportunities to recycle capital out of lower growth, higher CapEx communities and furthering our geographic expansion. Now turning to our outlook for the balance of the year.

We are tightening our core FFO guidance range to $0.97 to $0.99 per fully diluted share. As Tiffany discussed, our operating fundamentals are trending in line with our expectations, and we are seeing stable traffic and occupancy trends into the winter. We are confident that we will achieve high single-digit same-store NOI growth for the year, and we are reiterating our same-store NOI guidance range of 8% to 9%. Inclusive of Elme Druid Hills, we now expect our non-same-store multifamily NOI to range from $13 million to $13.75 million. We are tightening our guidance ranges for other same-store NOI and which consists of Watergate 600 and G&A. We are updating our interest expense guidance to reflect the impact of acquiring Elme Druid Hills. With the internalization of community-level operations now behind us, we will no longer be recognizing transformation costs going forward.

And finally, we continue to expect our core AFFO payout ratio for this year to be at or below our mid-70s target. In terms of our valuation, the public markets are valuing our multifamily business at an implied cap rate in the mid-7% range, which we do not believe reflects the long-term embedded value of our multifamily portfolio. As we advance our operational initiatives, execute value-add renovations and strong returns, capitalize on smart home technology investments and continue to identify opportunities to improve and grow our portfolio we expect to improve our valuation and earn a lower implied cap rate over time. And now I’d like to open it up for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question is coming from Jamie Feldman with Wells Fargo.

James Feldman: So I guess just to start, you gave good color on the Atlanta acquisition. You talked about potentially doing more in other markets. Can you just talk about what you’re seeing out there? I think if you just kind of leave the narrative we’ve heard so far in earnings. And even we did a call with RealPage a couple of weeks ago. I mean, they’re actually seeing more pressure on — RealPage just seeing more pressure on B. I think UDR is saying the same thing, just because you’ve got developers of new supply that are getting really aggressive trying to fill it and they’re taking tenants away. It sounds like you’re not seeing that, but can you just give more color across your submarkets and tie it into kind of what you might see in the acquisition market along those lines?

Grant Montgomery: Sure, Jamie. So this is Grant Montgomery talking. Just wanted to give you a heads up on that because we really did look into that data as well that RealPage published and I think one of the points that they made is that depending on the level of new supply coming into market, there was definitely an impact that was registered in that closing of the rent gap between Class A and B across the country nationally. And so we looked at it in a similar methodology and what we saw is that in their data, they showed that in some markets where you had new supply, annual supply, net inventory ratios of 1% to 3%, they were measuring about a 21% gap between Class A and Class B. In our submarkets, we were having that same methodology of looking at new lease-ups versus our product.

We have actually a 30% gap in our submarket. So that’s been a key part of our strategy overall is really positioning ourselves at that below the 95% market meeting rents, so that we’re not competing head-to-head. Our most recent analysis of the data using RealPage information it shows that we’re really only competing, for example, in Atlanta about against about 13% of the new product is priced below that point. And so we — although certainly are in markets where supply is having an impact, we are seeing direct really less direct head-to-head because we’ve been disciplined since the beginning and are price significant with these new price points.

James Feldman: Yes, I figured it had more to do with the supply risk in your submarkets was just different than some of these others, that makes a lot of sense. Can you comment on blends renewals and new lease spreads in the nonsame-store Atlanta portfolio?

Amy Hopkins: Sure. So I would say in the — well, let’s start with the same-store portfolio and then we can move into nonsame-store. For the same-store portfolio, we’re expecting renewals to continue to trend in the 3% to 5% range. And then for effective new lease rates, we’re seeing that the D.C. metro is trending kind of slightly negative, and Atlanta is trending towards the negative mid-single digits by year-end. So on a blended basis, we’re expecting the D.C. metro area to be between 3% to 4% and Atlanta to be approximately kind of 1%. You would see those same trends that I talked about for Atlanta carrying into the non-same-store portfolio.

James Feldman: So I mean what are your early thoughts on ’24 rents if you’re seeing latter negative.

Tiffany Butcher: Yes. So we’re going to give our guidance in February. So we’re going to be able to provide a lot more detail on the trends at that time. But overall, I would say right now, it varies significantly by market and by submarket. What we’re seeing today is a continued gradual normalization of rate growth as we head into the typical winter leasing season. Our D.C. Metro portfolio is performing very well and showing the stability that we would expect and that we’ve seen in our core markets over the longer term. In Atlanta, we’re seeing more of an impact on timing of addictions as we work through our addiction pipeline which still includes some leases that were underwritten before we owned the properties and improved our credit standards.