Elme Communities (NYSE:ELME) Q4 2023 Earnings Call Transcript

Elme Communities (NYSE:ELME) Q4 2023 Earnings Call Transcript February 16, 2024

Elme Communities isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good day and welcome to the Elme Communities Fourth Quarter 2024 (sic) [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 fourth 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 certain 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.

Presenting on the call today will be Paul McDermott, our CEO; Tiffany Butcher, our COO and Steve Freishtat, our CFO. And with that, I will turn the call over to Paul.

Paul McDermott: Thanks, Amy and thank you for joining us today to discuss our fourth quarter 2023 results and outlook for 2024. I’ll start by covering apartment fundamentals in each of our markets. Tiffany will cover our operating trends and growth initiatives and Steve will discuss our 2024 financial outlook. The Washington Metro, which drives over 80% of our multifamily NOI is positioned well with healthy demand trends and an outlook for rent growth that is above the U.S. average for a second year in a row. Furthermore, employment trends remain positive, with a favorable 2024 job growth outlook of 1.3%. Northern Virginia, which comprises over 80% of our Washington Metro footprint, continues to be the largest driver of job growth for the Washington Metro region and if the job growth outlet were to shift, the presence of the federal government and federal government contractors should provide continued stability and employment.

In terms of the supply picture, we have no exposure to capital south or northeast D.C., which are the highest supplied sub-markets in the district and only two of our Washington Metro sub-markets are projected to see increasing net inventory growth rates this year. Furthermore, our rent levels do not compete directly with new supply as the rent differential is $640 or 30% below recent deliveries. Overall, our Washington Metro portfolio is in a favorable and defensive position at this stage in the year and we expect it to be our primary NOI growth driver this year. Turning to Atlanta, the long-term outlook for population growth, household formation and job growth are strong and we remain optimistic about the longer term value creation potential of our Atlanta portfolio.

Employment is projected to grow by 1.2% during 2024 in line with the U.S. average and the sectors that are driving job growth in Atlanta are strong generators of demand for mid-market apartment homes in our sub-markets. Sub-urban employment growth is being powered by strong performance in the education and health, leisure and hospitality and finance industries, which together employ more than a third of our Atlanta residents. These sectors have registered annual growth rates in the range of 5% to 7% over the past year. While employment trends remain favorable, our Atlanta submarkets continue to experience pricing pressure due to both the normalization and rent growth following exceptional post pandemic growth and the impact of elevated deliveries.

While only two of our Atlanta sub-markets or about a third of our Atlanta homes are experiencing supply that is elevated above the U.S. average, we are experiencing a more widespread impact of new supply throughout the region relative to the Washington Metro, where the impacts of supply are more contained within each submarket. We do not anticipate supply elevating materially above the current levels in any of our Atlanta submarkets. However, we do expect the impact of new supply on our Atlanta portfolio to be felt throughout the year. Moving on to resident credit, wage growth relative to total rent growth across the Washington Metro and Atlanta Metro areas continues to trend positively and our residents’ financial status remains solid. The average rent to income ratio for new leases signed in the fourth quarter was 24%, representing a slight improvement compared to the 2023 average.

This reaffirms that our rental rates remain affordable for our new residents. And with that, I’ll turn it over to Tiffany to discuss our operating trends and growth initiatives.

Tiffany Butcher: Thanks, Paul. Starting with lease rate growth, we’re seeing favorable and positive trends in our same store portfolio. During the fourth quarter, we generated effective blended lease rate growth of 2.5% for our same store portfolio, comprised of renewal lease rate growth of 6.2%, an average new lease rate decline of 2.4%. Average resident retention was 65% due to a combination of our focus on maximizing rent growth by prioritizing renewals and the impact of our community teams who work very hard to create a great living experience for our residents. Another contributing factor is that our communities attract a higher composition of families and a more mature renter demographic, which supports strong renewal rate growth and longer average tenure in our communities.

Looking at our year-to-date trends for our 2024 same-store portfolio, which now includes all of our Atlanta communities except Druid Hills. Blended lease rate growth has averaged over 2.5% on an effective basis, up from 1.8% in the fourth quarter. The increase is driven by higher new lease rate growth and consistently strong renewal rate growth. For March and April renewals, we’re sending out renewals at an average rate above 6%. Moving on to occupancy, we maintained average same-store occupancy of 95.5% during the fourth quarter, representing strong growth of 50 basis points compared to the prior year. While we experienced occupancy pressure in our Atlanta portfolio, demand trend in our Washington Metro portfolio supported our ability to maintain a stable same-store occupancy trend over the course of the year.

On a year-to-date basis, occupancy for our 2024 same-store pool has trended down slightly due to the impact of temporary occupancy decline in our Atlanta portfolio, driven by the timing of evictions and the impact of new supply. Occupancy for our Washington Metro area communities has largely held steady on a year-to-date basis. As we move toward the spring leasing season, we anticipate continued strength in the Washington Metro market, allowing us to maintain occupancy within our targeted range. Turning to renovations, we completed over 300 full renovations and 77 partial renovations in 2023 at a total cost of $5 million, achieving an average renovation ROI of approximately 15%. In 2024, we expect to complete over 400 full renovations at an average cost of $16,000 per unit and over 100 partial renovations at an average cost of $5,000 per unit.

We believe that the renovations we are targeting this year will help us continue to attract high credit quality renters and will generate attractive returns as we are focusing 2024 renovations on submarkets where our renovated homes offer the best value proposition compared to nearby alternatives. Further, our renovation program is highly flexible since we execute renovations when units turn and we see the potential for outsized rent growth, which allows us to easily adjust the pace of renovations based on market demand for renovated units. Looking forward, we have an identified renovation pipeline of over 3,000 units, which represents more than enough runway to deliver renovation led value creation for the foreseeable future. Moving on to our operational initiative, previously, we said that we plan to deliver $4.25 million to $4.75 million of additional FFO growth between 2023 and 2025 from operational initiatives made possible by internalizing property level management.

We’re pleased to report that we captured 20% of that upside in 2023, which is in line with our expectations. The key drivers were new fee income initiatives, staffing efficiencies, our portfolio wide investment in smart home technology and cash management optimization. Looking forward, we expect to capture the remaining FFO upside split evenly across 2024 and 2025, with additional opportunity beyond that based on future staffing efficiencies related to leasing and maintenance. Furthermore, we plan to roll out managed Wi-Fi across our portfolio, starting with seven communities in 2024, which should generate additional upside beyond the $4.25 million to $4.75 million FFO target. Looking forward, we’re excited about the initiatives that we’re implementing and the upside that is yet to come as we drive increased profitability from our portfolio.

And with that, I’ll turn it over to Steve to cover our results, 2024 outlook and balance sheet.

Steven Freishtat: Thanks, Tiffany. We delivered a solid fourth quarter performance, closing out a year of exceptional growth that included 8.3% same-store multifamily NOI growth and 10.2% core FFO per share growth. As Tiffany discussed, we are seeing stable fundamental trends in our Washington Metro portfolio and we believe that we have the potential to outperform in our markets based on operational initiatives that are already underway. Our core business continues to perform well, our balance sheet is in great shape and we are laying the groundwork for NOI outperformance in the years to come. Now, I’d like to address our guidance assumptions. We expect same store multifamily NOI growth to range from 0.25% to 2% in 2024, driven primarily by rent growth in our Washington Metro portfolio and improving bad debt trends in our Atlanta portfolio in the second half of the year, partially offset by an 8% increase in non-controllable expenses.

The non-controllable expense increase is being driven by two of our Atlanta communities that are on a three year tax assessment cycle. We expect the impact of the timing of those assessments to drive an outsized increase in real estate taxes this year. Excluding those two communities, the expected increase in total non-controllable expenses would be closer to 5%. NOI for Watergate 600, which is currently 88% occupied, is expected to range from $12 million to $13 million. This represents a year-over-year decline of 6% at the midpoint due to an anticipated mid-single digit decline in occupancy over the course of the year. Interest expense is expected to range from $37.25 million to $38.25 million for the year, primarily driven by higher total debt balance following our acquisition of Druid Hills and a higher swapped interest rate on our term loan.

Our core FFO guidance range of $0.90 to $0.96 per fully diluted share reflects a year-over-year decline of 4% at the midpoint, coming off a year of over 10% growth in 2023. As I previously mentioned, after a year of exceptional performance, growth from our portfolio in 2024, which has been gradually easing is being mostly offset by higher interest rates. The drivers of our 2024 core FFO per share at the midpoint includes a $0.05 incremental contribution from our non-same-store multifamily portfolio and $0.02 of growth from our same-store multifamily portfolio, offset by an $0.08 impact from higher interest expense, a $0.01 decline related to Watergate 600, a $0.01 decline from higher property management fees as our portfolio grew in 2023 and a $0.01 decline from nonrecurring other income received in 2023.

Turning to our balance sheet, annualized adjusted net debt to EBITDA was 5.5 times at year end, in line with our targeted range and our liquidity position remained strong with approximately $550 million or 80% of the total capacity available on our line of credit at year end, with no secured debt and no debt maturities until 2025 with options to extend our 2025 term loan maturity another two years, our balance sheet remains in very good shape. And with that, I will turn it over to Paul.

Paul McDermott: Thanks, Steve. To wrap it up, our Washington Metro footprint and mid-market focus is well positioned given the stable demand trends we are experiencing and our mid-market focus which offers limited direct competition with new supply. While growth is moderated compared to 2023, operational progress is gaining momentum and we are capitalizing on the opportunity to focus on driving value creation within our portfolio. While macro uncertainty continues, we believe that the capital markets environment will improve over the course of 2024 and real estate transaction volumes will increase in the second half of the year. With improved clarity on real estate valuations, our current valuation should represent a compelling buyer opportunity as we establish a track record of strong NOI performance over time. And now, operator, I’d like to open it up for questions.

See also COVID-19 Stimulus Checks and 10 Other Things to Know About US Expat Taxes and 30 Fastest Growing Jobs In America.

Q&A Session

Operator: [Operator Instructions] Our first question is coming from Anthony Paolone with JPMorgan. Your line is live.

Anthony Paolone: Thanks and good morning. I guess first question is, I wonder if you could dive into the 2024 same-store pool a bit and give us a sense as to how bad debts look in, say, the Atlanta portfolio versus the D.C. portfolio and where you think they go over the course of the year, because it just seems like that occupancy slippage in Atlanta was pretty notable through the fourth quarter. And so just wondering how much that is bad debt, what needs to happen to kind of get that back on track and just any greater color there would be helpful?

Steven Freishtat: Hi, Tony, it’s Steve and maybe I’ll start and give just a little bit of a more detail on revenue and expenses and then I’ll kind of throw it over to Tiffany to go into bad debt more. But just looking at our NOI and breaking that down by revenue and expenses, we’re looking at revenue for the year as far as a growth percentage in the low threes and that’s driven by a few things, but primarily by rental revenue where we’re seeing that drive our growth for the year almost 90% of that growth is coming from rental revenue. And then smaller items in addition to that are filling out the rest of the bucket, including bad debt where as you talked about, we’re expecting a year-over-year increase there. We’re also expecting an increase in fee and ancillary income and that’s going to be partially offset by concessions, where we’re seeing increased concessions here in 2024 versus last year.

On the expense side, we see our expense percentage growth in the upper sixes and I’ll walk through because there’s a few things driving that here. The first is on the controllable side, where we see controllables going up about 5% for the year and that’s being pushed higher by revenue enhancing operational initiatives that we’re rolling out this year, including managed Wi-Fi, renters, insurance and centralized technology, where we’re reflecting an increase in expenses related to that and they’re being offset elsewhere in the income statement by things like the fee income and the ancillary income that I spoke about earlier. But the big driver, probably the biggest driver for the growth in our expenses is on the non-controllable side. The biggest one, of course, is taxes, which we talked about in the prepared remarks that we’ve got two assets on a three year cycle that came up this year and are being impacted by the fact that we acquired those within the last couple of years.

In addition to that, we’ve got insurance, which that’s a challenging market right now. We’ve got a pretty healthy double digit increase in insurance as well. So that’s really driving the non-controllables. And when you look at kind of everything I talked about on the insurance side, if you just – the operational initiatives and the two Georgia communities with their taxes, which are kind of unusual for us this year, expense growth would be about 250 basis points lower than that upper sixes I was referring to. As far as going into bad debt, Tiffany, if you want to go into that a little bit further?

Tiffany Butcher: Sure. Absolutely. As Steve was saying, we expect 20 to 40 basis points of same-store revenue growth to come from improvement in bad debt in 2024 compared to 2023. As we think about the projected improvement, it’s important to note that bad debt in 2023 was impacted by some transitional friction during the transition from third party to in house management and that’s obviously now behind us. Bad debt was also elevated in the back half of 2023 due to the end of rental assistance programs in most of our Atlanta counties, which happened in the late summer and early fall, which led to higher delinquencies starting in August, which is anticipated to improve in 2024 as these post rental assistance delinquencies work their way through the eviction process.

We’ve also made a number of procedural improvements to our collections process, including changing our policy on partial payments, which increases bad debt in the short-term, but positively impacts bad debt long-term, as it speeds up the eviction process for delinquent tenants, allowing us to backfill the units with credit quality tenants more quickly. We’ve also tightened our credit standards and improved our screening and income verification processes, which will improve our credit performance over the longer-term.

Anthony Paolone: Okay. I guess I’m just trying to understand like the occupancy moved down and just seems like the impact from supply in Atlanta is pretty notable. And so like what is sort of the concessionary environment like what are you doing to kind of offset that? And so should we think about this year-end occupancy there as being kind of a trough and just are you able to kind of move that back up?

Tiffany Butcher: Sure. Let me handle those two questions, both on occupancy and in concessions. First, the occupancy declines that we experienced in Atlanta in the back half of 2023 were driven, as you noted, by two key factors, the timing of evictions following the end of rental assistance and the impacts of new supply. With respect to the impact of evictions on occupancy, most of the Atlanta jurisdictions either closed or ran out of emergency rental assistance funds in the late summer and early fall, as I said earlier, which did start impacting delinquencies in August, which has impacted the timing because evictions are just which impacts occupancy because the timing of when evictions happen is just not entirely predictable.

So that does create some near-term drag on occupancy, while those units are turned and then released. But as I mentioned earlier, we have elected to implement end to partial payments, which does speed up that eviction process significantly. Again, that impacts occupancy in the near-term, but it will have that positive long term benefit that I was talking about. The second driver is obviously new supply and the story there varies by sub-market. 33% of our Atlanta communities have already seen the peak in supply and about 70% will see supply peak in mid-2024. So we anticipate that supply related pressures on occupancy will improve as we move throughout the year. While our guidance assumes that portfolio level occupancy remains relatively flat on a year-over-year basis, we do expect to see occupancy in the Atlanta market improve throughout the year as these eviction related vacancies moderate and we optimize revenue by adjusting pricing and concessions to meet market demand and drive occupancy.