Independence Realty Trust, Inc. (NYSE:IRT) Q3 2023 Earnings Call Transcript

Independence Realty Trust, Inc. (NYSE:IRT) Q3 2023 Earnings Call Transcript October 31, 2023

Operator: Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Independence Realty Trust Q3 2023 Conference Call. Today’s conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] At this time, I’d like to turn the conference over to Lauren Torres. Please go ahead.

Lauren Torres: Thank you, and good morning, everyone. Thank you for joining us to review Independence Realty Trust’s third quarter 2023 financial results. On the call with me today are Scott Schaeffer, Chief Executive Officer; Mike Daley, EVP of Operations and People; Jim Sebra, Chief Financial Officer; and Janice Richards, SVP of Operations. Today’s call is being webcast on our website at irtliving.com. There will be a replay of the call available via webcast on our Investor Relations website and telephonically beginning at approximately 12:00 PM Eastern Time today. Before I turn the call over to Scott, I’d like to remind everyone that there may be forward-looking statements made on this call. These forward-looking statements reflect IRT’s current views with respect to future events and financial performance.

A Real Estate Investment Trust (REIT) property manager inspecting a newly acquired apartment complex.

Actual results could differ substantially and materially from what IRT has projected. Such statements are made in good faith pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to IRT’s press release, supplemental information and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations. Participants may discuss non-GAAP financial measures during this call. A copy of IRT’s earnings press release and supplemental information containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most direct comparable GAAP financial measure is attached to IRT’s current report on the Form 8-K available at IRT’s website under Investor Relations.

IRT’s other SEC filings are also available through this link. IRT does not undertake to update forward-looking statements on this call or with respect to matters described herein, except as may be required by law. With that, it’s my pleasure to turn the call over to Scott Schaeffer.

Scott Schaeffer: Thank you, Lauren, and thank you all for joining us this morning. On our last earnings call, we specifically noted four areas of focus at IRT: drive occupancy, deliver plan, value-add improvements, further manage our cost structure, and reduce our [indiscernible]. Since then, we have made progress on each of these fronts and have recognized ways to further optimize our portfolio, which will accelerate our deleveraging and better position IRT for the future. Let me take them one by one. First, our same-store occupancy in the third quarter improved 40 basis points to 94.6% on both a year-over-year and sequential basis, reflecting our team’s ability to continue to implement operational enhancements. Second, we continue to invest in our communities, particularly through our value-add renovation program, where we renovated 709 units in the third quarter and 1,969 units in the first nine months of 2023, achieving an unlevered return on investment of 16%.

Third, we continue to better manage our cost structure by reducing overhead costs by $2 million this year as compared to our original guidance issued in February. This is in addition to the $2.5 million in annual savings associated with the centralization of resident services and sales performance management teams. Looking into 2024, we are rolling out several new technology initiatives that will create further efficiencies. And fourth, we are now announcing a program to accelerate the sale of non-core properties and immediately delever. More on this strategy in a minute. While we remain encouraged by our strategic initiatives to support continued growth at IRT, we and other multifamily operators are facing an increasingly challenging environment.

Specifically, we have seen a slower rate of occupancy gains than expected due to the softening economic environment, along with pricing pressure as new supply is offering aggressive concessions. These factors are affecting some of our markets such as Atlanta, Dallas, and Nashville. So as a result of these recent trends, we are adjusting our 2023 guidance. Jim will provide greater detail behind our guidance update later on this call. We firmly believe that our core markets are well positioned to continue to see strong absorption of multifamily units. Further, we will continue to benefit from our market diversification and affordable defensive middle market communities that are more resilient, but not immune to current elevated supply pressure.

While we work to navigate the current environment, we must also think strategically to ensure that we are well positioned for the future. Accordingly, we are initiating our portfolio optimization and deleveraging strategy, which is focused over the near-term on reducing our presence in non-core markets while also significantly deleveraging our balance sheet. We are accelerating this plan due to the broad view that interest rates will remain higher for longer, which will continue to impact property values. Our plan is to sell 10 non-core properties with the proceeds used to immediately reduce debt. The plan reduces near-term maturities and better positions IRT for an investment-grade rating. Before handing the call over to Mike, I’d like to stress our continued confidence in our core markets, where demand fundamentals remain favorable and supply pressure should begin to abate over the next 6 to 12 months.

We expect to continue to benefit from positive migration, demographic and employment trends. This is a core strength to the IRT portfolio and will position us favorably going forward. I’d now like to turn the call over to Mike.

Mike Daley: Thanks, Scott. As Scott mentioned and has been noted by other companies and multifamily economists, we are operating in a challenging environment with the impact of new supply and the impact of inflation on consumers. These factors have led to more options for renters in the near-term and higher sensitivity to price than we’ve seen in recent years. This has created headwinds for us and for the industry. Despite these challenges in the third quarter, we delivered a same-store average occupancy rate of 94.6%, a 40 basis point increase on a quarter-over-quarter and year-over-year basis, and a 150 basis point increase from Q1 of this year. As of today, our same-store occupancy is 94.6% and our same-store non-value add occupancy is 95%.

Our portfolio average rental rate increased 4.4% in Q3, contributing to 5.4% year-over-year property revenue growth for the quarter. New lease rent growth in Q3 reflected changing market conditions, with new lease rates 80 basis points higher. This includes the impact of concession activity to counter those conditions. In the third quarter, we increased the use of concessions, especially markets such as Atlanta and Dallas, to remain competitive and prioritize occupancy. Lease over lease effective rent growth for renewals in Q3 2023 was 4.8% and in Q4 2023 to date is 5%, which reflects approximately 82% of our total expected Q4 lease renewals. Our Q4 2023 to date blended lease-over-lease effective rental rate growth is 2.3%. We continue to achieve double-digit NOI growth in the third quarter in a number of markets, including Houston, Tampa, Louisville, and Lexington.

These markets have displayed increases in average monthly rent, benefiting from strong job markets. We continue to focus on driving operational performance through process improvement, role specialization, and ongoing technology enhancements. These initiatives include a pilot program to build on organizational improvements that have increased the speed of our response to local market changes. Another example is in the screening and qualification process for new residents. Across the industry, efforts to ensure screening effectiveness and to fight fraud are a high priority. We are deploying new technology solutions to improve the accuracy and confidence of prospect ID verification and are preparing to deploy a new robust income verification solution in early 2024.

We expect these technology enhancements will improve the speed and effectiveness of resident screening. In addition, our specialized teams focused on sales and residence account management have had a positive impact on staffing efficiency, resident experience and reputation, streamlining the collections process and greater efficiency and focus for our community teams. As we look ahead, our focus is on prioritizing occupancy throughout our portfolio, while optimizing rent growth where possible. Our results in Q3 show the success of our initiatives and we will continue to explore opportunities to increase efficiencies and drive results. I will now turn the call over to Jim.

Jim Sebra: Thanks, Mike, and good morning, everyone. Beginning with our third quarter 2023 performance, net income available to common shareholders was $3.9 million as compared to a $16.2 million in the third quarter of 2022. This decrease is a result of an asset impairment we recorded this quarter associated with the portfolio optimization and deleveraging strategies Scott mentioned. During the third quarter, core FFO per share increased 7.1% to $0.30 per share from $0.28 per share a year ago. This growth reflects the organic rent and NOI growth that we experienced in the quarter on a year-over-year basis. IRT same-store NOI growth in the third quarter was 4.8%, driven by revenue growth of 5.4%. This growth was led by a 4.4% increase in average monthly rental rates to $1,549 per month.

On the operating expense side, IRT same-store operating expenses increased 6.3% during the third quarter, led by higher property insurance and contract services due to inflation, as well as higher advertising expenses as a result of our increased efforts to drive occupancy amid a slowing macroeconomic environment. Turning to our balance sheet. As of September 30, our liquidity position was $276 million. We had approximately $17 million of unrestricted cash and $259 million of additional capacity through our unsecured credit facility. Before turning to 2023 guidance, I’d like to provide more details behind our newly initiated portfolio optimization and deleveraging strategy. As Scott mentioned, we are focused on reducing our presence in non-core markets, while also delivering our balance sheet.

In particular, we plan to sell 10 properties in seven markets for estimated growth proceeds between $521 million and $533 million, which equates to a weighted average economic cap rate of approximately 5.9% at the midpoint. After repaying debt at the property level associated with the sold properties, we estimate that we will have between $232 million and $244 million of remaining proceeds and we’ll use those remaining proceeds to repay unhedged floating rate borrowing and various other high-cost property mortgages that mature in 2024, 2025, and 2026. The weighted average coupon of the debt we plan to repay is approximately 6.1%. As we sell all these properties, nine of which were acquired from our merger with STAR in late 2021, we are expecting to record a net loss on sale of between $39 million and $51 million, which includes a $20 million to $24 million gain on the single legacy IRT asset that is expected to be sold.

We expect this strategy will result in $0.02 to $0.03 of annual dilution to core FFO per share and after the effect of annual CapEx, we expect it to be breakeven on a free cash flow basis. In addition, the related deleveraging is expected to reduce our net debt to adjusted EBITDA by almost one full term and further improve our unencumbered asset ratios as we work towards achieving an investment-grade rating. We also expect that the strategy will remove all floating rate risk from our balance sheet and will significantly reduce our debt maturities in 2024 and 2025 as we disclosed in our earnings supplement. With respect to our full-year 2023 outlook, we are lowering our EPS guidance range from $0.25 to $0.27 to a loss of $0.07 to $0.02, which now reflects estimated impairment losses of real estate assets just as discussed as a result of our strategy.

Our 2023 core FFO per share guidance midpoint changes by roughly half a penny. We are reducing our same-store portfolio from 115 to 106 properties as a result of this portfolio optimization and deleveraging strategy as we just discussed. The midpoint of our new same-store revenue guidance is 5.6% down from 6.35% previously. This reflects the following assumptions for the fourth quarter of 2023, average occupancy of 94.4%, a blended net effective rental rate increase of 90 basis points, and bad debt had approximately 2% of revenue. On the expense side, our guidance for full-year 2023 total operating expense growth is now more favorable at 5.7%, down from 6.1% at the midpoint of our ranges. Controllable operating expenses are now expected to be up 6.5% at the midpoint versus previous guidance of 5.1%, driven by higher inflationary pressure on services as well as higher cost to turn units associated with evictions.

Non-controllable operating expenses for real estate taxes and insurance are now expected to be up 4.5% at the midpoint. This is down from our previous guidance of 7.8%, driven by lower assessed values than expected and early successes with 2023 real estate tax appeals. As a result of these changes our revised midpoint for property NOI growth is now 5.5%, down from 6.5%. We are reducing our G&A and property management expense guidance to a midpoint of $50.5 million, down from $51 million previously. And we were also reducing the range and midpoint for full-year interest expense to $101.5 million, down from $103 million. While we’re still not assuming any acquisition volume for this year, we are maintaining our disposition guidance of $124.5 million at the midpoint, as we are not expecting the additional sales from our portfolio optimization strategy will occur this year, but rather in early 2024.

Now, I’ll turn the call back to Scott. Scott?

Scott Schaeffer: Thanks, Jim. In closing, we feel very good about our position despite the near-term environment. First, we have the right assets and the right markets that will continue to benefit from favorable demographic trends. Second, value-add is core to who we are and will remain a consistent source of organic growth with the portfolio throughout the cycle. And lastly, we are now taking decisive action to optimize the portfolio and fundamentally reset our leverage profile. We are committed to this strategy as we believe it will deliver sustainable earnings growth. We thank you for joining us today and we look forward to speaking with many of you at NAREIT’s REITworld Conference in the coming weeks. Operator, you can open the call for questions.

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Q&A Session

Operator: Thank you. [Operator Instructions] We’ll take our first question from Austin Wurschmidt at KeyBanc Capital Markets.

Austin Wurschmidt: Hi, good morning and thank you. Are the 10 assets being marketed as one-off sales or are you attempting to sell as a portfolio? And can you give us a sense how far along you are in the marketing process, and just how deep the pool of buyers has been so far?

Scott Schaeffer: Sure, Austin. Thanks for the question. They’re being marketed as one-off transactions because they’re in varied markets and we started this process a little bit ago and are well along. We have a couple under agreement, there’s a third agreement ready to be signed, there’s a couple more LOIs. So we’re well into the process and that’s what gives us confidence that we’ll get this done.

Austin Wurschmidt: And I guess just what gives you the confidence that you can execute a sale at the pricing you’ve alluded to in your prepared remarks? I mean, other than, it does sound like you’ve made some progress here before. But then upon executing a sale, I’m also curious what the ultimate target is now for net debt-to-EBITDA over, call it, the next 24 months or so?

Scott Schaeffer: Well, I’m going to let Jim answer the last part of that question, but there was good demand for these properties as we took them out to market. Multiple bids, very qualified and well-heeled buyers that we know is because we took them through buyer interviews. So it gives us confidence that we’ll get it done and we intend to sell these assets.

Jim Sebra: And Austin, on the question on the net debt-to-EBITDA, we’ve given our perspective that we expect it to be kind of mid-5s at the end of 2025. We fully expect that we’ll be pulling that up into certainly 2024, if not maybe mid 2024. So we expect our net debt-to-EBITDA to ratchet down by that almost that entire full turn and continue to make additional progress as just EBITDA grows.

Austin Wurschmidt: That’s helpful. I’ll leave it there. Thanks for the time.

Scott Schaeffer: Thanks, Wurschmidt.

Operator: We’ll go next to John Kim at BMO Capital Markets.

John Kim: Thank you. Can you discuss where bad debt was during the third quarter and how you see that improving or progressing over the next 12 months?

Jim Sebra: Yes, so bad debt in the third quarter was about 1.9%. We expect – right now – in our initial guidance for the year, we expected to be about 1.5%. We think that’ll be kind of hovering for the full-year rate around 2%. And then as Mike alluded to in his prepared remarks, as we make additional progress on the ID verification as well as an improved income verification tool, that will continue to see that bad debt ratchet down next year.

John Kim: And that 1.9%, was that gross or net of Resident Relief Fund?

Jim Sebra: There really wasn’t very much Resident Relief Fund, so I would say it’s both.

John Kim: Okay. On your value-add, the 23 properties, the new lease growth rate decelerated and was down 1.6% in the fourth quarter. Can you explain this dynamic? I thought the renovated units themselves were generating enough rent, I guess, the 20% uplift in rent to bring up the overall average of the building.

Scott Schaeffer: Sure. It’s really a seasonality and timing issue. As we worked to push occupancy, the value-add was part of that effort. There is good demand. We’re not carrying a lot of value-add units that have been completed. They’re getting leased and we expect that to normalize back to more historical levels next year. Now that occupancy is stable, it gives us the view that it’ll again normalize next year.

John Kim: Do you expect the return expectations to continue to moderate?

Scott Schaeffer: To moderate? No. No, I expect it to be back towards that 18% in 2024.

John Kim: Okay. Great, thank you.

Scott Schaeffer: Thanks, John.

Operator: We’ll go next to Brad Heffern at RBC Capital Markets.

Bradley Heffern: Hey, everybody. Can you talk about why you’re pursuing this deleveraging program now? Obviously, you bought STAR a couple years ago, so I guess why not sell these kind of one-off caps and [indiscernible] immediately and what made now the right time to do it?

Scott Schaeffer: So, good question. We looked at the current interest rate environment. And with the broad view that now rates will stay higher for longer, we felt that cap rates probably were not going to go down in the near-term. What kept us from doing it previously was that there was significant yield maintenance or defeasance costs associated with the property-level mortgages on these properties. Now those, because of the increase in rates and the passage of time, that prepayment penalty, if you will, is gone. So with the view that rates are going to be higher for longer and with no prepayment costs, now we’ve decided it was time to just exit these markets. So we had always planned on exiting and to use the proceeds to delever.

Bradley Heffern: Okay, got it. And then probably for you, Jim. I guess some of the building blocks for 2024, I was wondering if you could give them like your current expectation for earn-in the lost to lease and any initial thoughts on whether we’ll see market rent growth?

Jim Sebra: So good question. Obviously, 2024 is still very much unknown. But the current building blocks, the current loss to lease is 1.8% across the portfolio. Our current expectations for earnings for next year are about 1.3% and obviously that’s assuming kind of that – kind of continual what we’ve seen rent growth so far in the fourth quarter that continues for November, December. And then right now, CoStar is reporting that our sub markets should experience 2.4% market rent growth.

Bradley Heffern: Okay, thank you.

Operator: We’ll move to our next question from Anthony Powell at Barclays.

Anthony Powell: Hi, good morning. We’ve talked in the past about how Class B apartments should benefit from trade down in a slower economic environment. Are you seeing any of that or is the supply environment maybe making that more difficult this time around?