Mid-America Apartment Communities, Inc. (NYSE:MAA) Q3 2023 Earnings Call Transcript

Mid-America Apartment Communities, Inc. (NYSE:MAA) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning ladies and gentlemen and welcome to the MAA Third Quarter 2023 Earnings Conference Call. During the presentation, all participants will be in a listen mode. Afterward, the company will conduct a question-and-answer session. As a reminder, this conference call is being recorded today October 26th, 2023. I will now turn the call over to Adam Schaeffer, Senior Vice President, Treasurer and Director of Capital Markets of MAA for opening comments.

Andrew Schaeffer: Thank you, Brittney and good morning everyone. This is Andrew Schaeffer, Treasurer and Director of Capital Markets for MAA. Members of the management team also participating on the call with me this morning are Eric Bolton, Tim Argo, Al Campbell, Rob DelPriore, Joe Fracchia, Brad Hill, and Clay Holder. Before we begin with our prepared comments this morning I want to point out that as part of this discussion, company management will be making forward-looking statements. Actual results may differ materially from our projections. We encourage you to refer to the forward-looking statements section in yesterday’s earnings release and our 34x filings with the SEC, which describe risk factors that may impact future results.

Aerial view of a city skyline, where you can see the real estate developments of the company.

During this call, we will also discuss certain non-GAAP financial measures. A presentation of the most directly comparable GAAP financial measures as well as reconciliations of the differences between non-GAAP and comparable GAAP measures can be found in our earnings release and supplemental financial data. Our earnings release and supplements are currently available on the — for Investors page of our website at www.maac.com. A copy of our prepared comments and audio recording of this call will also be available on our website later today. After some brief prepared comments the management team will be available to answer questions. I will now turn the call over to Eric.

Eric Bolton: Thanks Andrew and good morning. MAA’s third quarter FFO performance was ahead of our expectations as the demand side of our business continues to capture good leasing traffic, low resident turnover, positive migration trends, and strong collections performance. During the quarter, we did see a higher impact from new supply deliveries across several of our larger markets with the resulting impact showing up in pricing associated with new move-in residents, while we continue to believe that MAA’s unique market diversification a more affordable rent structure and an experienced and capable operating platform will enable us to push back against some of the supply pressure. The high volume of new deliveries in several markets will continue to weigh on rent growth associated with new resident move-ins for the next few quarters.

Encouragingly, there is now clear evidence emerging that new supply deliveries are poised to meaningfully drop late next year into 2025. We have certainly worked through these supply cycles before and continue to believe that MAA’s more extensive market and submarket diversification new AI and technology tools and an experienced operating team has us in a position to outperform our markets. As we have discussed previously one of the benefits that typically emerges from a heavy supply cycle particularly one that is characterized by higher interest rates is an increasing volume of acquisition and external growth opportunities. We have seen a shift take place with seller and developer pricing expectations. The more challenging lease-up conditions coupled with higher interest rates that are likely to be with us for a while are generating more buying opportunities.

As Brad will recap in his comments the property acquisition we completed after quarter end is a good example of where we expect more opportunities to emerge specifically a recently completed new development that is still in initial lease-up with seller requirements to close within a short timeframe. Before turning the call over to the team to provide details surrounding our performance and market conditions, let me summarize what I believe are the four key takeaways in our report. First, demand across our markets remain solid and supportive of steady absorption of the new supply. Secondly, current high levels of new supply coupled with developer pressures related to the higher interest rate environment will cause the leasing environment to remain competitive for the next few quarters with new supply pressures expected to then decline.

We expect to see an increasing number of compelling external growth opportunities in 2024. And four, MAA’s long track record of performance and experience in working with markets with higher demand and supply dynamics now further supported by a stronger technology platform and a strong balance sheet with significant capacity has the company in very well position as we work through the current cycle. And with that I’ll now turn the call over to Brad.

Brad Hill: Thank you, Eric and good morning everyone. As anticipated we saw an increase in for-sale marketing activity emerge early in the third quarter. And while closed transactions are limited in number, we continue to see some upward pressure on cap rates on projects we track, with cap rates up by roughly 15 basis points from 2Q. As indicated in our earnings release, we recently closed the Phoenix market that we began pursuing early in 3Q. MAA Central Avenue is a 323-unit mid-rise property that fits the profile of the type of opportunities we expected to emerge. The property is in its initial lease-up and the seller was under some pressure to close on the sale by a specific date. So, counterparty risk considerations were paramount to the seller.

Our familiarity with the market, speed of execution and balance sheet strength that supports an ability to close all cash with no financing contingencies were all aspects of our offer that were very important to the sellers. Our pricing of approximately $317,000 per unit is substantially below current replacement costs and is expected to provide an initial stabilized NOI yield of 5.5%. With the property nearing stabilization, we expect over the following year or so to capture further margin and yield expansion opportunities as a result of adopting MAA’s more sophisticated revenue management practices and technology platform coupled with our future ability to achieve operational synergies with another MAA property that is only half a mile away.

Our transaction team is very active in evaluating other acquisition opportunities across our footprint. And Al and Clay have our balance sheet in great position to be able to take advantage of additional compelling opportunities as they continue to materialize later this year and into 2024. Despite pressure from elevated supply our new properties in their initial lease-up continued to deliver strong performance producing higher NOIs and earnings than forecasted creating additional long-term value for the company. These properties on average have captured in-place rents 15% above our original expectations. For the five properties that are either leasing or will start leasing by the end of the year this rent outperformance which is partially offset by higher expenses including taxes and insurance is estimated to produce an average stabilized NOI yield of 6.7% significantly higher than our original expectations.

Leasing has progressed well at MA Windmill Hill in Austin and we expect this community to stabilize this quarter. We continue to advance predevelopment work on several projects, but due to some permitting and approval delays three projects that we plan to start this year will likely instead start in early 2024. In a number of markets — in a number of our markets, construction costs have been slower to adjust than we expected, but we continue to see signs that a broader reduction in cost is likely to come. Numerous consultants that we work with including architects and engineers have indicated their volume of work has significantly decreased in the last few months providing further evidence of a decline in new construction activity. Additionally, general contractors are indicating they have more capacity to start new projects and in many cases with a larger pool of subcontractors available.

In addition to the three projects mentioned that we expect to start over the next six months, we have five more projects representing approximately 1,320 units that could be ready for construction start by the end of 2024. Our team has done a tremendous job building out our future development pipeline. And today we own or control 13 well-located sites representing a growth opportunity of nearly 3700 units. We have optionality on when we start these projects allowing us to maintain our patience and discipline when making capital deployment decisions. Any project we start in 2024 will deliver units into a stronger leasing environment with lower competitive supply in late 2025 and 2026. Our development team continues to evaluate land sites as well as additional prepurchase development opportunities.

In this more constrained liquidity environment we are hopeful that we may find additional development opportunities to add to our future pipeline. In addition to continuously monitoring the construction market and evaluating costs at our projects in predevelopment, our construction management team is focused on completing and delivering our remaining five under construction projects. During the third quarter the team successfully wrapped up construction on novel West Midtown in Atlanta completing the delivery of all 340 units. That’s all I have in the way of prepared comments. So with that I’ll turn the call over to Tim.

Tim Argo: Thanks, Brad and good morning. Same-store revenue growth for the quarter was essentially in line with our expectations with sequentially higher occupancy offsetting sequentially declining new lease pricing. Increasing supply pressure did impact pricing in some of our markets resulting in a blended lease over lease pricing of 1.6% comprised of new lease rates declining 2.2% and renewal rates increasing 5%. Average physical occupancy was 95.7% resulting in revenue growth of 4.1%. The various metrics we measure related to demand remained strong. Employment markets remained stable with continued job growth across our Sunbelt markets. Net positive migration trends to our markets continue with move into our footprint well ahead of move-outs outside of our footprint and remain consistent with what we have seen in the last several quarters.

Resident turnover was down once again in the third quarter a 4% decrease from prior year. Collections remained strong and consistent with prior quarters. Our new resident rent-to-income ratio remained low and in line with prior quarters and our lead volume is consistent with what we would expect and in line with pre-pandemic levels. But as mentioned, we did feel the impact of new supply in the third quarter which manifested itself in lower new lease pricing particularly beginning in August and September. This pressure was driven by higher concession uses by developers in many of our markets with the resulting reduction in net pricing in a number of our direct market comps. This peer pricing movement obviously does impact market pricing it impacts our asking rents.

We believe the lingering higher interest rate environment with the 10-year treasury moving up quickly in the third quarter is driving merchant developers to get more aggressive on pricing and is creating some pockets of pricing pressure. Historically with typical seasonality pricing tends to moderate some in Q3 as compared to Q2 and then moderating quite a bit more from Q3 to Q4 typically in the 200 basis point range. While we did see a greater degree of moderation in the third quarter as compared to the second quarter with the solid demand factors mentioned previously we expect less moderation than normal from Q3 to Q4. October to date Blend and lease-over-lease pricing is zero which is within 10 basis points of what was achieved in September and a lower rate of decline than the more typical 60 basis points.

Average physical occupancy for October month to date remains strong at 95.6% with exposure which is a combination of current vacancy and units on notice to vacate up 6.9% and in line with October of last year. In addition to the demand factors mentioned increased absorption through the third quarter in the Sunbelt markets provides further evidence of continued solid demand to help mitigate the impact of the continuing new deliveries. The amount of new supply that was absorbed in the third quarter in our markets was the highest it has been since the beginning of 2022. Despite the new supply pressure in some markets, our unique portfolio strategy to maintain a broad diversity of markets submarkets asset types and price points is serving us well with many of our mid-tier markets leading the portfolio and pricing performance both in the third quarter and into October.

Savannah Charleston, Richmond Greenville and Raleigh are examples of markets outperforming larger metros with more new supply pressures such as Austin and Phoenix. We expect this market diversification combined with the continued strong demand fundamentals noted earlier will help continue to mitigate some of the impact of new supply as compared to a less diversified portfolio. Regarding redevelopment, we continued our various product upgrade initiatives in the third quarter. For the third quarter of 2023, we completed nearly 2,300 interior unit upgrades and are nearing completion on the Smart Home initiative with over 92,000 units now with this technology. For our repositioning program we have five active projects that have either begun repricing or will begin repricing in the fourth quarter with expected yields in the 8% range.

Additionally, we are evaluating an additional group of properties to potentially begin construction later in 2023 or early in 2024, with the target to complete by early 2025. That’s all I had in the way of prepared comments. I’ll now turn the call over to Clay.

Clay Holder: Thank you Tim and good morning. Reported core FFO for the quarter of $2.29 per share was $0.03 per share above the midpoint of our guidance. The outperformance was primarily driven by favorable interest and overhead costs during the quarter. Overall same-store operating performance for the quarter was in line with our expectations. Same-store revenues were slightly ahead of expectations as average occupancy was better than forecasted. The increase in occupancy was offset by the moderation of effective rent growth on new move-in leases as Tim mentioned. As expected, we began to see some moderation in same-store operating expense growth during the third quarter. However, this moderation was less than what we had forecasted.

Personnel costs came in higher than expected, primarily due to higher contract labor costs and higher leasing commission, which helped drive the improvements in occupancy. The personnel costs were partially offset by real estate taxes that were favorable to our forecast for the quarter. We received more information related to the Texas state legislation that was passed in the quarter that reduced property tax rates in the state. Our projection for real estate taxes for the full year remains unchanged. During the quarter, we invested a total of $19.7 million of capital through our redevelopment repositioning and smart rent installation programs. Those investments continue to produce strong returns and add to the quality of our portfolio. We also funded just over $47 million of development costs during the quarter toward the completion of the current $643 million pipeline leaving $296 million remaining to be funded on this pipeline over the next two years.

As Brad mentioned, we also expect to start several new projects over the next 12 to 18 months which our balance sheet remains well positioned to support. We ended the quarter with $1.4 billion in combined cash and borrowing capacity under our revolving credit facility providing significant opportunity to fund potential investment opportunities. Our leverage remains historically low with the debt-to-EBITDA ratio at 3.4 times, and at quarter end our debt was 100% fixed for an average of just over seven years at a low average interest rate of 3.4%. In October, we refinanced $350 million of maturing debt utilizing cash on our balance sheet and our commercial paper program. Our current plan is to continue to be patient and allow interest rates and financing markets to stabilize before refinancing.

That’s all I have for my prepared comments and I’ll turn it over to Al to discuss Q4 guidance.

Al Campbell: Thank you, Clay, and good morning everyone. Given the third quarter performance outlined by Clay as well as expectations for the remainder of the year we have updated and narrowed our guidance ranges for the year which is detailed in the supplement to our release. Overall, the third quarter core FFO favorability primarily related to overhead and interest costs is expected to be essentially offset by higher-than-projected same-store operating expenses for the remainder of the year, which I’ll discuss a bit more in just a moment. Thus, we’re maintaining the midpoint of our core FFO projection for the full year of $9.14 per share which reflects a 7.5% growth over the prior year. The midpoint of our total revenue growth projection for the year remains unchanged as the expected impact of pricing moderation, which is reflected in effective rent growth is largely offset by the increase in projected average occupancy for the year.

However, we have increased our guidance for same-store operating expense growth for the full year by 45 basis points to 6.5% at the midpoint, primarily reflecting the continued pressure in labor costs partially related to building higher occupancy. Both personnel and repair and maintenance costs are expected to moderate more as we move into 2024. While we maintained our full year guidance range for real estate taxes, we are impacted by some timing-related pressure during the fourth quarter, as some of the initial favorability related to the Texas rate reduction is essentially offset by delays in litigation related to high valuations, which is being pushed into next year. We do expect real estate taxes overall to continue moderating over the next couple of years, as we work through the changing cap rate environment.

We also reduced our total overhead cost projection for the year by $2 million to $126.5 million at the midpoint and we removed our disposition expectations for the current year, to reflect the current market conditions. So that’s all that we have in the way of prepared comments. Brittany, will now turn the call back to you for questions.

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Q&A Session

Operator: We will now open the call for questions. [Operator Instructions] We will take our first question from Michael Goldsmith with UBS. Your line is open.

Michael Goldsmith: Good morning. Thanks for taking my questions. My first question is just on the impact of the merchant builders delivering into a higher supply higher rate environment? It seems like it’s changed the lease-up strategy. So I guess, is the largest impact here that rental rates have gone — have moved lower and will remain lower longer. And so I guess, in initial expectations. So will this — does this create more pressure in the near term and also for longer? Or is it just kind of a lower dip, before it gets better kind of seems like back half of 2024 early 2025.

Tim Argo: I mean I don’t think it necessarily means longer. I think what did happen as we talked about it happened a little bit quicker. And I think the comments, I made about the treasury and developers get more aggressive called that moderation of new lease rates to occur a little bit earlier than we would have thought or a little bit quicker really. But we don’t see much further deceleration. I think what we see is with renewal rates continuing to be strong, we’re getting 5% on what we’ve set out or what we’ve got acceptance on for November and December the 5% range. The spread between new lease rates and renewal rates is pretty typical honestly, for this time of the year and tends to gap out both in Q4 and Q1. I think as you get into later into 2024, there will be some normal seasonality that will narrow that gap, but we’ll be in this supply environment for the next few quarters, but don’t expect materially worsening from here.

Michael Goldsmith: Got it. And are you seeing any difference in the performance between your Class B properties with your price stated discounted supply versus the Class A, which should be competing more in line with where the new supply is coming in? Like where is the pressure hitting the hard. Thank you.

Tim Argo: At a portfolio level, we’re not seeing a huge difference between the performance of As and Bs. I will say at a market level some of our larger markets that are getting more of the supply we’re seeing a little more pressure on some of those B+ A- assets where that gap has narrowed. But I do think that creates some opportunity longer term. Those new developments are going to stabilize, at some point at higher rents and that will create some opportunities there. But in some of our more mid-tier markets, smaller markets that are getting quite the supply pressure we’re not seeing that pressure.

Eric Bolton: And I think it’s worth noting that, even at the — use of concessions is happening by some of the merchant developers, in the third quarter. The price gap between what we’re seeing of the new product delivering in the market with those concessions as compared to the average rent in our portfolio, is still a spread of $300. That’s down a little bit from $350 million, we saw in Q2 but it’s still a pretty healthy spread there.

Michael Goldsmith: Thank you very much. Good luck in the fourth quarter

Operator: Thank you. We will take our next question from Austin Wurschmidt with KeyBanc. Your line is open.

Austin Wurschmidt: Great. Thank you. Last quarter Eric, you had mentioned, that you really didn’t expect new lease rate growth to drop off and kind of highlighted that demand remained strong. So I guess, is it just been the cumulative impact of supply and concessions on lease-ups that’s driven the softness? And really, how does that change your view around how 2024 market rent growth could shape up?

Eric Bolton: Well, Austin, I think that as Tim alluded to I mean the thing that frankly, was a little bit surprising in the third quarter was the more aggressive practices, taking place by some of the merchant developers that was directly impacting some of our product in some of the larger markets. We do think that there’s — it’s interesting we were looking at just sort of what happened during the third quarter in terms of the sort of rapid ramp-up, of the junior treasuries. And — and I think as developers are facing particularly merchant builders, who are facing a more competitive leasing landscape, with the reality of a prolonged high interest rate environment there was a motivation if you will to get pretty darn aggressive and trying to get leased up before we got into the holiday season.

And so that affected market dynamics in some of our markets, and I think cause new lease pricing to moderate a little quicker than we would have otherwise thought, just because these merchant builders are a little bit of an urgency to get stabilized sooner rather than later. And so I think that that performance we think likely probably continues at some level probably for the next couple of quarters or so. As Tim mentioned, we don’t – given the strong absorption that we see happening overall across our markets. It’s hard to see it getting any worse than what we kind of saw in Q3. And then we’re encouraged by the fact that October performance in the normal seasonal pattern that we see from Q3 to Q4 frankly is better than what we have seen in the past.

So I mean there are reasons for us to feel that we think that the environment we find ourselves in right now is likely to sort of continue for a while probably through – I’m guessing through Q2 of next year. By the time we get to Q3 of next year comparing against this year we think that the – that things start to feel a lot more comfortable. Now we’ll have the compounding effect of Q3, Q4, Q1 that we have to carry and kind of work through revenue performance through most of next year. But we think that there’s arguments to be made that the supply-demand dynamics that we see taking place right now are likely to sort of hang where they are for the next few quarters but not get materially weaker.

Austin Wurschmidt: Got it. And so I mean I guess that kind of went to my second question was it sounds like you think demand remains stable from here which has actually been fairly strong. I think even accelerated the last couple of quarters and helped absorb some of the supply. I mean is it fair to say that you think you get some level of market rent growth positive next year, despite kind of this cumulative impact based on your thoughts on how demand shakes out.

Eric Bolton: Yes, we do. I mean assuming that the economy continues to hold up as it is. We continue to capture the sort of tailwind that we’re seeing with low resident turnover lower levels of move-outs to buy homes. Collections continue to remain strong. I mean there’s just – as I’ve said for many years – to me at the end of the day what really drives performance over long haul is the demand side of the business. And that can – in the that’s why we’ve always focused our capital in the way we have across the Sunbelt markets believing that the demand dynamic continues to provide a foundation for how we like to create value and drive performance over a long period of time. We have to deal with this periodic supply pressure that comes from time to time and that’s kind of what we’re dealing with right now.

But because of the demand side being as strong as it is the absorption continues to be where it is and because of the approach that we take with diversification across the region we think there are things that we can do to help sort of mitigate some of the supply pressure that you otherwise might think would – if you look at just overall market dynamics we think that when you put the portfolio together the way that we have that we can push back against some of these supply pressures when they do occur from time to time. So I think that – we think that as we get into the back half of next year that we probably do start to see supply levels start to moderate and some of the developer pressures start to moderate. We will probably do start to see market rent growth turn positive on the new lease pricing.

And then as Tim mentioned, we continue to get pretty solid performance on our renewal practices. And if you go back over a number of years you’ll see that our renewal practices have always been fairly strong. And we take a certain approach to how we think about renewal pricing and we continue to believe that that will remain a tailwind for us over the coming year.