The RMR Group Inc. (NASDAQ:RMR) Q1 2024 Earnings Call Transcript

The RMR Group Inc. (NASDAQ:RMR) Q1 2024 Earnings Call Transcript February 8, 2024

The RMR Group Inc.   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 morning, and welcome to the RMR Group Fiscal First Quarter 2024 earnings call. All participants will be in listen-only mode. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations. Please go ahead.

Kevin Barry: Good morning, and thank you for joining RMR’s first quarter of fiscal 2024 conference call. With me on today’s call our President and CEO. Adam Portnoy, the Chief Financial Officer, Matt Jordan. In just a moment, we will provide details about our business and our quarterly results, followed by a question-and-answer session. I would like to note that the recording and retransmission of today’s conference call is prohibited without the prior written consent of the company. Today’s conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward-looking statements are based on RMR’s beliefs and expectations as of today, February 8, 2024, and actual results may differ materially from those that we project.

The company undertakes no obligation to revise or publicly release the results of any revision to the forward-looking statements made in today’s conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, which can be found on our website at www.rmrgroup.com. Investors are cautioned not to place undue reliance upon any forward-looking statements. In addition, we may discuss non-GAAP numbers during this call, including adjusted net income, adjusted earnings per share, distributable earnings, adjusted EBITDA and adjusted EBITDA margin. A reconciliation of net income determined in accordance with US generally accepted accounting principles to adjusted net income, adjusted earnings per share, distributable earnings, adjusted EBITDA and the calculation of adjusted EBITDA margin can be found in our financial results.

I will now turn the call over to Adam.

Adam Portnoy: Thanks, Kevin. And thank you all for joining us this morning. Before providing an update on our first quarter results, let me first discuss the macro commercial real estate environment. There is no question the commercial real estate has been under pressure since the Federal Reserve began raising interest rates in early 2022. The higher cost of capital has resulted in significant headwinds to property values and a deterioration in capital markets activity. However, as I sit here today, we are currently seeing positive signs as the US economy continues to perform well with strong GDP growth, a healthy labor market in declining insulation with anticipated interest rate cuts later this year, we believe we are entering a generally more favorable environment for commercial real estate.

Looking across our diversified portfolio. I also see several encouraging trends and we are highly confident in the strength, diversity and durability of our platform and the opportunity for our clients to benefit as the commercial real estate sector normalizes. Turning now to our quarterly results. RMR reported a strong first quarter that reflects the continued strength and stability of our operations through all real estate cycles. We delivered sequential growth and adjusted earnings per share that exceeded the high end of our guidance. This quarter we reported distributable – distributable earnings of $0.53 per share, adjusted EBITDA of $25.3 million and adjusted EBITDA margin of 52.1%. Our results also continue to demonstrate the strong alignment between RMR and our clients.

We remain focused on assisting our clients with the execution of their business plans and expect to capitalize on the significant upside that exists from a possible recovery and share prices at some of our publicly traded clients. To put this into context, all of our managed equity reads are paying base business management fees on an enterprise value basis, given the depressed levels of the stock prices, we have a total annualized revenue opportunity of more than $60 million, as we work to close the gap between enterprise value and the historical cost at our managed equity REITs. To this end, during the quarter all of our perpetual capital clients achieved double-digit percentage growth in the share prices supported by recent actions we have taken at RMR, which helped drive this quarter’s revenue growth at RMR.

In mid-December, we successfully closed the CARROLL Multifamily Platform Acquisition. The acquisition adds approximately 500 real estate professionals with deep residential market knowledge, value add real estate experience, and long-term relationships with a number of high-quality Global Institutional partners. As of December 31st the CARROLL business which we are now calling RMR Residential, consisted of $5.5 billion of assets under management, at 66 properties with more than 21,000 units largely low created located across the Sunbelt. As a result of this acquisition, total AUM at RMR grew more than 15% sequentially this quarter, to over $41 billion and Private Capital AUM now represents more than $13 billion or approximately 32% of our total AUM.

We are especially proud of these metrics, given that private capital Assets Under Management was close to zero, just over three years ago and growing this part of our business has been a strategic objective for the company, for the last few years. We believe there is significant long-term growth to be realized by RMR Residential in the future. More specifically, our current General Partner Fund or Fund VII, which we assumed as part of the CARROLL Acquisition, has approximately $200 million in available equity capital remaining which equates to approximately $3 billion of gross acquisition capabilities and residential properties. In terms of expectations for deployment of this capital, while residential transactions have remained subdued Bid-Ask Spreads are tightening and general market expectations are turning cautiously optimistic for more residential active — transaction activity as the year progresses.

Accordingly, our financial expectations for the Residential business are muted in the first half of the calendar year, before an expected significant increase in contributions to EBITDA and distributable earnings in the second half of the calendar year. Looking beyond RMR Residential, we ended the quarter with more than $200 million of cash and no corporate debt, giving us the flexibility to continue evaluating growth opportunities to build on our existing capabilities, expand RMRs Private Capital AUM and create long-term value for our shareholders. As a reminder, we are limited as to what we can discuss this quarter regarding our publicly traded clients, as we are reporting results in advance of them. With that said, I wanted to highlight some public announcements of note across our clients.

In December, DHC made significant progress towards strengthening its financial profile, issuing $941 million of zero coupon bonds. The notes generated net proceeds of approximately $732 million that was used to repay all of DHC’s 2024 debt maturities. Importantly, this financing puts DHC back in compliance with its debt covenants and positions the Company to access lower cost, GSE financing in the future, with ample liquid liquidity and a fully unencumbered SHOP portfolio DHC is in an excellent position to continue funding the necessary capital and drive the recovery in its senior living communities. OPI has also taken significant actions to address its debt maturities and successfully execute new financings, despite tougher market conditions that remain especially challenging for office owners.

Last month, OPI closed new secured financing facilities for $425 million with a group of 19 banks, replacing its previous unsecured revolver. Additionally, last night OPI priced a five-year $300 million Senior Secured Bond offering and announced the redemption of its $350 million, Senior Unsecured Notes maturing this may. These recent successful financings at OPI, within a difficult market backdrop for office reached speaks to the strength of OPIs assets and RMR’s management as well as positions OPI well going forward. Lastly, our Mortgage REIT, Seven Hills Realty Trust has continued to generate outsized returns for its shareholders, during a period when banks have broadly pulled back on commercial real estate lending Seven Hills has remained active.

The strength of its loan book and strong investment returns have contributed — contributed to a total shareholder return of more than 60% in 2023. We believe our lending platforms underwriting and asset management capabilities are best in class, and something we can ultimately leverage to expand our private capital assets under management in the future. In closing, we are off to a strong start in 2024. We are taking meaningful actions to position RMR and our clients for long-term growth and deliver increased value for our stakeholders. We look forward to updating you on our ongoing process throughout the year. With that, I’ll now turn the call over to Matt Jordan, our Executive Vice President and Chief Financial Officer who will review our financial results for the quarter.

Matt Jordan: Thanks Adam. Good morning, everyone. For the first quarter, we reported adjusted net income of $0.49 per share, adjusted EBITDA of $25.3 million and distributable earnings of $0.53 per share. Our results exceeded the high end of our guidance primarily due to construction management fees coming in stronger than expected, as well as improvements in the enterprise values of certain of our managed equity REITs. Adam highlighted earlier, we closed the CARROLL acquisition on December 19th. While, we remain excited about the long-term contributions of the acquisition to our platform. For calendar 2024, we expect earnings accretion from RMR residential to begin in the back half of the year given the lack of transaction volume across the residential real estate sector.

Our residential platform is built to manage far more than its current $5.5 billion in AUM, which will result in breakeven results for the first six months of calendar 2024. Turning to this quarter’s results, recurring service revenues for the quarter were $46.2 million, which was up almost $900,000 sequentially. This increase exceeded our expectations primarily due to enterprise value improvements at our managed equity rates and increases in construction management activity within SVC’s hotel portfolio. As it relates to next quarter based upon the current enterprise values of our managed equity rates, projected declines in construction volumes and approximately $5.5 million in RMR residential revenues. We expect service revenues to be between $48 million and $50 million.

Turning to expenses. Cash compensation this quarter was approximately $34.8 million, an increase of $456,000 sequentially due to annual merit increases that were effective October 1st and $1.5 million in compensation related to the partial month impact of RMR residential, partially offset by strategic actions we’ve undertaken over the last 12 months to streamline our operations. Looking ahead to next quarter, we expect cash compensation to increase to approximately $45 million inclusive of RMR residential, the first calendar quarter of each year is always our highest level of compensation as payroll tax and 401(k) contributions reset each January 1st. In the first quarter, our cash compensation reimbursement rate was 48.4%. With the addition of RMR residential, our cash reimbursement rate is expected to increase to approximately 50% next quarter.

G&A costs of $9.5 million were higher than projected due to increases in third party costs to help support the sizable increase in construction activity we experienced this quarter with the inclusion of RMR Residential, G&A should be approximately $10 million next quarter. Aggregating all the assumptions I previously outlined and factoring in $0.04 per share from the adverse impacts of lower interest income and $800,000 of incremental amortization resulting from purchase accounting, next quarter we expect adjusted earnings per share to be approximately $0.40. With the increased levels of non-cash impacts to our earnings, we believe adjusted EBITDA and distributable earnings are becoming our most important measures. Next quarter we expect adjusted EBITDA to range from $21 million to $22.5 million.

Finally as it relates to distributable earnings, next quarter we expect it to be closer to historical averages and range from $0.48 to $0.51 per share. That concludes our formal remarks. Operator, would you please open the line to question?

Operator: We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Bryan Maher with B. Riley Securities. Please go ahead.

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Q&A Session

Bryan Maher: Thank you and good morning, Adam and Matt. Maybe to start on a big picture basis. Adam you touched upon this early in your prepared comments. We ran an article last week. I guess it was in Barron’s on a large real estate PM. Runs $80 billion talking about how whereas 2024 still faces challenges they see our recovery in 2025 seems to be somewhat consistent with what you started off the call with. Can you give us a little bit more color on what kind of green shoots you’re seeing out there to give you that positivity.

Adam Portnoy: Sure. Thank you for that question, Bryan. I think that is correct. I think that the biggest positive impact that can happen for real estate is it reduction in interest rates. And then maybe the second biggest positive that can happen for real estate, especially, around office and maybe some pockets of retail real estate is a unfreezing or a filing of Capital Markets and access to capital markets activity. I think, RMR we have been very fortunate given the depth of our platform and our experience and relationships throughout the country and Wall Street that we are able to access capital on pretty attractive rates that I think many of our peers would not be able to do given — just given our expertise in the area.

That all being said, I think, it’s really macro conditions that need to improve. And I think the fact that I think pretty universally believed is that the Fed is not raising rates anymore, I believe is a pretty robust debate about how fast or when they will reduce interest rates. I think, all that is a part — is much more positive for commercial real estate. And we have seen just the fact that we were able to get 19 banks to participate in a in a secured financing at OPI and Office REIT. Yes, OPI is a strong has a strong portfolio. It is well managed, but it’s still on an asset class that it’s heightened scrutiny no matter where you are in what part of the capital markets with because it’s office. The fact in 19 banks came along for that is also an indication that there is some thawing going on with capital markets.

So I see all those as positive signs. In terms of fundamentals and operations. Look I think office leasing activity continues to occur and that is probably the biggest and best sign we have as an organization is that you still see leasing activity occurring and happen and it’s happening on a reasonably compare — on a comparative basis to what’s happened in the past equal to that — equal to what we saw in the past year. So we haven’t seen a big drop-off in activity in terms of leasing activity in our portfolio. That being said, obviously, vacancy rates generally speaking in office are pretty high probably the highest they’ve been in. It certainly generation if not longer. And so that while we might have a strong portfolio, we’re managing it weighs on the entire market and affects rental rates that you can charge and so on.

So the green shoots are really buying you know the fact that interest rates aren’t going up anymore and they’re probably coming down and the fact that capital markets are starting to unfreeze. We expect in the second half of this year, especially to see a lot more transaction volume and we expect to be a significant participant in this transaction volume. We have a tremendous amount of dry powder that we can use, especially, as we bought at RMR residential to put to work there. And we also have opportunities to put capital to work in pockets in other parts of the organization as well. So we’re pretty much — we’re looking forward to the really the second half of the year and being able to really turn our attention to growth in a much more meaningful way.

Bryan Maher: And thanks for that. And just to follow up on RMR residential. I mean this is kind of new to us maybe a little bit less so to you. And how should we think about that back half of the year growth? And does that come organically? Does it come from bolt-on acquisitions? And what kind of capital might you need to deploy to get that growth?

Adam Portnoy: So RMR residential as I said in my prepared remarks, we inherited or acquired a fund what we call Fund Seven. That is a — it’s a general partnership fund and I won’t go into the details, but what that means is we have about $200 million of untapped equity there that that fund life time does — we have until the end of 2025 to deploy that capital. So we have a fair amount of runway, two years to put that money out. Because it’s a GP fund, you bring in LPs and you put leverage on that’s how you get to the $3 billion of buying power. So, we’re — that’s largely organic. And we don’t — the other areas where I think you could see us grow is — in 2024 and as we get further into 2025, we are basically setting up really, really well to possibly raise our first true what I call private capital co-mingled, closed-end funds, however, you want to talk about it, vehicles.

And I think we’re gearing up to do that. I think the two areas that we are going to be best positioned to try to raise a fund around that is going to be in the loan fund, or a fund that’s basically making loans and leverage fund and then perhaps in residential. I think in the residential space, I think we have more — we have plenty of runway to put money to work under our existing vehicle. And so that’s all organic, what I just went through, Bryan. I’m not talking at all about M&A there or acquisitions. And I think on the M&A front, we have $200 million of cash. We have no corporate debt. We will be opportunistic. But we’re also very focused at the moment on successfully integrating the RMR Residential platform and getting it to be a significant contributor to our earnings and EBITDA in the second half of the year as well as thinking about ways to organically raise funds and strategies that we think will be particularly appealing to investors.