UDR, Inc. (NYSE:UDR) Q4 2023 Earnings Call Transcript

UDR, Inc. (NYSE:UDR) Q4 2023 Earnings Call Transcript February 7, 2024

UDR, 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: Greetings and welcome to UDR’s Fourth Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Vice President of Investor Relations, Trent Trujillo. Thank you, Mr. Trujillo. You may begin.

Trent Trujillo: Welcome to UDR’s quarterly financial results conference call. Our press release, supplemental disclosure package, and related investor presentation were distributed yesterday afternoon and posted to the Investor Relations section of our website at ir.udr.com. In the supplement, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G requirements. Statements made during this call, which are not historical, may constitute forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be met. A discussion of risks and risk factors are detailed in our press release and included in our filings with the SEC.

We do not undertake a duty to update any forward-looking statements. When we get to the question-and-answer portion, we ask that you be respectful of everyone’s time and limit your questions to one plus a follow-up. Management will be available after the call for your questions that did not get answered during the Q&A session today. I will now turn over the call to UDR’s Chairman and CEO, Tom Toomey.

Tom Toomey: Thank you, Trent, and welcome to UDR’s fourth quarter 2023 conference call. Presenting on the call with me today are President and Chief Financial Officer, Joe Fisher; and Senior Vice President of Operations, Mike Lacy; Senior Officers, Andrew Cantor and Chris Van Ens will also be available during the Q&A portion of the call. To begin, for this quarter’s call, we enhanced how we communicate our outlook for the year ahead. The volatility we have experienced over the last 5 years, combined with the supply-induced challenges our industry is expected to face in 2024 translate into a wider range of potential outcomes for this year versus our typical year. As such, in conjunction with our earnings release, we published an outlook presentation that highlights these potential outcomes and their drivers.

Our prepared remarks aligned with the presentation, and those on our webcast should see the slides on your screen. We will resume our usual format of prepared remarks only on future earnings calls. Moving on, key takeaways from our press release and our 2024 outlook are summarized on Slide 4 of the deck. These are first, fourth quarter and full year 2023 FFOA per share and same-store results met the guidance expectations set forth on our third quarter call. Full year 2023 same-store NOI growth of 6.8% was particularly strong and one of the highest amongst our peer group. Second, based upon consensus estimates, we expect that economic growth and apartment demand will remain resilient in 2024, but historically high new supply will continue to lay on our core growth.

Third, ongoing investments in innovation will continue to drive incremental NOI growth above the broader market in 2024 Mike Lacy will give you greater detail on this subject. Fourth, we are maintaining a capital-light strategy given our still elevated cost of capital, but we will take advantage of opportunities when appropriate. For example, in 2023, we executed roughly $1 billion of accretive deals through joint venture and operating partnership unit opportunities. We will continue to keep our eyes open for external growth and feed our cost of capital signals. And fifth, our balance sheet remains well positioned to fully fund our capital needs in 2024 and beyond. With that, I’ll turn the call over to Joe.

Joe Fisher: Thank you, Tom. The topics I will cover today include our fourth quarter and full year 2023 results, including recent trends and transactions, the 2024 macro outlook that drives our full year guidance, and the building blocks of our 2024 guidance. First, beginning with Slide 5. Our fourth quarter and full year FFO as Adjusted per share of $0.63 and $2.47 achieved the midpoint of our previously provided guidance ranges. On the bottom half of the slide, you can see that during the quarter, we shifted to a more defensive operating strategy and build occupancy going into 2024. Occupancy trended sequentially higher for each month during the fourth quarter, resulting in a 20 basis point sequential improvement versus that of the third quarter.

As anticipated, this occupancy pivot resulted in lower blended base rate growth versus original 4Q expectations, but it was the right decision to place our portfolio in a position of strength given elevated new multifamily supply in 2024. For January, operating trends have improved. Market rent growth turned sequentially positive and is following normal seasonal patterns thus far. Blended lease rate growth improved to positive 0.2% with new lease rate growth of minus 3.6% and renewal lease rate growth of plus 4%. Concessionary activity continued to trend lower, and occupancy increased further to 97.2%. One month does not make a trend, but we are encouraged by these results. Moving on, as detailed on Slide 6, during the quarter, we executed a variety of transactions that both enhance our liquidity and set us up well for future accretive growth.

These include: number one, our joint venture with LaSalle acquired a 262 home community in Suburban Boston, were approximately $114 million at an initial mid- to high 5% yield. Through platform initiatives and various fees, we expect the stabilized yield to be in the mid- to high 6% range to UDR. We continue to explore investment opportunities with LaSalle, which will provide scale-oriented efficiencies to our operations, expand our fee income, and drive future earnings accretion and enhanced ROE for our shareholders. Number two, we sold our [indiscernible] on $180 million of dispositions. These are expected to be executed at a weighted average buyer cap rate in the mid-5% range and further enhance our already strong liquidity. And three, we assumed a DCP developer’s ownership interest in a distressed Oakland asset.

1.5 years old community was appraised at $67 million or $387,000 per unit, which resulted in a non-cash investment loss of approximately $24 million to UDR. The community is still in lease-up and a submarket of Oakland were 2 to 3-month concessions or the norm. The initial yield on the assumed asset is in the mid-3% range. However, once stabilized, we expect the yield to be in the low 5% range. Turning to Slide 7 and our macro outlook. As in years past, utilize top-down and bottom-up approaches to set our 2024 macro and fundamental forecast. Our 2024 market rent growth forecast of roughly 1% was informed by third-party forecast and consensus expectations for a variety of economic factors that drive market run growth and our internal forecasting models, we combined this top-down forecast with a bottom-up growth estimate built by our regional teams as they best understand local supply and the demand dynamics in their markets.

Our 1% market rent growth forecast for 2024 is slightly conservative when compared to prominent third-party forecaster estimates at 1.7% and is driven by stable to positive demand set against historically high multifamily deliveries and the expectation for continued elevated concessions. As Mike will discuss, the approximately 1% rent growth ties to our assumption for 2024 blended lease rate growth. Primary variables to our forecast include GDP growth, employment and wage growth, changes to the homeownership rate, supply and its impact on pricing, economic uncertainty. Turning to Slide 8. If we step back and consider the near to intermediate-term outlook for the industry, we remain encouraged by a variety of key supply and demand metrics. First, at the top left, our consumer remains resilient with rent-to-income ratios at the long-term average.

Second, at the top right, relative affordability versus alternative housing options remains decidedly in our favor at roughly 50% less expensive to rent than own, a 20% improvement from pre-COVID. This supports a stable to declining homeownership rate and absent a major correction in home prices or a significantly more accommodated long-term interest rate environment, we do not expect this dynamic to change near term. Third, at the bottom left, the latest census data indicates that the largest U.S. cohorts remain in their prime renter years. This should provide continued support for future long-term rental demand. And fourth, at the bottom right, while multifamily deliveries are expected to remain elevated through at least 2024, starts activity is significantly retreated and is down 70% from recent highs, and is now well below historical averages.

This should benefit outer-year growth absent a near-term change in financing costs. Moving on to Slide 9. Third-party data providers are forecasting record multifamily deliveries for the U.S. and in our markets over the next 4 to 6 quarters. Based on completion forecast, peak deliveries are currently expected to occur in the middle of 2024 before trending downwards, closer to long-term historical averages in the second half of 2025. We are cognizant that there will be supply slippage as they move to 2024, and that lease-up concessions could remain elevated after new deliveries update. Positively, peak deliveries in the coming quarters are not materially above the levels we have seen in the second half of 2023, and into the start of 2024. When market level concessions move throughout 2024 will be a primary driver of our ability to capitalize on our market rent growth forecast.

On Slide 10, we provide more context on which regions and markets are expected to feel the greatest impact of 2024 supply. The Sunbelt is forecast to face significantly higher absolute deliveries than the coastal markets, although all regions will face higher relative supply in 2024 as compared to their long-term averages. As is evident on the bottom of the page, this dynamic is reflected at the market level, with Sunbelt market supply growth rates expected to be more pressured than coastal markets this year. Mixing this all together, we arrived at our 2024 guidance, which is summarized on Slide 11. Primary expectations include full year FFOA per share guidance of $2.36 to $2.48, same-store revenue, expense expectations that translate to NOI growth ranging from negative 1.75% to positive 1.75%.

Slide 12 shows the building blocks for our full year 2024 FFOA per share guidance at the $2.42 midpoint, representing a 2% year-over-year decrease. Drivers include a $0.07 increase of same-store revenue and lease-up income from recently developed communities, offset by a $0.07 decrease from same-store expenses, a $0.025 decrease on DCP activities due to a lower average investment balance in 2024, including a potential $0.02 impact from assuming ownership of a DCP development, dependent on the refinancing of its senior construction loan. While the developer continues to advance refinancing discussions, we have chosen to take a conservative approach by including the downside scenario in our guidance. We expect to have clarity on the refinancing by the second quarter and do not see additional 2024 earnings risk from our DCP investments at this time.

Continuing with the building blocks, and approximately $0.02 decrease from interest expense due to higher average interest rates and the expiration of certain hedges and an approximately $0.01 decrease in G&A, reflective of inflationary wage growth. Moving on to Slide 13, and specific to the first quarter, our FFOA per share guidance range is $0.60 to $0.62 or an approximately 3% sequential decrease at the midpoint. This is driven by a $0.015 decrease of same-store NOI, primarily due to higher expenses attributable to seasonal trends and approximately a $0.05 decrease of higher interest expense and G&A. Last, on Slide 14, we present our debt maturity schedule and liquidity. Only 13% of our total consolidated debt matures through 2026. The thereby reducing future refinancing risk, combined with roughly $1 billion of line capacity, minimal committed capital, our projected first quarter disposition and strong free cash flow, our balance sheet sits in an excellent position.

In all, despite near-term macro and potential DC-related headwinds in 2024, our balance sheet and liquidity remain in excellent shape. We remain opportunistic in our capital deployment, and we continue to utilize a variety of capital allocation better advantages to drive long-term accretion. With that, I will turn the call over to Mike.

Mike Lacy: Thanks, Joe. Today, I’ll cover the following topics. How our 2023 results and other drivers factor into the building blocks of our full year 2024 same-store revenue growth guidance, an update on our various innovation initiatives, expectations for operating trends across our regions and our outlook for same-store expense growth. Turning to Slide 15. The primary building blocks of our 2024 same-store revenue growth guidance include our embedded earn-in from 2023 lease rate growth, our blended lease rate growth expectations for full year 2024, and contributions from our innovation and other operating initiatives. Starting with our 2024 earn-in of 70 basis points or about half of our normalized historical average, the 20 basis point increase in average occupancy we achieved during the fourth quarter of 2023 came at the expense of some rate growth, which reduced our earnings by approximately 30 basis points versus what I spoke to on the third quarter call.

We believe this is prudent, defensive trade given the elevated new supply outlook in many of our markets. Next, portfolio blended lease rate growth is forecast to be approximately 70 basis points in 2024. Given a midyear convention, rate growth should add about 35 basis points to our same-store revenue growth this year. Our expectation is that blends will be lighter through the first half of 2024 before marginally improving during the second half of the year. This dynamic, if accurate, means that blended growth should have less of a positive impact on 2024, but more impactful to our 2025 growth. Underlying our blended rate growth forecast, our assumptions of approximately 3% renewal rate growth in 2024 and approximately negative 1.5% new lease rate growth.

As a reminder, even during recessionary periods, we have seen approximately 2% renewal rate growth on average, which, combined with recent trends, provides support for those assumptions. Lastly, we expect the combination of occupancy and bad debt to be roughly flat in 2024. Moving on, innovation and other operating initiatives are expected to add approximately 45 basis points to our 2024 same-store revenue growth, which equates to $5 million to $10 million. The bulk of this growth should come from the continued rollout of our property-wide WiFi, other property enhancements such as the addition of package lockers as well as improved retention and less fraud. For retention, our guidance assumes that our 2024 resident turnover will be 200 basis points below that of 2023.

Half of this comes from the easier first half comp. As you may remember, long-term delinquent skips and evictions were elevated through the first half of 2023. We do not anticipate this repeating in 2024 as we have seen long-term delinquent activity stabilize. The other 100 basis point improvement should come from our proprietary customer experience project, which helps us improve our resident experience throughout their time with UDR, thereby improving their probability of renewal. We have seen the early benefits of this initiative with resident retention higher on a year-over-year basis for 9 consecutive months. For every 100 basis points of improved retention or reduced turnover, approximately $3 million drops to our bottom line. We believe our customer experience project will continue to improve our turnover and expand our operating margin advantage relative to peers.

Regarding fraud, we are implementing a variety of AI-based screening measures process improvements and credit threshold reviews to enhance our upfront resident screening. Given the resident-friendly legislation, we continue to see throughout our portfolio, minimizing the potential for bad debt before it gets in the front door is critical. Rolling all this up, our 2024 same-store revenue guidance range from 0% to 3%, with a midpoint of 1.5%. The 3% high end of our same-store revenue growth range is achievable to improve year-over-year occupancy, additional accretion from innovation, and blended lease rate growth that occurs more ratably throughout the year or at a higher level than our initial forecast. Conversely, the low end of 0% reflects full year blended lease rate growth of approximately negative 2%.

And some level of occupancy loss and delayed income recognition from our innovation initiatives. Turning to Slide 16 and our regional revenue growth expectations, we expect the coast will continue to perform better than the Sunbelt in 2024, led by the East Coast. The East Coast, which comprises approximately 40% of our NOI is forecast to grow same-store revenue by 1% to 4%. We expect Boston, Washington, D.C., Baltimore, and Philadelphia to each deliver full year same-store revenue growth of at least 2%. Signs of recent softening in demand in New York, leave us slightly more cautious on that market. The West Coast, which comprised of approximately 35% of our NOI is forecast to grow same-store revenue by 0% to 3%. Orange County, Los Angeles, and the Monterey Peninsula are expected to produce upper tier growth, while San Francisco, San Diego, and Seattle are forecast to be softer.

Last, our Sunbelt markets, which comprise roughly 25% of our NOI, our forecast to grow same-store revenue by negative 2% to positive 1%. Austin, Nashville, Denver, and Orlando are scheduled to see some of the highest levels of new supply in which should continue to pressure pricing power. On a relative basis, we expect Dallas and Tampa to be leaders among our Sunbelt markets. Moving on, as shown on Slide 17, we expect 2024 same-store expense growth of 5.25% at the midpoint. This is primarily driven by growth in real estate taxes, personnel, and insurance. While only 6% of total expenses, insurance expense growth of 16% to 20% reflects the premium increase we realized when our policy was renewed in December. In terms of year-over-year expense growth guidance, the first quarter should be elevated due to a onetime $3.7 million employee retention credit we realized at the beginning of 2023.

This has the effect of increasing total first quarter 2024 same-store expense growth by more than 300 basis points. Additionally, for full year 2024, the costs associated with our property-wide Wi-Fi initiative amount to an incremental $2 million. Absent these two factors, we would expect normalized same-store expense growth to be in the low 4% range throughout the year or approximately 120 basis points lower than our full year midpoint. In closing, while the near-term operating environment presents some challenges, we continue to innovate with the intention of increasing revenue growth, improving resident retention, and further expanding our operating margin over time. I thank our teams for their collaboration and eagerness to leverage new and innovative tools to drive superior results.

I will now turn over the call to Tom.

Tom Toomey: Thank you, Mike. And as summarized on Slide 18, when we consider our potential 2024 growth trajectory, I come back to the key components of running a successful business. First is to understand your customer. Our residents have healthy rent-to-income ratios and relative affordability continues to favor apartments over other forms of housing. So we view the effect of elevated supply as transitory and expect that the demand versus supply dynamics will revert to our favor sometime after 2024. In terms of resident satisfaction, we can measure success through our customer experience initiatives and how they translate into greater retention, which has improved for 9 consecutive months. We expect this trend to continue.

The second component is the understanding of your associates. Through frequent discussions, surveys, and town halls, we have created an open dialogue and a culture that fosters engagement and innovation. UDR is proud and recognized leader in corporate responsibility as well. And third characteristic is to listen to investors. We are highly engaged, conducting roughly 500 investor calls, meetings each year. We are confident that we have a good read on what investors think we are doing well and where we can improve. From these interactions, we have created a company we believe is a full cycle investment and maximize value creation for our stakeholders regardless of the economic outlook. In 2024, we plan to focus on what we can control, namely, this means leaning into our operating platform and innovation, developing talent, nimbly adjusting our operating strategy in the face of supply and taking a capital-wide approach to maintain liquidity and balance sheet flexibility.

Taken together, we believe we can successfully navigate whatever macro environment we face moving forward. With that, I’ll open it up to Q&A. Operator?

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Q&A Session

Operator: Thank you. [Operator Instructions] Thank you. Our first question comes from the line of Eric Wolfe with Citibank. Please proceed with your question.

Eric Wolfe: Hey, thank you. Can you walk us through the math on how you get to the $0.025 of dilution from taking ownership of the two DCP assets? And I think in the past, you’ve talked about a third asset that might see a similar outcome. So just help us understand if there is likely any incremental impact beyond what’s in the 2024 guide?

Joe Fisher: Hey, Eric. Good morning. It’s Joe. Maybe some quick math on the $0.025 and then I’ll kind of take you through some of that remaining DCP risk and how we approach that. So as I think we kind of mentioned upfront, there is a Philly asset that I’ll get into that has a binary outcome coming up in 2Q related to its refinancing, which right now is in process and discussing with lenders. But if that were to not be refinanced and we were to take ownership of that asset, we’d effectively be moving from a high-yield DCP investment to a lower yield acquisition, which naturally results in some dilution. So that’s about $0.02 of that number that shifts the whole range down, including at the midpoint. So if that refinancing did occur in theory, the entire range would shift right back up by $0.02.

The rest of that has to do with we took ownership of Modera Lake Merritt, as we mentioned there in the release it has a little bit of dilution to it. In addition, we’ve got an assumption in there that we have roughly $75 million of payoffs in the back half as we have some of these deals that are opening into their prepayment window and it may make sense for them economically to go out and refinance with a cheaper cost of capital. And so you get a little bit of drag from that as well, offset by continued accruals on the rest of the portfolio. So it’s kind of the puts and takes on the $0.025. As it relates to getting into the rest of the portfolio, we walked through Modera Lake Merritt, I think everybody understands kind of what took place there.

When we go into these deals, you really have three primary areas of risk that we’re trying to underwrite One is the upfront kind of cost and delay and timing aspect of any development. Two is going to be the cash flow perspective, what’s going to take place on rents and the supply in any given market, and three, just the capital markets component, what happens with interest rates, cap rates and capital availability. And so that’s kind of the three main areas we are trying to underwrite when we go into these. Clearly, any one of those factors is not going to be enough to drive distress on any of these deals. But when you kind of get a couple of them that stack up, you do run into a little bit more distress, which is really what happened with Modera Lake Merritt.

Yes, I think everybody is pretty familiar with what happened in NorCal since pre-COVID, rents still being down and then downtown Oakland, perhaps one of the worst submarkets in that respect, with rents still down 30% plus. And so we did take the keys back on that asset as the developer didn’t want to continue to support the cash flow shortfalls. That said, as we continue through lease up and hopefully burn off the concessions in the next couple of years, you see it in the presentation, getting to a more palatable yield here in the next couple of years. As it relates to the Philly asset that I mentioned a couple of those same risks not to the same degree, but a challenged market in downtown or City Center Philadelphia from a supply and concession perspective.

And so that NOI has been a little bit weaker. We did have some delays coming through COVID on that development. But as I mentioned, that development partner is in process with a couple of different lenders, just trying to make sure that they can get it to the finish line on proceeds and terms, but we felt it prudent to take perhaps a more conservative approach and put the risk out there to the street. Beyond that, you mentioned what else is out there. So you kind of got 12 other assets, roughly $475 million of outstanding balance of those 12 when we go through the stress testing and scenarios, just three of those are what we would consider watch list and the balances on those three are plus or minus $50 million, so, only about 10% of the rest of the book.

They don’t have the same degree of risk that the first to do, but they are on our watch list for varying reasons, they don’t have maturities come up until ‘25 and ‘26. So we do have a little bit of time there, unless, of course, the developer partner decides not to continue making payments. So if we did have to take those back, that’s really plus or minus $0.01 of risk over time. We don’t see all three obviously have in near-term and/or potentially even longer-term. Beyond that, you get into the rest of the book of the business, the other $400 million plus that’s out there. Most of these are in their lease-up and/or stabilization process. So we’ve got pretty good visibility on rents and NOI, which, at this time, the rest of those are in-line to above pro forma expectations.

And so we feel pretty good about the rest of that book of business.

Eric Wolfe: That’s very helpful. And then maybe just quickly, the Oakland property, Lake Merritt, I guess, why not just try to sell it, take the small loss. You mentioned some of the struggles in Northern California. So I guess the question is why sort of increase your exposure there versus just selling it today, putting into more accretive uses in the near-term?

Joe Fisher: Yes. So I think the valuation, obviously, a third-party appraisal there that dictated that non-cash impairment. But when you look at where we’re at today on that asset, we are taking it over, and we do think there is quite a bit of upside be it through real estate tax resets, other income, obviously, burning off concessions and getting it stabilized. So it’s probably better value in our hands than bringing it to the market right now where, clearly, in Northern California as a whole and Oakland specifically from a transaction market perspective pretty challenged, given some of the risks out there. So I’m not sure you optimize price and value by simply trying to liquidate. I think it’s better to keep it in our operations team’s hands for a couple of years and then evaluate down the road when the market is a little bit better.

Eric Wolfe: Got it. Thank you.

Operator: Thank you. Our next question comes from the line of Austin Wurschmidt with KeyBanc Capital Markets. Please proceed with your question.

Austin Wurschmidt: Great. Thanks. Mike, you guys averaged 60 basis points of blended lease rate growth in the second half of last year. And you mentioned the 70 basis point lease rate growth assumption in guidance assumes lower growth in the first half of this year and then kind of picks up a little bit in the back half. Is it fair to say that you think that lease rate growth bottoms in the first half of ‘24, and we see continued improvement in the back half and then into 2025?

Mike Lacy: Hey, Austin, thanks for the question. Yes, I think what you can expect to see is the first half is going to look very similar to the back half of last year. So that 60 basis points first half is where we expect things to track today. As of right now, the second half is closer to 1% on blends. And I’ll tell you what we’ve been – we promised to see the – where we’re at today just in terms of blends. If you look at December to January, you can see it in our deck. We went a 150 basis point increase, and a lot of that has to do with our strategy. And you’ve heard us talk about this before, but we tend to operate closer to 96.5% to 97%, we’re able to drive our occupancy closer to 97.2% in January. Again, that put us in a better position today to start driving our rents.

We’re seeing some promising trends. We don’t want to call that things are significantly better – as we have to get through some more of the leasing season. But to start the year, things are starting off a little better than we expected.

Austin Wurschmidt: Okay, great. So it sounds like the lease rate growth should inflect, I guess, comparing spreads year-over-year in the back half of this year. The Sunbelt markets have been kind of the most challenging for your portfolio. And I’m just wondering sort of how that stacks up versus the portfolio overall this year and how you’re thinking about inflection or further deterioration across the markets that you’re in? Just any detail you can provide on how you’re thinking about the cadence for that 25%, 30% of the portfolio.

Mike Lacy: Yes, Austin. That’s another really good question. We put a good slide in here, Page 16, that walks just where we expect East Coast to perform against the West Coast as well as the Sunbelt. And I’d tell you that even though the Sunbelt we’re definitely facing higher supply and that’s playing out in some of our expectations for the year. We’re coming off a very strong year. And we compare ourselves on a relative basis within the markets against our different peers. And I can tell you, the teams are proud of what they were able to accomplish. And we’re off to a good start for this year as well. I think a lot of this has to do with what we expect with supply that we’re facing here over the next four quarters or so.

But on top of that, it’s still relatively strong job growth. We’re still seeing wage growth in that area. So we’re seeing pretty positive absorption. And for us, what’s interesting when you think about what we put on Page 15, and we break down our earn-in versus our expectation from blends and other income. Other income is expected to make up about 45 basis points of our total revenue at the portfolio level for the Sunbelt. That’s double. So a lot of things that we’ve been working on as it relates to rolling out our WiFi, for example, that’s starting to pay dividends, and that’s what’s translating to positive relative performance against our peers.