Investors Real Estate Trust (NASDAQ:IRET) Q3 2018 Earnings Conference Call March 13, 2018 10:00 AM ET


Matt Volpano – Investor Relations

Mark Decker Jr. – President and Chief Executive Officer

John Kirchmann – Executive Vice President and Chief Financial Officer

Anne Olson – Executive Vice President and General Counsel.


Rob Stevenson – Janney Montgomery

Alex Cubesic – Baird

Carol Kemple – Hilliard Lyon


Hello, everyone. And welcome to the Investors Real Estate Trust Fiscal Third Quarter 2018 Results Conference Call. All participants will be in listen-only mode [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Matt Volpano. Please go ahead.

Matt Volpano

Thank you, and good morning. IRET’s Form 10-Q was filed with the Securities and Exchange Commission yesterday after the market closed; additionally, our earnings release and supplemental disclosure package, have been posted on our website at and filed yesterday on Form 8-K.

Before we begin our remarks this morning, I want to remind you that during the call, we will be making forward-looking statements about future events based on current expectations and assumptions. These statements are subject to risks and uncertainties discussed in yesterday’s Form 10-Q, during this conference call and in the risk factors section of our Annual Report and other filings with the SEC. Actual results may differ materially and we do not undertake any duty to update any forward-looking statements.

Please note that our conference call today will contain references to financial measures such as funds from operations or FFO and net operating income or NOI that are non-GAAP measures. Reconciliations of non-GAAP financial measures are contained in yesterday’s press release and definitions of such non-GAAP financial measures can be found in our most recent supplemental operating and financial data, both of which are available in the Investor Relations section of our website at

With me today are Mark Decker Jr., President and Chief Executive Officer; John Kirchmann, Executive Vice President and Chief Financial Officer; and Anne Olson, Executive Vice President and General Counsel.

I will now turn the call over to Mark.

Mark Decker Jr.

Thanks Matt. And welcome, everyone. This is the most exciting earnings call I have been on. We’ve all been working hard to infill the core principles of capital allocation, operational excellence and balance sheet strength into our management of the business. And it’s starting to show in the results. Also, for the first time these results are focused on our core business. After today, we are finished talking about our transformation. We now have the multifamily business we’ve been working toward. Going forward, we can talk exclusively about our pharma communities and put behind us the discussions of large, non core asset sales and other events that created uncertainty for our investors and divided our internal resources. And with the portfolio of transition behind us, we can focus all of our attention and yours on improving what we have. And I am confident we can.

With that said, I’d like to summarize at a high level what we’ve done over the past two years to bring us to this point. I’d like to start by thanking those of who you’ve been with us through this process. If you are a new listener, we are glad you are here as well. We communicated our intent to focus exclusively on multifamily in June of 2016. And we move with purpose and speed to execute on that goal. Informed by the view that the clinical capital, relative economic stability, low interest rate and deep demand for real estate provided opportune conditions to sell non strategic properties. We’ve generated almost $800 million through non core property sales in June of 2016. And nearly $1.5 billion since 2013 when we embarked on this transformation. We took that capital and we invested over $860 million in new apartment communities, paid down almost $400 million of debt, repaid over $40 million of high cost preferred stock and repurchased or redeemed over $20 million of shares and units.

Including Westend, a 390 community we have under contract to purchase in downtown Denver. We’ve redeployed over $370 million in the last 12 months into 1,355 apartment homes in our strategic growth markets of Minneapolis and Denver. Of course, we carried out the multifamily redeployment in the same environment of abundant capital and low rates that we sold into, but we believe we substantially improved our business and growth profile. We traded heavy exposure to multi-tenant commercial assets with large tenant concentrations for a pure, 1,400 home apartment portfolios with leverage to a growing economy. We traded long duration leases with large event-driven capital needs for short duration leases and consistent capital expenditures.

We traded out of healthcare which is highly regulated and constantly evolving for the simplicity of housing. We also transform the nature of our multifamily cash flows. From almost exclusively secondary and tertiary markets to meaningful exposure in Minneapolis and Denver, two key markets that have diverse fundamentals and a positive outlook. Four years ago, Minneapolis communities provided 3% of our multifamily NOI. Today, we generate 20% from Minneapolis and Denver. Looking forward and taking into account our new non same store assets, we expect 30% of our NOI will come from those top 25markets. We also pruned and will continue to enhance our multifamily portfolio taking our average community size of 24% from 127 homes per property to 157, creating greater efficiencies.

We fundamentally changed our approach to leverage moving from 100% secured to 80% today and heading lower. We lower the absolute amount of leverage and today we have more liquidity and balance sheet flexibility than ever before. One of the biggest changes we’ve made is how we’ve strengthened our operations team to uncover and unlock efficiencies, and improve our customer experience. We have an exceptional team that inspires me every day and has massive capability, capacity and desire to execute on our strategic goals as well as our day-to-day operations.

At the Board level, we added experience and diversity of perspectives while maintaining some of the best governance in the business. These positive changes aren’t immediately reflected in our financials, but I believe they will be instrumental in achieving consistent and long-term growth. Most importantly, this is a company that now has a clear mission and focus. And as we transition from transactional to operational, our same-store portfolio continues to strengthen. Third quarter same-store revenue grew 5.2% over the prior year’s quarter, accelerating over the results from the first two quarters of fiscal 2018. And notably that revenue growth resulted in 5.8% NOI growth over the same period. This is the first quarter we’ve posted meaningful same-store NOI growth in roughly three and a half years. And this is an obvious testament to the hard work of our operations team and our improving markets.

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Looking forward, we are excited to spend a 100% of our time and effort to make IRET better. And we will accomplish this by putting our customer at the center of everything we do as we work to fulfill our mission of providing great homes to our residents, our employees and our investors.

In summary, we are thrilled to be where we are. We are pleased to have sold our entire MOV portfolio prior to the recent interest rate increases and softness in healthcare REIT. We have done all the redeployment we feel we need to do and can be opportunistic in our external growth going forward. And at the same time, we have identified numerous initiatives for solid internal growth. Having said all that, there’s no mission accomplished banner hanging behind us and a few data points do not make a trend. We are optimistic about where the business is today. And maintain a clear-eyed view of the tasks that remain ahead of us. And the realm of competition, we are stepping into as we’ve come to be compared to some truly great owner operators with outstanding portfolios. But we are excited to be in the ring.

With that I’ll turn the call over to John.

John Kirchmann

Thank you, Mark. I am pleased to elaborate on how our transformation is reflected in our reported financials, as well as on our progress with operating initiatives and balance sheet activities. Last night, we reported core FFO for the third quarter of fiscal of 2018 of $0.09 per share, a decrease of $0.03 from the third quarter of fiscal 2017. For the nine months of fiscal 2018 core FFO was $0.30 per share, a $0.05 decrease from the prior year-to-date period. The decrease was primarily due to a reduction in NOI from the sale of commercial and non core multifamily assets, and our previously announced capitalization policy changes.

Moving to our same store results, year-over-year same store revenues grew5.2% for the quarter and 4.3% for the nine months of the year. Revenue growth was driven by increases in occupancy, rental rates and other resident based rental revenues. Our weighted average occupancy in our same-store portfolio increased 440 basis points to 94% for the quarter, and 190 basis points to 93.3% for the nine month period. Our goal remains to achieve a weighted average occupancy near 95% by April 2018, a goal we believe will increase our efficiency, drive pricing power and expand our margin. As we approach our occupancy goal, we have begun to shift our focal point from occupancy growth to increasing asking rents.

Same store expenses for the quarter increased 4.5% compared to the prior year resulting in a 5.8 % increase in NOI. For the first nine months, same store expenses increased 11.3% compared to the prior year, resulting in a 1.2% decrease in same store NOI. Both the expense and NOI results are in line with our expectations and reflect our strategy to build our operating platform, increase efficiency and improve financial reporting. The primary components of the $4.5 million increase in same store expense for the first nine months of the year were an estimated $2.1 million increase for the capitalization policy changes. $700,000 increase in turnover and labor costs related to increases in occupancy and a suspension of redevelopment activities in the current year. A $200,000 increase in marketing costs related to increasing leasing activities to achieve higher occupancy. A $900,000 increase in real estate taxes due to stabilizing developments and higher levy rates in select markets. And a $400,000 increase in casualty losses related to an increase in the number of small dollar weather-related claims. Offsetting these increases was a $500,000 reduction of snow removal costs during the third quarter due to higher than normal snowfall in the prior year.

We expect expense growth in the fourth quarter to be consistent with the higher comparative expense growth for the first six months of the year, rather than the lower comparative expense growth for the third quarter, as we do not expect the reduction of snow removal costs achieved during the third quarter to reoccur. Moving to capital expenditures, as presented on page S17 of the supplemental, during the first nine months of the year same store CapEx was $10 million as compared to $9.1 million for the prior year. The aggregate increase of $900,000 is comprised of the following components. An increase of $1.4 million related to increased CapEx at properties that were undergoing redevelopment activities in the prior year. And an increase of $1.7 million related to a change during the third quarter in our presentation, as we now allocate all accrued capital to their respective categories, which does not represent increase spend but does affect how the numbers are presented in the CapEx tables in our supplemental.

These increases were offset by a reduction to CapEx of an estimated $2.1 million due to changes in the capitalization policy that resulted in a corresponding increase to property expenses. Turning to value add, our same store value add capital expenditures decrease from $14.1 million during the first nine months of the prior year to $400,000 for the current year. As you may recall, we suspended redevelopment activities in May 2017 while we evaluated the program with the intent to re-launch our value add initiatives under a new asset management team. We have now identified several redevelopment opportunities in our portfolio and expect to see those expenditures increase in the coming quarters.

General and administrative expenses for the quarter were $ 3million, a $1.1 million decrease from the prior year. The decrease was primarily due to decrease salary and related costs. We expect our quarterly G&A run rate to return to approximately $3.5 million per quarter as we fill open positions and recruit talent to boost our operations and management teams. Adjusting for year-to-date transition cost of $650,000 G&A during the first nine months decreased by $1.7 million from the prior year.

Turning to the balance sheet. We continue to improve our financial position during the quarter. As of January 31st, we have $175 million in total liquidity, including $152 million available on our corporate revolver. We also have $116 million of restricted cash from the sale of assets during the quarter to be utilized for tax-deferred property acquisitions. Upon closing on the Westend acquisition in Denver mentioned by Mark, we will have utilized all of these restricted cash and we’ll have approximately $30 million of remaining gains to defer. This acquisition we’ll also join our pool of unsecured assets and increase the availability of funds on our corporate revolver, further enhancing our financial flexibility. We obtain the $70 million unsecured term loan that matures in 2023 and executed a swap agreement to synthetically fix the interest rate for the full duration of the loan, and reduced our exposure to the risk of increases in interest rates. While on the prior quarter we increased our debt as we pre-funded the redeployment of proceeds in anticipation of the third quarter asset sales, we have now stabilized our leverage and will continue to work toward increasing our unencumbered NOI and achieving debt metrics in line with investment grade benchmarks.

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Finally, our operating initiatives continue to be on track with actions taken during the quarter that we expect will continue to drive margin growth, including restructuring our operations department to create dedicated in-house expertise to ensure consistency across markets and create scalability. Expanding our amenity pricing programs to grow revenue, introducing additional programs to isolate resident specific expenses allowing us to recapture an increasing portion of our cost, completing the optimization of our expiration profile to better manage seasonality, and turnover expenses and concluding an asset review of our portfolio to prioritize redevelopment initiatives.

With that I will turn the call over to the operator for questions.

Question-and-Answer Session


[Operator Instructions]

Our first question comes from Rob Stevenson with Janney. Please go ahead.

Rob Stevenson

Good morning, guys. Mark how many non apartment assets do you have in the portfolio as of today? After all these transactions have been done.

Mark Decker Jr.

Good morning, Rob. We have nine assets left that are not multifamily that it counts.

Rob Stevenson

And how significant is the NOI that’s being generated off of those these days?

Mark Decker Jr.

Pretty insignificant, less than 10%, probably –five actually.

Rob Stevenson

Okay. And I mean is from — as we think about it going forward is it just opportunity, is there no mortgage debt that has big defacement issues or anything to prevent you from selling those things tomorrow? Should we expect that by sometime in the middle of the next fiscal year or is that a longer process? How should we be thinking about it as you rid yourself of those last nine assets?

Mark Decker Jr.

Yes. Well, we’re going to work hard to be non dilutive and opportunistic as much as possible. So we’d like to pair that, pair some of those sales with value add or other investments that don’t feed up our cash flow which we’ve done lot of in the last 18 months as you know. But there are no mortgages or any other sort of inhibited, inhibitors to us acting on those in an opportunistic fashion.

Rob Stevenson

Okay and then is it — how significant is investor demand today for the non core apartment assets, the smaller stuff that you guys want to sell? Some of the tertiary markets, is that a given what’s going on with the economy is that –is a decent demand there? Is it sort of hit and miss how would you sort of characterize that market these days?

Mark Decker Jr.

Yes. I’d say for the most part, one, we do have the business we want and so will be focused on enhancing. We will be strategic about selling things that we think are not long term winners. I think thematically there has never been a deeper bid for secondary and tertiary market assets. I think the 10 year could affect that a little bit and I think it will affect that market sooner than it affects the primary markets, just when you think about the fit and finish of the buyer and their resources and mindset. But I’d say so far we haven’t seen a big deterioration although these are markets that are not, we don’t have a lot of data points in terms of trading. So the last, well the last non-core assets we’ve sold in multi or the last pairing we’ve done at the multifamily portfolio was the Copperfield portfolio which was in Minot which is a reasonably tough environment economically. Those were just very clearly not on strategy for us as you know they included a range of sizes from three to sixty units. The assets we sold in Rochester last, late last fall, those were really opportunistic and I think that’s how we’ll be going after it. So we look at our NAV, we carry every asset at a price in our mind those are could be viewed as similar to release prices. And if we get interested that makes sense we would act on that basis. In the multifamily portfolio, we do have a lot of — a lot more debt constraints and things like that, that we have to navigate. So we’re navigating how do we go to market in the whole sub market. How is it financed? What’s our long term view of the asset? Is there anything we can do to improve it today?

Rob Stevenson

Okay and then how are you sort of factoring in the comments in terms of not wanting to dilute on either apartment or non apartment asset sales, as well as the purchase of Westend versus buying back your stock especially with it below $5? And I know that you guys did some in the quarter but how are you prioritizing stock repurchases today at that price at $4.80 or so and even cheaper on some of the weaker days when the REITs are getting clobbered? So how does that — how did you and the board thinks about that?

Mark Decker Jr.

Yes. So we have a lot of discussion about it. I think it’s important to understand the nature of the capital we deployed at Westend was our gain. It was a rollover of gained, so it wasn’t pure free cash, it was in an essence restricted cash. It had only a few different ways to utilize it. It was our judgment this was the best allocation of capital for the shareholder. So buybacks are absolutely still on the table. And as you noted, we have been active in the last 12 months.


Our next question comes from [Alex Cubesic] with Baird. Pleased go ahead.

Alex Cubesic

Good morning. This is Alex on for Drew. We’re just looking for a little additional color that you guys could provide on the Westend acquisition. And maybe some just additional commentary on what’s this really about the asset made it the right fit for you guys to add that kind of the foundation of your Denver portfolio?

Mark Decker Jr.

Sure. Thanks, Alex. Good morning. This is Mark. We — as I just noted with Rob, we had to deploy this capital through a 1031process. So we tried to create the largest funnel we possibly could for ideas we were centered in Minneapolis in Denver. We felt like it would be important, if possible to deepen our exposure to Denver Westend as an asset. We’re very excited about it. It’s in downtown, it’s 11.5 acres, its new product, its stabilized it has some features we think are very exciting specifically it’s pretty differentiated product. It’s really garden product in the city sits on a 50 acre park on the Platte River. It looks at the city. It looks at the mountains, its 10 minute walk to Union Station, 10 minute walk to some of the grid stuff on the on Platte Street. You can walk to low high, so there are a lot of good amenities there, and we think it’s a great value play. So if you want to spend a little less money and still be in the city, this is a good option. If you want to have a garage to park your car, which is incredibly rare, this is the only option, so for a lot of reasons we felt like it was great long-term real estate. It is also zoned for 12 story development. So that is not an immediate plan but that was something that we found interesting and compelling. It’s a large piece of land in the middle of the city.

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Alex Cubesic

Great. Do you have any color but cap rates, acquisition price can we assume you’ve spent a majority of the $116 restricted cash on it or kind of just a little more in that realm?

Mark Decker Jr.

Yes. We won’t be specific until we close which are a couple weeks away, but we have deployed as John commented, we will deploy all of our $116.8 million of cash which is a large portion of that [$168] million gain.

Alex Cubesic

Perfect, thanks for the color that helps a lot. And just kind of backing out a little bit just look at the Denver and Twin Cities market as a whole. Are you guys seeing additional opportunities available and especially in a relatively hot market like Denver, would you say you guys are running into much competition on the bidding process now that you guys are two properties?

Mark Decker Jr.

We– look; I think the markets are very competitive. We’re not seeing a slowdown in the bid at this point having deployed the bulk of our gain. We’re really turning our attention internally and will be focused on a number of initiatives to move our margin up. So we would love to grow in Denver when the circumstances dictate. I think the signal from the market with respect to our stock price right now is do otherwise, and given our leverage hold here and improve what we have.


Our next question comes from Carol Kemple with Hilliard Lyon. Please go ahead.

Carol Kemple

Good morning. How is new supply in your markets? Are you seeing more impacted this year than last year or any real changes there?

Mark Decker Jr.

Yes. If you look across all of our markets it really depends I’d say in Rochester. We do have a lot of supply that we’re dealing with that we think will moderate rent growth. I’d say the Dakotas for the most part are having absorbed the supply and we don’t see a lot on the horizon. And we expect some of the markets there will be a little bit weaker, this market in particular. But on the whole, our existing markets are pretty healthy. Denver which is obviously a new market for us does have a lot of supply coming on a historical basis. And obviously they have a lot of jobs coming as well. So we’re confident in that market long term. We realized it’s a little bit– could be a little bit choppy this year. But we feel great about it. In Minneapolis, supply continues to be pretty disciplined. I mean we’ve been less than 2% of deliveries I believe through this whole cycle besides the supply does tend to gravitate into a couple of sub markets. So and that will affect some of our assets. So in Edina where we have 71 France asset that we would expect there’s about 1,200 units that have come or will come around that likewise in the Westend where we have our Arcata, there’s about a 1,000 units coming in and around that market. That is almost half of the supply of the whole city coming in those two sub markets. And then likewise in downtown where we have Red 20 which is a smaller asset but an important one. There are about 900 units coming in and around that market. Now they’re all coming in significantly prior higher prices per door. So hopefully they can drag rents up and we can come in behind them. But, in general, we feel really good about the portfolio. Those are the supply, the areas of concern.


This concludes our question-and- answer session. I’d like to turn the conference back over to Mark Decker for any closing remarks.

Mark Decker Jr.

That’s all we have everybody. Thanks very much for joining us today. And we’ll talk to you next quarter.


The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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