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Independence Realty Trust (NYSEMKT:IRT)

Q4 2013 Earnings Conference Call

February 26, 2014, 09:00 AM ET

Executives

Andres Viroslav - Director, Investor Relations

Scott Schaeffer - Chairman, President and Chief Executive Officer

James Sebra - Treasurer and Chief Financial Officer

Farrell Ender - President, Independence Realty Advisors

Analysts

Brian Hogan - William Blair

Wilkes Graham - Compass Point

Dan Donlan - Ladenburg Thalmann

Doug Weiss - DSW Investment

Operator

Good day, ladies and gentlemen, and welcome to the fourth quarter 2013 Independence Realty Trust Inc. earnings conference call. My name is Shantelle and I will be your facilitator for today's call. (Operator Instructions) I would now like to turn the call over to your host for today, Mr. Andres Viroslav. Please proceed, sir.

Andres Viroslav

Thank you, operator, and good morning to everyone. Thank you for joining us today to review Independent Realty Trust's fourth quarter and fiscal 2013 financial results. On the call with me today are Scott Schaeffer, IRT's Chief Executive Officer; Jim Sebra, IRT's Chief Financial Officer; and Farrell Ender, President of Independent Realty Advisors.

This morning's call is being webcast on our website at www.irtreit.com. There will be a replay of the call available via webcast on our website and telephonically beginning at approximately 1:00 PM Eastern Time today. The dial-in for the replay is 888-286-8010 with a confirmation code of 92995354.

Before I turn the call over to Scott, I would like to remind everyone that there may be forward-looking statements made in this call. These forward-looking statements reflect IRT's current views with respect to future events and financial performance. Actual results could differ substantially and materially from what IRT has projected. Such statements are made in good faith pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Please refer to IRT's press release and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations.

Participants may discuss non-GAAP financial measures in this call. A copy of IRT's press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to IRT's most recent current report on Form 8-K available at IRT's website, www.irtreit.com, under Investor Relations. IRT's other SEC filings are also available through this link. IRT does not undertake to update forward-looking statements in this call or with respect to matters described herein, except as maybe required by the law.

Now, I would like to turn the call over to IRT's Chief Executive Officer, Scott Schaeffer. Scott?

Scott Schaeffer

Thanks, Andres, and thank you all for joining our call today. I'd like to start with the financial highlights of 2013 as compared to 2012. Total revenues for the quarter grew 29% to $5.8 million. Operating income for the quarter increased 44% to $1.3 million. Core funds from operations per share increased 11% to $0.20 for the fourth quarter.

During the fourth quarter, we acquired a property in Jackson, Mississippi and subsequently to quarter end we acquired a property in Illinois. In addition, we expect to close the Oklahoma City portfolio acquisition shortly. Subsequent to yearend we raised $67 million through the sale of 8 million shares of common stock to close on properties we have under contract and also to fund our pipeline of opportunities.

We continue to see solid opportunities to purchase stable apartment properties in submarkets with strong rental demand and limited additions to supply, which results in the potential for rent increases and improved operating efficiencies. The financing for these properties also remains very favorable.

As a result of our progress and performance of the portfolio, IRT's board announced monthly dividend increase to $0.06 or $0.18 per quarter for the first quarter of 2014, a 12.5% increase from the prior monthly dividend rate.

At this point, I'd like to turn the call over to Jim Sebra to go through the financial numbers. Jim?

James Sebra

Thanks, Scott. During Q4 2013, core FFO was $0.20 per share, up from $0.18 per share in Q4 2012. Note that our weighted average shares outstanding were 9.6 million shares this quarter as compared to a fully diluted 5.6 million shares in Q4 2012. This increase is due entirely to the 4 million shares we issued in our August public offering.

Earnings per share was $0.03 this quarter, up from $0.01 loss per share during Q4 2012. For 2013 core FFO was $0.81, a 14% increase from $0.71 in 2012 on higher weighted average shares. We reported GAAP earnings per share of $0.12, up from a loss of $0.02 per share in 2012.

A few items of note on the annual income statement. Revenue was up $3.3 million in 2013 as compared to 2012. This increase breaks down into $2.8 million of revenue from additional properties that were acquired in 2013 or present for full year in 2013 as compared to 2012 and $500,000 of additional revenue from improved occupancies and increase in rental rates during 2013.

Property operating expenses increased $1.4 million in 2013 as compared to 2012. This increase breaks down into $1.2 million from new properties in 2013 as compared to 2012 and $100,000 from increased expenses for real estate taxes, utilities and property insurance.

As a result, property NOI was $10.5 million for the year, up 23% or $2.0 million compared to 2012. Occupancy at the same-store properties was 93.9% at yearend compared to 91.7% at December 31, 2012. The average rental rate for the same-store properties was $779 per unit per month in the fourth quarter as compared to $755 per unit per month during the Q4 last year.

Our Heritage Trace asset continues to improve after the close last year reduced its occupancy for the first half of 2013. In order to accelerate occupancy growth at this asset, we reduced our asking rents until occupancy returns to a more stabilized level. Excluding Heritage Trace, rental rates increased 4% in our same-store assets since Q4 2012.

Other expenses, including G&A, are down primarily due to the movement of our transfer agent from DST to American stock transfer in May of 2013. Interest expense increased by $354,000 year-to-year due to the $10 million of agency financing we used to purchase Runaway Bay in October of last year. The annual coupon of that debt is approximately 3.6%.

On the balance sheet, our leverage was 52% at December 31, 2013, based on debt to gross assets. In August 2013, we raised $34 million to our initial listing of IRT on the New York Stock Exchange, MKT and properly deployed the majority of this proceeds in the two properties, Berkshire Square in September 2013 and the Crossings assets in November 2013.

Berkshire Square is a 354-unit apartment property located in Indianapolis that was purchase for $13.25 million. The Crossings is a 432-unit apartment property located in Jackson, Mississippi that was purchase for $23 million.

During Q4 2013, we closed a $20 million acquisition line of credit with Huntington National Bank. At yearend, we had $2.5 million outstanding under this line of credit. In addition, we financed Berkshire Square with $8.6 million of permanent financing at yearend. This new first mortgage has a term of seven years and bears interest at 4.4%.

In January 2014, IRT accessed the capital markets for a second time, issuing 8 million common shares and raising gross proceeds of approximately $67 million. $29 million of these proceeds were used in late January to acquire a 370-unit apartment property in Waukegan, Illinois. Lastly, IRT is paying its common dividend monthly at quarterly rate of $0.18 per quarter.

Scott, this concludes the financial review.

Scott Schaeffer

Thank you, Jim. And at this time, I'd like Farrell to discuss IRT's acquisition strategy and pipeline. Farrell?

Farrell Ender

Thanks Scott. We continue to make progress growing the portfolio, by acquiring well-located assets in secondary markets. In the fourth quarter, we closed on one asset. Subsequently in January, we close one additional asset and are under contract negotiations to acquire eight properties, representing 2,150 units, all of which we expect to close in next 45 days. Once these acquisitions close, IRT's portfolio will be approximately $350 million, consisting of 19 apartment communities and 5,300 units.

In November 2013, we closed on the Crossing, a 432-unit property located in Jackson, Mississippi, for $23 million and a going in cap rate of 7.5%. In late January, we closed on The Reserve at Eagle Ridge, a 370-unit apartment complex located at 45 minutes north of Chicago. The purchase price for Eagle Ridge is $29 million and had a going in cap rate of 7.1%. We financed Eagle Ridge with a 10-year loan at 4.67% interest rate. The asset was sourced by RAIT Residential, as they managed the property for the previous owner.

As Scott mentioned, we expect to close the Oklahoma City portfolio this week. The portfolio contains five properties, totaling 1,600 units. The purchase price is $65 million and we will assume $45 of existing debt, requiring $20 million of equity.

This week we also expect to go under contract on a property in Creve Coeur, Missouri, a suburb in St Louis. The property is a mid-rise apartment community with 152-apartment units and 10,000 square feet of retail space. We are buying the property for $32.7 million and assuming $21 million of existing debt that had nine years remaining at a 3.96% interest rate. The asset will provide in excess of a 10% cash-on-cash return and we expect to close in the middle of March.

St Louis is a market we expect to grow. It has a population of 3 million people and apartment inventory of 135,000 units, contains four universities with 40,000 students, a diverse economy that includes healthcare and manufacturing. The market has had very few units added and no meaningful amount of new supply is expected. The overall vacancy rate in this market is less than 5%.

We are also in the process of finalizing purchase and sale agreements on two properties totaling 338 units to combine $38 million purchase price located in Ridgeland, Mississippi, a suburb north of Jackson. These two acquisitions combined with The Crossings property we already own, will create a small region for us and will benefit from the combined operating efficiencies. We expect these acquisitions to close within 45 days.

Lastly, in regards to the pipeline, we are constantly looking at our target markets and underwriting potential acquisition opportunities. The pipeline currently stands at nine properties, with a total acquisition cost of $175 million containing 2,000 units. The property is on various stages of underwriting and due diligence.

Many these opportunities are sourced through our external manager RAIT Financial Trust existing relationship platform, which is proving to give IRT unique access to transactions. Additionally, our property manager RAIT Residential has proven to be a good source of deal flow, as they have an extensive relationship and now work in 17 states in which they manage properties.

Scott, back to you.

Scott Schaeffer

Thank you, Farrell. At this point, operator, I'd like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Brian Hogan of William Blair.

Brian Hogan - William Blair

And I'll just start with a question on competition in your target markets. The St. Louis deal, the Mississippi deal, I mean, Oklahoma, just in your target markets, give us a feel of what the competition is?

Farrell Ender

It's generally a REIT before your local operators to have a couple of thousand units. We feel given our size and the excellent management and the resources we have with RAIT Residential and RAIT that we are able to compete on higher level and underwrite the deals, significant cost savings that we generate from that platform.

Scott Schaeffer

We have a lot of competition at this point Brian.

Brian Hogan - William Blair

You have not, you said.

Scott Schaeffer

We have not seen a lot of competition in these markets, again any organized competition. And the Oklahoma City deal and the Illinois deal, again, were sourced off market. The seller didn't hire a broker and put out the properties to bid. We were able to do that off market just from the relationships that we've had here at RAIT, and we expected to do a lot more of that. St. Louis was a deal that was marketed. We felt that we identified some operating efficiencies, and were able to come to terms, because of that come to terms with the seller at a number that were true for both of us.

Brian Hogan - William Blair

What are you seeing terms of cap rates/pricing, if you will?

Farrell Ender

It's relatively unchanged since the last call. Interest rates have been steady, so we're able to see the same cap rates to be identified at 7-plus. In some cases like St. Louis, they may go a little bit lower because of the quality assets, but the debt that's in place in St. Louis made it attractive.

Scott Schaeffer

We're still seeing the 6.75 to 7-to-7.25.

Brian Hogan - William Blair

And then I know it's going to vary by markets, but can you maybe a sense of a feel of where we're at in the cycle in the terms of rental rates and occupancy rates? Is it a point where you can still push rental rates and still maintain occupancy or is it given the point where rental rates have to level off? And with that should we still assume 3% increases in rental rates on an annual basis or is it [multiple speakers]?

Scott Schaeffer

I would assume 4% on an annual basis. I think the markets that we're targeting, again, are areas where there is no new or very limited additions to new supply being added. That's one of the things that we like and we look for. And as far as occupancies go, occupancies, they're pretty strong. And I would say mid-90s is full occupancy.

You don't want to be higher than that. And again, one of the things that we do is that we subscribe to the [ph] ORO service, which allows us to manage rental rates relative to occupancies and to make sure that we're getting the highest possible rate relative to the demand for that unit in the market at that time.

So we're happy with occupancies, where they are. We do believe, however, that in these markets that we still have another year or maybe two of 4% or so year-over-year rental increases. And it may drop a little bit down from there, but these are markets, again, with no new additions to supply.

They are properties and markets that have strong occupancy, so there is no place for these tenants to go to other than to buy a house, and that's not as easy as it was years ago. And at the same time you have growing population and growing employment. So the dynamics are there for continued rental increases over at least the next year or two.

Operator

Next question comes from the line of Wilkes Graham of Compass Point.

Wilkes Graham - Compass Point

I have a number of questions up here. Some of these are pretty easy, I think. I just want to clarify, for myself, some of the things you said. I've got the eight properties on the contract that obviously includes the five in Oklahoma City, and then you mentioned the other three. Did you mention a cap rate on those three new assets?

Farrell Ender

No, I did not. The St. Louis property is in the low-6s, but that's a product of the existing debt, but then placed itself at 4%. The two in Jackson are going to be around 7.25%.

Wilkes Graham - Compass Point

And those are nominal cap rates, right, before CapEx?

Farrell Ender

Yes.

Wilkes Graham - Compass Point

Do you have, how much CapEx you spend during the fourth quarter?

Farrell Ender

Jim has that number.

James Sebra

Sure. The CapEx for the quarter was about $315,000, broken down into about $200,000 for what we call recurring and about $100,000 is non-recurring.

Wilkes Graham - Compass Point

And do you have the incentive fee?

James Sebra

I don't have it in hand in front of me, but it was relatively nominal. I can call you a little bit later.

Wilkes Graham - Compass Point

Just to clarify, you said same-store rents were up 4% year-over-year?

James Sebra

Yes.

Wilkes Graham - Compass Point

Do you have the NOI number?

James Sebra

NOI growth year-over-year was just over 6%.

Scott Schaeffer

For that same-store portfolio, 6.3% actually.

Wilkes Graham - Compass Point

You mentioned the St. Louis asset, the $38 million, the two extra assets, did you say where those were?

Farrell Ender

They're in Ridgeland, which is a suburb north of Jackson. With The Crossings, you've got a nice 700-unit portfolio there.

Wilkes Graham - Compass Point

And do you just have any general comments about particular markets where you're seeing more acquisition opportunities?

Farrell Ender

They're coming from the markets that were -- I mean that's where Jackson came from, because we're there. So usually we're closing deals. The locations we're closing, we're obviously seeing opportunity. But now that we're out, we're in the CB network, we're in the HFF network, all of our mortgage back as we dealt with. I mean we're seeing deals from all over the place to kind of honest with you. We're trying to just pick up the best opportunity we see.

Wilkes Graham - Compass Point

Can you give us a sense for where, maybe Fannie and Freddie pricing on a single multifamily asset has gone from maybe that it seems to me last summer it was somewhere around 200 bps over the seven-year, which came out to maybe as high as 4.5%, but I am just curious if that's come down and where that's?

Farrell Ender

That right now is extremely attractive. That product is it's just being the beginning of the year as well. Freddie on that product that you just talked about, a seven-year loan is probably 185 over now, the seven-year treasury is at 215. Yes, you're right, around 4%. We're also seeing a lot of like companies being aggressive as well, so they'll be pricing, if they like your asset, I mean they're a lot more selective than Freddie and Fannie, they are pricing anywhere from 130 on a high quality asset to 160 over a seven-year. So you're seeing sub-4 percentage rates now.

Operator

Your next question comes from the line of Dan Donlan of Ladenburg Thalmann.

Dan Donlan - Ladenburg Thalmann

Jim, just going back to the comment on the incentive fee, is that roped into the G&A expense for the quarter.

James Sebra

I don't have in hand. I'll get it for you and send it around.

Dan Donlan - Ladenburg Thalmann

And then as far as the dividend is concerned, was kind of curious as to why you guys raised the dividend for the first quarter. I think the stock is, the current yield is 8.5%, the average apartment REIT is 3.5%. I'm not necessarily sure you're being compensated for paying a larger dividend. Why not just pertain the cash and use it towards new acquisitions?

Scott Schaeffer

Well, first of all the amount of cash in dollar terms that you're speaking about is relatively minor. So to retain that for acquisitions really wouldn't amount to much. So as we grow the company, we were going to need additional capital anyway, regardless of whether we raise the dividend or not.

And the reason that the board agreed to raise it was, because they looked at the pipeline, they looked at the cap rates versus the financing costs and felt that the company's cash flow was increasing quarter-over-quarter at a level which warranted an increase in dividend.

Again, we're a REIT. We're going to payout a majority of our cash, as the company grows. I think you may see us dial back the percentage of the amount of cash that we're paying out to a more standard level. But at this point in early stages, the board felt it was more important to distribute out the cash flows that we're generating. And it has been increasing and is projected to continue to increase, the cash flow that is.

Dan Donlan - Ladenburg Thalmann

I guess I'm kind of curious as to, and I hear you on how small the number it is. I'm just kind of curious as to how you're going to look at on a going-forward basis. And I won't speak to the validity of my model, but when you look at the dividend on a going-forward basis, do you look at it more on your operating cash flow or CAD, so including principal amortization as well as all CapEx or do you look at it more on kind of an FFO percentage number, because obviously as a REIT the last thing you want to do is reduce the dividend. So just kind of curious, how you're thinking about that as we look out a year or two or three years from now?

Scott Schaeffer

We're looking at it on a percentage of core FFO. And I agree with you, we never want to be in a position where we're going to be reducing the dividend. But you have to remember that, again, we're in this growth mode, where we're acquiring properties that are very accretive, notwithstanding the cost of the capital. They are accretive to that capital. So we have a growing cash flow at this point.

Dan Donlan - Ladenburg Thalmann

And then as you're looking on acquisitions, I know you mentioned that you acquired an asset at a low-6 cap, and the reason it was low was because the debt on that property was lower. Do you expect though that that asset is going to have a higher growth rate though than some of the ones that you're acquiring in the low-7 cap range?

Scott Schaeffer

We expected to have a similar growth, at the same time when we set a low-6s cap rate, that's based upon the trailing cash flow. And we think that we've identified some operating efficiencies that over the course of the first year that that cap rate based upon our operations would be higher.

You combine that with, again, a debt cost that is lower than what the market was at that time, the market may have come back to that now a little bit, but it's still generating north of 10% cash-on-cash return going in. So we do expect that and we expect that to grow. So it goes there within the model that we've laid out.

Dan Donlan - Ladenburg Thalmann

And then the other thing going back to your property manager, asset managing so many different properties, can you maybe talk about how that's impacting your ability to purchase assets that you believe? What does that give you versus somebody that maybe only manages 20 properties? I mean what's the scale that you have there from operating expense and savings?

Scott Schaeffer

Well, I'm not sure I got that question completely. But we have a wide reach through our property manager. We're in many different markets and dealing not only with properties that we own or control, but also managing third-party property. So there is an enormous amount of opportunity that comes from those relationships.

The Illinois property, for example, is one that we had managed for a third-party for years. They decided they wanted to sell it. We were able to just talk with them amongst ourselves and come to an agreement and buy it. Those are opportunities that a typical company without those relationships wouldn't see.

But as far as the operating efficiencies, we think that, again managing, I think we're up to 13,000 units give or take now on RAIT Residential. There are benefits from size, utility contracts; cable contracts are basically on a national basis. As you know, [ph] Nowcom basically controls the whole country.

So as we go in and negotiate cable and internet contracts with the provider, we have a relationship with them. We are a big provider of business to them. It gives us an advantage, the same thing with trash removal, waste management. You're dealing with the same company in many different markets. You're not just going in and negotiating a one-off transaction. So we've talked about this, where we actually have a personnel in staff here, whose sole job is, when we acquire properties, when renegotiate all of these contracts, and what we found is there is enormous savings associated with that effort.

One example is the Oklahoma City portfolio. We have a Blanket Policy here, insurance policy that covers north of $1 billion worth of real estate assets. That with Oklahoma City's five property portfolio was insured by itself. When we rolled into our policy, it's already been priced. It's going to save $0.5 million a year. So that happens over and over again and before you know it adds up the real money.

Operator

Your next question comes from the line of Doug Weiss of DSW Investment.

Doug Weiss - DSW Investment

I was wondering if you could speak a little more generally about how you look at your all-in cost to capital. I recognized that your financing rates are well, but the cost of equity capital looks pretty high here. And whether there is a sort of minimum cap rate threshold, at which point you say, as much as we want to grow, we're going to wait until the equity is fairly valued?

Scott Schaeffer

Well, the cost of our capital right now is our dividend rate because what we have other than the property level debt is common shares outstanding. So having said that, we are looking at that cost of capital all the time, we would like it to be lower, but it's a factor of the size of the company. And we do expect that as the company grows and the portfolio becomes larger and more diverse that the market would view it as being somewhat safer and reduce the cost associated with that equity capital.

Having said that, when we put the acquisitions and the cap rates that are available to us in the model with the debt, we're actually still doing accretive acquisitions even with that higher cost of capital. So that's part of the opportunity as we see it. We grow the portfolio in a way that's accretive even to the high cost of capital today, and as that cost comes down, there is real growth potential within the shares.

Doug Weiss - DSW Investment

I guess my follow-up would be, is there kind of a sweet spot in terms of portfolio size, where you envision getting more of a market multiple?

Scott Schaeffer

I am sure, there is. But at this point, we haven't really thought about it that way. We are so small relative to the other multifamily REITs out there, that we just know that we need to grow the company from where it's at and do that for some time and that's our plan. There are lots of opportunities out there and we just want to take advantage of them in every instance.

Operator

At this time, there are no additional questions in the audio queue. And I would like to turn the conference back over to Mr. Scott Schaeffer for closing remarks. Please proceed, sir.

Scott Schaffer

Well, thank you for joining us today. And we look forward to speaking with you next quarter. Have a good day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Have a wonderful day.

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