Kennedy-Wilson Holdings, Inc. (NYSE:KW)
Q2 2016 Earnings Conference Call
August 04, 2016, 10:00 AM ET
Daven Bhavsar - IR
Bill McMorrow - Chairman and CEO
Mary Ricks - President and CEO of Kennedy-Wilson Europe
Matt Windisch - EVP
Justin Enbody - CFO of Kennedy-Wilson
Mitch Germain - JMP Securities
Vincent Chao - Deutsche Bank
David Ridley-Lane - Bank of America Merrill Lynch
Craig Bibb - CJS Securities
Good morning and welcome to the Kennedy-Wilson Second Quarter 2016 Earnings Conference Call. All participants will be listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Daven Bhavsar, Director of Investor Relations. Please go ahead, sir.
Good morning, everyone, and welcome to Kennedy-Wilson's second quarter 2016 earnings conference call. This is Daven Bhavsar, and joining us today are Bill McMorrow, Chairman and CEO of Kennedy-Wilson; Mary Ricks, President and CEO of Kennedy-Wilson Europe; Matt Windisch, Executive Vice President of Kennedy-Wilson; and Justin Enbody, Chief Financial Officer of Kennedy-Wilson.
Today's call is being webcast live and will be archived for replay. The replay will be available by phone for one week and by webcast for three months. Please see the Investor Relations section of Kennedy-Wilson's website for more information.
On this call, we will refer to certain non-GAAP financial measures, including adjusted EBITDA and adjusted net income. You can find a description of these items, along with a reconciliation of the most directly comparable GAAP financial measures, in our second-quarter 2016 earnings release, which is posted on the Investor Relations section of our website.
Statements made during this conference call may include forward-looking statements. Actual results may materially differ from the forward-looking information discussed on this call due to a number of risks, uncertainties, and other factors indicated in reports and filings with the Securities and Exchange Commission.
I would now like to turn the call over to our Chairman and CEO, Bill McMorrow.
Thank you, Daven. Good morning, everybody. I am here in our office in Dublin, Ireland and I would like to thank everybody for joining us today.
We're pleased to have reported a solid second quarter, driven by continued growth in our property net operating income. Today we'll cover the following topics. We'll start off with our key financial highlights for the quarter, followed by a review on our increase in recurring cash flow and solid operating performance at our properties.
Next, we'll discuss our balance sheet before turning to a summary of our investment transactions for the quarter and finally we'll discuss our current market outlook before opening up to your questions.
So starting off with the financial highlights for the quarter, adjusted EBITDA was $74 million compared to $113 million during Q2 2015. Adjusted net income for the quarter was $43 million compared to $63 million in the second quarter of 2015.
To give you a bit of context around these results during the second quarter of 2016, our share of property NOI was up by $11 million. Our share of transaction related gains was down by $54 million.
In particular in the second quarter of 2015 we sold our Japanese multifamily portfolio, consisting of 2400 units. We also reinvested the proceeds from that sale actually on the same day into the 5500 unit Vintage Housing West Coast U.S. apartment portfolio, the results of which we'll discuss later in the call.
The NOI growth in our multifamily portfolio has been a key source of recurring income for the company. On a same property basis, we've now seen 12 consecutive quarters of 8% or higher NOI growth and six consecutive quarters in excess of 10%.
For the quarter our multifamily revenues were up 8% and our NOI was up 11%. If you look at the second quarter same property stats for four of our large publicly traded apartment REITs, on average they put up 5.5% revenue growth and 6% NOI growth.
We outperformed as a result of our unique strategy, in the western U.S. which makes up 86% of our equity investments in the multifamily sector, our properties are not typically located in the Central Business District or CBDs.
Most of our portfolio is in suburban, garden style apartments with relatively low densities and typically sit on large tracks of land. We tend to buy slightly older products and implement capital improvement initiatives to enhance value add high quality amenities and increased rents.
Our typical rents can be anywhere from 30% to 60% lower than rents at newly built CBD-located apartments. This delivers a unique value proposition and relatable affordability to our tenants.
Our team has done fantastic in driving these impressive results, especially considering that when we went public in 2009, we had a 15% ownership interest in a total of 10,000 units and only one 100% owned property that at that time generated $1 million of NOI. Today, we have a 43% ownership interest in over 25,000 units, including 7,800 units that we own 100% of. Those 7,800 units alone generate $88 million of annualized NOI. So we've gone from $1 million to $88 million during that period of time.
Looking at our stabilized commercial portfolio for the quarter, occupancy grew by 2% while revenue and NOI increased by 1%. The same property pool and commercial was relatively small to the size of our overall commercial portfolio because we tend to buy lower occupied properties where we can add value through leasing and capital improvements. These properties do not show up in the same property pool until they have been stabilized for both periods that are being compared.
We continue to make progress on our leasing efforts across our un-stabilized commercial portfolio. For example during the quarter, we completed leasing at 150 South El Camino in Beverly Hills, which is a 60,000 square foot building that we acquired vacant in 2013.
After complete renovation we've now fully released the property with the last tenant, Imagine Entertainment, expected to take occupancy after they finished their TIs in the first quarter of 2017.
I would like to now review our balance sheet. The second quarter ended with another way of volatility caused by the U.K Referendum vote. As discussed on many of our past calls, we've been preparing for this type of volatility over the last several years by continuing to extend our debt maturities and grow the recurring cash flows across the business.
Besides our revolving line of credit, we have no corporate debt maturities until 2024. At the property level, our loan-to-cost is approximately 50% and that ratio would be much lower against today's market value of our properties. In total, 66% of our corporate and property level debt is fixed and 82% is hedged against long-term increases and interest rates.
Now moving on to the investing side of the business, for the first six months of 2016 Kennedy-Wilson invested approximately $138 million of cash from our balance sheet. Of the $138 million, $92 million or two thirds of our investment dollars were invested in a combination of KW share repurchases. KWE stock purchases and CapEx related to our existing portfolio where we expect to create new recurring income streams.
Specifically with regards to our share repurchase plan, we have spent $28 million including $23 million in Q2 since launching the $100 million program in February of 2016. Also during the first six months of the year, we invested approximately $46 million or one third of our investment dollars on the acquisition of new properties.
On the acquisition side in Q2, we and our equity partners acquired $382 million of real estate, including $223 million through KWE. These acquisitions had a weighted average cap rate of 6.8%.
On the disposition side, together with our partners we sold $380 million of real estate at a weighted average cap rate of 4.3%. Excluding KWE sales, KWs equity multiple on these realized investments was 2.3% including our share of promoted interests.
We remain focused on our strategy of selling lower yielding investments and redeploying our capital into higher yielding well located higher quality assets. In fact for the year, we have now sold non-income producing investments generating over $100 million in gross proceeds.
Subsequent to the end of the second quarter, we completed $288 million of investment transactions. In July, the company acquired a 100% ownership interest in a 430 unit multi-family property in the Seattle Suburb of Auburn, Washington for $81, investing $19 million of equity.
In addition, subsequent to the end of the quarter, we sold two multi-family properties totaling $207 million in sales price. These sales generated net proceeds of $116 million at a total profit of $108 million to KWE and our partners. KWE share of the profit including promoted interest was $20 million equating to a 3.9 times equity multiple.
In addition, our partners in these dispositions included what we call our Fund III and Fund IV which our RKW value add funds. In total these funds receive cash profits of $41 million and a deal level IRR of 50%.
On our most recent fund, Fund V, we completed a $500 million fund raise in the second quarter of this year. Fund V's investors include a number of the best-in-class global institutions. Additionally, Kennedy-Wilson is a 12% investor in the fund.
Fund V's current portfolio consists of 12 investments with a total purchase price of $580 million. In addition to its existing portfolio Fund V still has $500 million in purchasing power using 50% leverage.
Turning to KWE, earlier this morning KWE released its half year result. KW owns 21.6% of the share capital in KWE and acts as its investment manager. The annualized NOI in KWE's portfolio as of June 30 stands at $215 million.
During the quarter, KWE completed leasing transactions on over 420,000 square feet. The KW portfolio has a number of ongoing value added development initiatives that will be completed this summer, which will create further cash flow for the company.
In fact, KWE has now completed its renovation of the Baggot Street Office Complex in Dublin, where they increased the existing 92,000 square foot office building by 38,000 square feet.
The 130,000 square foot building was recently handed over to the Bank of Ireland on a 25-year lease and remember this building was obviously empty while we were doing the renovation. Additionally post-Brexit, strong leasing momentum continued in our U.K. portfolio as KWE has now completed over a dozen leasing transactions post-Brexit adding $1 million of annualized NOI.
Next, I would like to give you an update on a few of the larger projects we have in progress. At our five-acre waterfront capital block development in Dublin, which sits adjacent to our state street office building in Dublin South docks, we recently appointed a contractor to build the 660,000 square foot mixed use project, which includes 330,000 square feet of office across three buildings, 190 apartment units across three buildings including a 23-storey tower along with 25,000 square feet of retail and cultural space.
We estimate, currently estimate that it will take three years to fully complete this project with the first office building being delivered in late 2017. Kennedy-Wilson has a 42.5% ownership stake in the capital dock developments.
Another significant investment where we have a lot of value creation underway as a Vintage Housing Holdings that I previously mentioned. We are now just over a year into our investment in Vintage Housing portfolio and it’s performed beyond our expectations.
Vintage housing as you might remember is engaged in the development and management of affordable housing on the West Coast with a focus on independent senior properties. At the time of our investment, Vintage owned interest in 5,500 units across 30 multifamily communities. Over the past year through operating, financing and tax credit equity related distributions, our investment in Vintage has returned 55% of our initial capital of $78 million and today produces are cash-on-cash yield of over 12% to KW.
Additionally, through Vintage we have over 1,200 units under construction in Seattle and the San Francisco Bay area that we expect to complete in the next 18 to 24 months. Once these units come online, we will have nearly 7,000 units in this portfolio.
In conclusion, looking into the second half of 2016 and beyond, we believe that global volatility will continue to persist driven by a variety of factors. The election in the U.S., the ultimate outcome of the U.K. referendum vote, uncertainty around interest rates and currency fluctuations and so on.
However Kennedy-Wilson is well positioned to take advantage of any market dislocations, but more importantly we remain focused on executing on our asset management investment strategies. Our powerful global network of relationships continues to provide us with real time market information and give us an edge in making the best real estate investments possible.
With that, I’d like to open it up to any questions.
We will now begin the question-and-answer session [Operator Instructions] Our first question comes from Mitch Germain of JMP Securities. Please go ahead.
Good morning, everybody. Bill, I'm just really curious if you can give some thoughts about plan dispositions, what specifically you might be targeting in the portfolio right now, maybe is it safe to assume that you guys could be a net seller based upon what your outlook is. Just maybe some thoughts around that please.
Well, I don’t know about the net seller part Mitch. Obviously -- I think to make sure I frame this properly, we went into that Brexit vote, well, now I am talking about KWE, with nothing in Escrow to buy. And we were very, very well positioned in the sense that we have maintained a lot of liquidity in that company.
So as far as the United Kingdom is concerned, I think it just its way too early to see how this is all going to play out in terms of new acquisitions. You've seen some activity among the open ended funds, but really not a lot has transacted yet.
In both KWE and KW, we are operating under a similar philosophy. Right now what we're getting rid of or selling what I would call the lower priced inventory that we have in both companies and converting that money into higher quality, higher earning asset, so that's happening in both of -- in KWE and KW.
In addition to that, we have -- in the U.S. we have three reasonably sizable apartment properties that we're in the process of marketing right now. But we plan to redeploy the proceeds from those hopefully meaningful gains into additional multifamily units that are earning a higher gross income.
It's hard to say at this point whether we are going to be net sellers or not during the second half of the year, but obviously we have some planned dispositions underway.
And I guess we've seen a couple of assets trade in the U.K. post Brexit, a couple of refinancing as well. Are you guys seeing any indication of new capital, opportunistic capital maybe entering into the market?
Mary, you want to answer that?
Sure. I would say that especially given the currency situation, you definitely are hearing a lot from U.S. investors, so that we're seeing. But we're still seeing very good liquidity especially as Bill indicated in the smaller lot size transactions.
So when you think about this low interest rate environment for the kind of the tail of our portfolio, these are great opportunities for investors to put their capital to work, for example on high street assets in the town that they live in, it's a great investment opportunity to pass somewhere in that 5% kind of yield when they can get no real yield elsewhere. So we think that there is still really good liquidity within our own portfolio.
Great. And last one for me is just a bookkeeping question on the development schedule and the supplemental, we saw I guess some of the disclosure change, I think some of the items that -- projects that were seeking entitlement no longer on there, is that anything behind that?
Yes, Mitch, this is Matt. So, nothing behind it except we just wanted to really focus on the projects that were actually underdevelopment as opposed to the ones that are seeking development. So we just thought, everyone should be more focused on what's actually being built as opposed to what might be built in the future.
Got you. Thank you.
Mitch, I would add to Mary's point, I think both in United States and Europe we're seeing tremendous demand on part of the investors that are searching for yield. So there is very, very good liquidity right now particularly in assets, I would say under $15 million in value and particularly in the apartment market in the U.S.
I think the point we were trying to make when we talked about the two sales post the second quarter, those were meaningful profit numbers on those apartment sales, really in a relatively short period of time in our ownership.
Great. Excellent quarter. Thanks guys.
Our next question comes from Vincent Chao of Deutsche Bank. Please go ahead.
Good morning, everyone. Just sticking with the U.K. and Brexit, I know its early days, but just curious how you are thinking about timing of deployment of capital. I know right now there is no one transacting, but I know I guess what even if the spreads look attractive on some of the deals that you might be able to get, I guess, how you are thinking about getting in now versus waiting a little bit longer, just how things play out? And then two, do you expect the opportunities will be more on the loan side versus the asset side?
Yeah, I would say what we're seeing right now is a lot of the U.K. property fund looking to -- they are facing redemptions due to some liquidity mismatches, where they're getting marked weekly often time.
So the stuff that we're looking, the U.K. property funds have always owned good assets in good location. So I think the opportunity is really to pick up high quality assets often times good long income and/or assets where if there is a real need for liquidity very quickly, then obviously the price will reflect that.
So I think the timing is good now, if we see opportunities that make a whole lot of sense relative to good covenants and long income because I think as you guys probably know, the length of leases in the U.K. and Ireland versus on the commercial side versus the U.S. we usually sit here, are generally much longer than U.S. leases. So you can by stuff that has 7 to 15 year lease terms that we think will withstand any bumps in the market over time. So those are I think going to be some interesting opportunities.
We've seen a little bit of that come out of the U.K. property fund. I think there is way more to come as there is political uncertainty as it bumps along before there is a real resolution as Bill said.
So we're seeing that and then on the PRS space on the multi-family space in U.S. name -- we think that there is really good potential opportunity here in the U.K. and London and there are some structural changes that happened before the vote that we saw a softening in residential assets in London and that’s been exacerbated by the Brexit vote.
So we have teams looking at that and having lots of meetings and conversation. So I think there is going to be some pretty interesting opportunities here to come. But we're going to be very selective as we always are and seek really the best risk adjusted returns across our markets here and I am sure in the U.S. of course.
Thanks for that.
I think too, Vince to add to that. just on the acquisition side, remember we have a number, Baggot Street, [Claim], now Capital Dock. We have and what I said in the vintage portfolio, the units that we have under construction there and so we have many, many projects underway right now that will be coming online here in the next really three months to -- in the case Capital Dock over the next really two to three years and so all of those are going to be adding to the recurring income of both companies.
Okay. Thanks for that. And just a question on the performance in the U.K. I know it’s a small part of the same store pool, but the commercial NOI was down 9%, was there something specific going on there?
No, no, not 9%. No.
You are looking at you are talking about for KWE Holdings?
Yeah for KW, sorry. Yeah the same sore that you guys report?
You're looking at a total of really two portfolios there and one in particular there was raw and free rents and we do cash NOI, so as you can see the occupancy was actually up slightly. So it's just free rents running through primarily.
Okay. And did you have a sense of when that runs out?
It should be -- it should run out the next three to six months.
Okay. Thanks guys.
Our next question comes from David Ridley-Lane of Bank of America Merrill Lynch. Please go ahead.
Sure. If you look across the U.S. multifamily portfolio, how many of those building are still undergoing some level of property improvement or unit refurbishment? I am trying to get a sense of what percentage of that portfolio is still to have some, let’s call it above-average NOI growth?
I don’t know if we have an exact number in terms of -- we’ve got 130 properties across the Western U.S., Japan and in Europe. I’d say in the Western U.S. given the age and the timing of which we bought these, I would guess you still have between 25% and 50% that are undergoing some sort of renovation, whether its common area amenities or unit upgrades. So, still a fair amount of the portfolio where we’re adding pretty significant value.
And then more of a market comment, if you I appreciate the commentary about how your multifamily assets are in suburban areas regarding style with the rents being lower, if you look at the market trend there, do you see a number of years where those types of multifamily assets could continue to see above-average rent increases given the value that they represent to the renters?
Well, I don’t know that we’re going to make a forecast on what we think the rents are going to happen. As I've said before on these calls the markets that we're in and in addition to the fact that they are not generally CBD and they're suburban value add properties where we can do unit renovations and add amenities, particularly in the Seattle market, in East Bay, San Francisco you've got extremely strong job growth.
And so I would say that to me the continuation of the rent increases whatever they're going to be, I don't want to forecast, whatever they're going to they are driven in large part by the continued job growth, particularly in those two markets.
And as I've said many times for example in the Seattle markets, you've got more what I would call Fortune 500 types of companies than we have in Southern California. And of course everybody I think is well aware of what's going in the tech world in Northern California.
Right. And then I know KW has boots on the ground in Spain and Italy and has been underwriting a lot of transactions, curious to get a sense of deal flow in those two markets?
Yeah, we're, I think we're very focused right now on executing our asset management plan in both of those markets. We've got our LNG property, which is a shopping center in one of the best residential areas with a big office park next to it in Madrid. That’s going to undergo a major renovation.
We're in discussions now with probably the largest retailer in all of Europe, definitely in Spain to increase the size of their unit and its all positive discussion. So pre-focus there, it's kind of an all hands on job, right now. And then we've got, of course our Porto del Sol retail unit that will be a flagship store for a retailer, it's really the best location in Madrid. It's kind of a Piccadilly Circus or the Times Square in New York, reference of Madrid.
So again that's a big focus of our asset management team in Spain. We're always looking for opportunities. We just underwrote a big office complex in Madrid. We're constantly staying clearly disciplined in terms of our underwriting and I think the difference between KWE and a lot of our competitors is we’re not going to underwrite massive double-digit rental type growth, which is what I think some of the buyers that are looking at especially office assets in Spain are doing.
And so for us it’s very much about staff selection and conservative underwriting and really, buying the right asset that have good underlying cash flow, but also growth opportunities and I would say the same holds true in Italy as well constantly working through and looking at assets.
But we’re going to be really careful with our capital right now and I think our focus over the first half of the year, we were net acquisitors in Ireland, about half of our acquisitions were in Ireland and in Dublin.
We’ve been very focused on the South Suburb office market which we’ve made some excellent acquisitions there. In fact our chase office building we already have under offer 8500 square foot suite office space there that we -- the passing rent in that building is 19 years a foot. We underwrote in the mid 20s and we have it under offer in the high €29 a foot. So making really great progress there.
So when you think about KWE in the landscape for investing our capital, it's very much organic growth driven. So, what our owned asset management initiatives where we can invest capital for the right risk adjusted return and there is a lot to play for there and then of course other future acquisitions and we're underwriting deals all the time.
Right, I think just again last footnote of that, we feel no pressure to buy anything but the second part of the answer is that as we have been saying for several years, we have many, many opportunities to add value and increase cash flow from existing assets that we already own or pieces of land that we got for literally almost nothing, next to properties we already own.
So, we're very, very focused on the asset management and value-add initiatives attached to things that we already owned while we're been looking at things, but we're being very careful about the things that we're looking at right now.
All right, thank you very much.
Our next question comes from Craig Bibb of CJS Securities. Please go ahead.
Hi, guys. Bill, you're talking about -- with I think 10-year rates and near 0.5% is got to beat a ton of people searching for yield, you have to wait till Fund V is fully invested before you start to work on Fund VI?
We have to wait Craig until its 70% invested, we were -- I guess we’re in the Escrow now on a property non-refundable apartment property that will take that fund to roughly 62% and so relatively soon after that we’re going to be through the 70% threshold.
Well, in Q3 we'll be through the 62% number that I mentioned.
Okay. And then would it likely be a larger fund?
I think that would be the hope, and if you look at the progression of looking at Fund III, Fund IV, Fund V, Fund V was the largest fund that we’ve done co-mingled fund and that was that $500 million and the prior Fund IV was 300 and so we would certainly have an expectation that it's going to be larger than Fund V.
And then I have a couple of questions for Mary, it sounds like post-Brexit its mostly the activity has been with smaller properties, have any large assets traded hands and there was enough activity that you could characterize cap rate post-Brexit.
Yeah, actually some larger assets have traded. There is one asset that’s coming to market in Mid Town that’s a very good asset, an office asset with some retail on the ground floor in very prime location. And they're still looking for an aggressive price and there is a lot of demand.
So I think people look at London is one of the great cities in the world and it is a safe heaven and I think you're still going to continue to demand good investor, a good investor appetite from across the globe for London for the foreseeable future. So we are seeing -- and there aren't as many larger assets coming to market, of course, but there are some, and many others still demand.
And then it seems like the timing of the completion of Capital Dock could be good if financial firms are taking a look at Dublin, there’s been any dynamic hires there?
That’s a very good point. It is arguably the very best development site in all of Dublin and I think as I may have mentioned just to refresh everybody's memory, we bought the debt on the State Street Bank Building, Mary in 2012 or 2011?
I think it was 2012.
And so with that acquisition came roughly say 3.5 acres next door to it that was part of the same collateral package. Mary, we did the State Street Bank lease for term certain 15 years that have been very nice income stream. But when we bought the State Street Bank building, we did not allocate a lot of bases to that piece of land.
We were since able to acquire through the addition or contribution of acre and half next to our side to now rounded out to roughly a five-acre site that is going to encompass the things that I just went through the office, the multifamily and the retail. The vacancy rates in the area that we're building in right now are very, very low. Mary, correct me if I'm wrong, but they're generally in the 2% vacancy range.
So it's roughly there's 98% occupancy in that market with very little new construction going on. We obviously as a result of what's going on with Brexit have dealers out everywhere. And we're in an active marketing program right now. Because this is going to be one of the really first class developments that's going to be available to really anybody, but if any financial institutions decide that they want to have a different location than London we’re going to -- Dublin is clearly one of the places that they would consider.
And so we're not only reaching out to the financial institution industry but of course, the tech industry and the other parts of the service industry, the Irish economy as you all know is the fastest growing economy now in Europe. And so that's creating opportunities too in the service sector, the bigger law firms are expanding also. So there's many opportunities for us and we think it's going to be coming online at a very good time in the market.
Okay. And then Mary, you guys are liquid going into the Brexit vote, but you're still liquid, what’s keeping you up at night or where do you see KWE as maybe vulnerable?
What's keeping me up at night is I think all the political risk kind of just around the world, stuff that you can't really control, is clearly something that we were watching and always concerned about. My number one concern always is just the retention of our people.
So we just have such an unbelievably good team. So when I come in every day, I want to make sure we've got all of our people happy and committed and walk down. So I would say that’s my biggest concern right now.
And you guys have no City of London exposure or real finance exposure?
Yes, zero City of London, zero Canary Wharf. We have in our U.K. portfolio 12% of that is Central London office, which is really made up of two assets, one is 111 Buckingham Palace Road, in Victoria where a passing rent is £47 a foot, 40% below market, I would say. And then the second asset is Friars Bridge Court where passing rent is £22 a foot.
So if we did nothing and just roll the tenants over, we could double that rent, if we did light touch refurb, we could even increase the rent further. And then we’ve just gotten the preliminary approval to have that -- that’s a 100,000 square feet building to build the 200,000 square foot building and the planning commission for three years.
So it gives us real good optionality and flexibility. So really and that's £22 a foot when market deals for new builds are being done at £60 a foot and it's a really tight market. It's the South Bank market in London. So those are two -- really are two only office buildings in London, Central London.
All right. Well, thanks a lot guys.
And this concludes our question-and-answer session. I would now like to turn the conference back over to Bill McMorrow for any closing remarks.
All right. So thanks everybody for listening in today. We appreciate all your support and as always we’re always available to answer any questions that come up post this call. So thanks again.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.
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