Associated Estates Realty Corporation Q4 2008 Earnings Call Transcript

| About: Associated Estates (AEC)
This article is now exclusive for PRO subscribers.

Associated Estates Realty Corporation (NYSE:AEC) Q4 2008 Earnings Call February 5, 2009 2:00 PM ET


Jeff Friedman - President & CEO

Lou Fatica - CFO

John Shannon – SVP of Operations

Patrick Duffy - VP of Strategic Marketing

Kimberly Kanary – VP Corporate Communications


Paula Poskon - Robert W. Baird

Unspecified Analyst – RBC Capital Markets



Welcome to the Associated Estates Realty Corporation fourth quarter conference call. (Operator Instructions) At this time, I would like to turn the call over to Ms. Kimberly Kanary, Vice President of Corporate Communications for opening remarks and introductions; please go ahead.

Kimberly Kanary

Good afternoon everyone. I’d like to remind you that our call today is being webcast and will be archived on AEC’s website through February 19. Joining me on the call are Jeff Friedman, President and CEO, Lou Fatica, Chief Financial Officer; John Shannon, Senior Vice President of Operations and Patrick Duffy, Vice President of Strategic Marketing.

Before we begin, I would like to note that statements made during this call that are not based on historical facts are forward-looking statements. These forward-looking statements are based on current judgments and knowledge of management, which are subject to risks, trends, and uncertainties that could cause actual results to vary from those projected.

The risk factors and cautionary statements identifying important factors that could cause actual results to differ materially from those in these forward-looking statements are detailed in the company’s fourth quarter press release.

A reconciliation of non-GAAP measures are found in the supplemental available on our website at

At this time, I’d like to turn the call over to Jeff Friedman.

Jeff Friedman

Thank you Kimberly, the following quotation is how I closed my prepared remarks on our fourth quarter earnings call last year. “We expect rents to grow higher then inflation, we expect occupancy to remain high, and we expect less increase in expenses then we have seen in recent years. We’ve taken the defensive posture with our business plan. Under pending this is the belief that the fundamentals of the apartment business and more specifically the fundamentals of AEC’s business are very solid.”

We did just what we said we would do. We are proud of our 2008 performance in what was a challenging environment. Clearly the bricks and sticks make a difference and our portfolio of properties, one of the youngest of all of the publically traded apartment REITs is not only well located in high barrier to entry submarkets but was well positioned to deliver market leading performance.

However our business is a service business and nothing can replace the importance of our hands on approach to delivering extraordinary customer service and the significant investment we’ve made over the years in positioning our people, and our properties to compete.

As all of us at Associated Estates know we can’t rest on our laurels. Our objectives for 2009 are clear even though the overall business climate may be less certain. Let me be more specific. We believe household formation is the number one driver of apartment demand. The 18 to 24 year old cohort continues to grow at the highest level in history.

Propensity to rent continues to rise and at the same time multifamily starts are at historical lows. Offsetting these positive trends are the overall negative economic headwinds. We believe that nationwide unemployment will reach 1982, 1983 levels of 10.8%. In light of these headwinds for 2009 we are assuming that our same community NOI decreases 1% to 3%.

At our properties we expect occupancy declines to level off and begin to increase in the second quarter. John will get into more specific details in his prepared comments. Let me touch on our balance sheet, we have remained keenly focused on making sure our debt maturities are well laddered.

In addition given the high coupons on our fixed rate CMBS debt maturing in 2009 and 2010 we would expect our refinancings to be at lower rates. Additionally we have no corporate debt maturities until 2011 which is when our revolver matures.

This may be unique to Associated Estates. Certainly concerns about refinancing risks that are making headlines don’t apply to us. We’re a pretty simple story. For all basic purposes we’ve exited the third party management business, we have no joint ventures, and from a quality of earnings standpoint 98% of our revenue comes from our wholly owned properties.

We resisted the temptation to over extend on the development side or acquire more properties with short-term financing. As a result we are not facing related write-downs or having to sell properties to meet obligations. And when we cut our dividend in 2003 to our current $0.68 level, we did so with the stated objective of generating enough cash from our operations to not have to borrow to pay the dividend.

And we expect that to continue to be the case. Chatham Financial, a company we consult with on some of our interest rate hedging activity wrote in their January 30, 2009 newsletter about whom can we trust. And one of the points they made was that the worst times get, the harder it becomes to trust anyone or anything.

Investors and REITs are no different. They must be able to trust that the companies they invest with will deliver what we said we would deliver. I’m not talking about earnings guidance, although that’s certainly important, I’m talking about dividends. There are a number of reasons that [beta] has historically been relatively low for most REITs and one of those reasons is the large component dividends make up of the expected total return.

These regular dividends have been expected to be paid in cash. So I want to comment on the recent announcements by some REITs who will pay a portion of their regular dividend in stock. I believe that a large percentage of REIT investors buy REITs common stock primarily for the cash dividend and although a shareholder could always sell the stock they receive in lieu of cash, this deviation is not good.

At Associated Estates barring anything totally unforeseen we plan to pay our regular dividend in cash. We appreciate all of the support we have received over the past year. We expect to once again deliver sector-leading performance.

At this time I’ll turn the call over to Lou.

Lou Fatica

Thank you Jeff, on the call today all my references to 2008 FFO as adjusted exclude net preferred redemption discounts of $2.1 million or $0.13 per share for the quarter and full year as well as defeasance and other prepayment costs of $2 million or $0.12 per share for the full year. We had no defeasance costs during the fourth quarter.

Our fourth quarter FFO as adjusted was $0.35. Full year FFO as adjusted was $1.33 which is $0.13 or 11% higher then the midpoint of our original guidance and $0.03 or 2% higher then the midpoint of the guidance provided on our third quarter call.

Although we did see some deterioration in fundamentals during the latter half of the year our full performance and results truly underscore the diligence and accomplishments of our employees, some of which I would like to highlight.

On the operation front, same community revenue increased by 3.2%. Same community NOI grew by 5.4%. Same community operating margins improved 120 basis points to 56.9%. We enhanced the online features of our property websites which allows prospective residents to apply and reserve a unit and current residents to make a payment online, order services, and submit maintenance requests.

On the transaction side, we divested all of our ownership interest in the affordable housing business. Our 11 wholly owned properties were sold in the first and second quarters of 2008 at a 7.9% economic cap rate after a 3% management fee and $700 per unit in capital reserves. In 2008 we also exited the Toledo market where we sold our four-property portfolio at a 7% economic cap rate after a 3% management fee and $800 per unit in capital reserves.

In terms of acquisitions we acquired two Class A properties in Richmond, Virginia. These newly built Virginia properties complement our 2007 acquisition of the Alexander at Ghent in Norfolk and allow us to ride operational synergies in this portfolio.

As it relates to financing activities, 2008 we enhanced our financial flexibility by expanding our unsecured credit facility to $150 million from $100 million. This was done in conjunction with extending the term by one year to March, 2011 while obtaining favorable covenant modifications and keeping pricing constant.

Current pricing on our credit facility is 160 basis points over LIBOR. At the end of 2008 we had $128.5 million of available capacity. Our remaining availability on the line will allow us to capitalize on acquisition opportunities with no financing contingencies.

Additionally using proceeds from property sales we repaid $32 million of high coupon CMBS debt in early 2008. These repayments coupled with earlier ones have created an unencumbered pool of 18 properties with an estimated market value of $245 million. Said another way, our unencumbered pool net of current borrowings on our credit facility represents a per share value of approximately $14.

Now I would like to talk about our guidance for this year, we expect FFO as adjusted to be in the range of $1.17 to $1.23. At the midpoint our FFO as adjusted is supported by flat same community revenue and 2.5% same community expense growth resulting in same community NOI declining by 1.8%.

Impacting our 2009 FFO expectations are our disposition and acquisition assumptions. We expect to sell roughly $80 million worth of properties and acquire about the same amount. We anticipate our sales to occur in the late second or early third quarter and we foresee our acquisitions taking place in the second half of the year.

Our sales include a five property portfolio in Columbus, Ohio and our only in Pittsburg, Pennsylvania. We will not sell properties at the pricing of our assets, is not inline with our internal expectations. We have no significant cash needs, they are not expected to be funded from operations outside of our development of 60 units on a continuous parcel of land at one of Richmond properties.

This development will cost about $7 million and we’ll fund it using our credit facility. We expect unlevered returns of 13% in addition to operational synergies as we will not need to add any additional staff at the property or in the region.

Our projected FFO and FAD levels sufficiently cover our expected regular dividend of $0.68 per share annually paid in cash. Additional details regarding our full year guidance for 2009 can be found on page 25 of our supplemental.

Finally I would like to address the topic that is on everyone’s mind today, upcoming debt maturities. This year we have four loans totaling approximately $72 million coming due. As of today we have commitments in our rate locked for three deals totaling roughly $52.5 million with Fannie Mae through [read] mortgage capital and we expect to close on two of the deals next week.

These two deals which total $35 million are seven year, LIBOR based, variable rate mortgages with an initial pay rate of 4.85% and are subject to a 2% cap over the term of the loan. The third deal is a seven year, 5.98% fixed rate mortgage and is expected to close in early March which is the earliest we can prepay the existing 7.5% CMBS debt at par.

That leaves $19 million or so for a loan due later this month that is secured by a property which we are marketing for sale. Thus when we repay this maturing loan using our credit facility and carry the loan until the property is sold. In 2010 we have six loans maturing totaling approximately $78 million that have an average coupon of 6%.

We have had preliminary discussions with multiple financial institutions regarding a plan to address these maturities. At this point I will turn the call over to John to provide more color on our operational performance and expectations for 2009.

John Shannon

Thank you Lou, we had a very good 2008. Our strong financial performance is a function of many factors including our talented employees, the enhancements we made to our management platform, marketing programs, and our property web pages, and the strong and stable competitive submarkets in which we operate.

On a year over year basis for the quarter our same community NOI was up nearly 1% and 5.4% for the year. Today I will spend much of my prepared comments on our expected performance in 2009 and our thoughts regarding the apartment business as much of the 2008 data and performance metrics are contained in the supplemental.

These are uncertain times for apartment operators. Nationally unemployment is nearing 8%. Chattel supply in many markets is real competition. Renters are doubling up and moving back in with family. An out migration of immigrants is continuing to occur.

These broader economic concerns have made it more difficult for us to increase rent and we have seen downturn pressure on occupancy. On a sequential basis Q4 same community revenue was 2% lower then Q3 and average physical occupancy was down almost 2%.

For 2009 our full year projections reflect average physical occupancy of 93.1% down 30 basis points from 2008 and total revenue on par with 2008. The flat year over year revenue is driven by growth in the Midwest and Mid Atlantic and declining revenue in the Southeast.

With this in mind let me take a minute to discuss our markets, the competitiveness of our Midwest, Mid Atlantic, and Southeast properties and our projections for 2009.

In the Midwest which contributes about 60% of our NOI for 2009 we are anticipating 1.9% revenue growth and physical occupancy down slightly to 94.3%. This solid projected performance is because our properties are located in high barrier to entry submarkets that are in close proximity to major employment centers and have highly regarded, retail centers, and neighborhoods.

This outperformance when compared to many other regions may seem contrary to what many folks believe. But the Midwest region over the past few years has already experienced significant job losses and declining home prices. The fall out from the current economic conditions seem to have been felt much earlier in this recessionary cycle.

With this being said our assumptions presume that the Detroit automakers remain and there are no further large-scale automotive layoffs. In the Mid Atlantic and Southeast, we believe that our markets may be nearing the bottom and we look for improving fundamentals in the second half of the year.

Our full year projections for 2009 reflect 1.4% negative revenue growth and average physical occupancy of 91.5% down 30 basis points from 2008. This projected revenue is the result of 3% growth in the Mid Atlantic which is offset by 3.2% negative growth in the Southeast.

Baltimore, Washington, which contributes approximately 9% of our NOI we are anticipating a 2.5% increase in revenue and physical occupancy on par with 2008 at 93.5%. The Baltimore, Washington region is expected to benefit from net job growth as a result of the new Administration which should offset some of the pressure from the [chattel] supply that is drawing renters into two and three bedroom townhomes and single-family houses.

In Virginia, which contributes 8% of our NOI we are forecasting a 4% increase in revenue and physical occupancy down slightly at 95.5%. In 2008 revenue was up nearly 10% and we believe our proximity to military bases and new jobs in Norfolk and Richmond metro areas, will allow us to continue to grow rents albeit at a slower year over year pace.

In Atlanta, representing approximately 12% of our NOI we are forecasting 5% negative revenue growth and physical occupancy down 1% at 89%. We operate in two distinct markets in Atlanta, Buckhead, and South [Gwinnett] County. Clearly job losses have impacted most Atlanta markets but we are forecasting the Buckhead market to have flat rent growth and average occupancy of 93% similar to 2008.

In South Gwinnett County where we have two properties representing 1400 units we are forecasting declining revenue and NOI as a result of both lower occupancy and increased concessions. This submarket weakened rapidly in the latter half of 2008 due to the loss of jobs in construction, hospitality, retail, and other service sectors.

In Florida we have four communities that deliver approximately 14% of our NOI. We are forecasting a 1.5% decrease in revenue and physical occupancy down slightly to 92%. The 2009 revenue forecast for this portfolio is impacted by job losses, out migration of immigrant workers, and [chattel] supply.

We know that 2009 will be a challenging year. The key to our success will be continuing our focus on the details and providing exceptional service. We will continue to evaluate and prioritize every property level discretionary expense and we will enhance our expense containment and cost savings programs.

Most importantly recognizing the value of always maintaining and improving our properties we will continue to invest in our communities. Our recurring and investment capital expenditures will be on par with 2006 to 2008 levels. So, to sum it up, we expect our Midwest markets to provide a consistent and stable balance to our other markets.

Based on historical and current market conditions our 2009 expectations are realistic. Its going to take a lot of hard work but I know our teams are up for it. Now I’ll turn the call back over to Jeff.

Jeff Friedman

We are now ready for your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Paula Poskon - Robert W. Baird

Paula Poskon - Robert W. Baird

The Senate yesterday put an amendment to the stimulus package to provide tax credit of up to $15,000 for homebuyers. How does that, does it and if so how much, does that concern you in terms of when there is an economic recovery that people will jump back into home ownership. Or do you think that the market is just so bad that’s not a risk in the foreseeable future.

Jeff Friedman

That’s a tremendous benefit to help get the housing market primed which the economy desperately needs so that people can once again regain some confidence in the, where the bottom is. And so I think that that stimulus relating to that tax credit to the extent that it gets even one buyer to make a decision to buy or sets a price that, by the way this is first time homebuyers, a buyer wouldn’t have otherwise purchased.

There are many buyers who are renters by choice today because of the uncertainties relating to the single-family housing business. On the other hand because the economy is in such a tailspin there are renters who are putting off making the decision to relocate to another community for a job, to possibly move out of their home or from a roommate situation, so I think overall what’s good for the economy is certainly good for Associated Estates.

We are not concerned about anything that Congress does to stimulate single-family home purchases. I can go into the gap between the cost to own and the cost to rent, we can look at our submarkets and tell you about the average prices. Many of these buyers in our submarkets are not going to be what they call first time homebuyers so in many of these submarkets it probably won’t even qualify for the masses.

But I do think in many markets where there’s an abundance of foreclosed homes, bank owned homes, that it will make a difference and I think that’s good.

Paula Poskon - Robert W. Baird

What you seeing in terms of tenants looking to terminate their leases early or move to month-to-month.

John Shannon

We are starting to see folks at the expiration of their lease going to month-to-month because of uncertainty but what I think is the most telling thing that we’ve seen at the properties is, are reasons for move outs and this kind of goes into what you’re talking about with the month-to-month.

Reason for move out, home buying continues to tick down, relocation continues to tick down, but what we’ve seen the most significant change in is our in house transfers. It has increased from historical levels of 5% to 7%, in this quarter it was at 10%. So we are seeing not only people wanting to go month-to-month but we are seeing them doubling up and we’re also seeing them buying down, going from a two bedroom to a one bedroom as a roommate leaves.

Paula Poskon - Robert W. Baird

What’s happening with the average length of stay, I remember when I visited in July the length of stay was already lengthening, is that continuing, escalating?

John Shannon

It really has stayed fairly consistent within our portfolio at 18 months and I think that ties to our turnover on an annualized basis where in 2007 we were at 59%, we’re going to finish at 61% in 2008 so I think there’s a direct correlation between that 18-month mark and where our turnover is.

Paula Poskon - Robert W. Baird

What’s happening at the Reflections property.

John Shannon

The Reflection property, the renovation went very well. For the first several months we were able to get significant increases, that has pulled back in the Columbia market. What we’re seeing in the Columbia market is [shadow] supply of townhome product and lower end homes have pulled people into that product from apartments. But we think that as I said before, the second half of the year we’ll start to see the Columbia market pick back up.


Your next question comes from the line of Unspecified Analyst – RBC Capital Markets

Unspecified Analyst – RBC Capital Markets

With regards to your unemployment assumptions, 11% seems kind of high although you do believe that your markets are going to hold pretty well, could you actually pinpoint where you see unemployment going for each of your markets.

Patrick Duffy

What we’re projecting is is that the 2009, that we’ll lose approximately 400,000 in our 12 markets in 2009 and that level of job loss is approximately the same as we experienced in 2008. At the end of 2008 the average unemployment rate in our portfolio was 7.2%, we’re forecasting that at the end of 2009 the unemployment rate will be 9.7%.

Jeff Friedman

When you look at the broader information available from either [Reece] or Bureau of Labor, they talk about MSAs and its not as easy to garner for example when you look at a Detroit number where we don’t have a property in the city of Detroit, to garner what in suburban Detroit, for example Anne Arbor, what unemployment or employment may be in those specific markets.

So you really have to drill down a lot more specific and in more detail to understand the nuances in each of these submarkets but yet we only have the information that’s available.

Unspecified Analyst – RBC Capital Markets

With regards to spending capital requirements for next year, what’s your recurring CapEx as well as your revenue generating CapEx for 2009.

John Shannon

Our all in CapEx both recurring and investment capital is approximately $775 at the property level and typically its about $600 on a recurring basis and then the $175 on the investment capital.

Unspecified Analyst – RBC Capital Markets

What’s the expected contributions from your fee and [paying] services in 2009?

John Shannon

We would expect that to be flat just as it was in 2008.


Your next question is a follow-up from the line of Paula Poskon - Robert W. Baird

Paula Poskon - Robert W. Baird

I appreciated your comments about what’s happening in REIT land in terms of the dividend payouts, some companies are cutting their dividends just because they think they should because the yields are too high, whatever too high means to them, is that a position that AEC’s Board would consider or do you think that’s just off the table.

Jeff Friedman

I would answer it by saying we regularly, we management, regularly consider our expected performance and the cash we generate from our business against what we’ve said would be the suggested dividend policy and the dividend that we recommend to the Board. So I would say that management to the extent that we saw deteriorating fundamentals where over an extended period of time there would not be enough cash generated from the core business then I would say that it would be prudent to review everything including reducing the payout of the dividend. But at Associated Estates we just don’t see that.

And so from our perspective its just not something that we have to deal with and I need to emphasize the importance when we go back to 2003 because the tendency when a company reduces the dividend is to take the smallest haircut to minimize the hurt so to speak. But when we did this in 2003 we did it and we told everyone we were taking it down to a level that we thought we would be able to cover.

And it took us a couple of years to be able to do that in a significant way and we’re comfortable based on what we see today that the operations will be able to cover that dividend and that that $0.68 annual dividend will be paid out in cash.

Paula Poskon - Robert W. Baird

How do you answer people who say why continue to make an effort to reposition the portfolio into “high growth, high barrier markets” when clearly over the last many quarters your Midwest portfolio continues to post better results then the Mid Atlantic or Southeast.

Jeff Friedman

We think about that a lot. There’s a couple of reasons, first of all we said from a strategic standpoint we wanted 50% of our NOI to come from our Midwest markets and now as we finish the year we’re at almost 60% and that’s not because we acquired more or we didn’t sell, its because the Midwest performed so well and further we said that we’d like to have no more then 15% from any specific submarket.

So our goal is to pare down that exposure and also to benefit from the strength we’ve seen over the last few years and as a result we’ve identified certain properties where we may have a number of properties in a specific submarket, in the Columbus market for example, properties where we’ve identified and quantified our expected return on equity and then those pop up in our annual analysis of our, its really a bottom up approach where we evaluate every property and determine what we expect to produce the highest returns on equity.

And then those properties that we don’t have the highest returns on, show up as those properties we sell so we want to reduce our ownership in certain Midwest submarkets so that so goes those markets, so goes, doesn’t go AEC. And we continue to pursue that strategy and also to benefit from the strength in terms of the prices we’re able to get as we approach the sale market.


There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Jeff Friedman

Thanks to everyone for participating and we appreciate your participation and questions.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to All other use is prohibited.


If you have any additional questions about our online transcripts, please contact us at: Thank you!