Jernigan Capital. (NYSE:JCAP) Q2 2016 Results Earnings Conference Call August 3, 2016 11:00 AM ET
Dean Jernigan - Chairman and CEO
John Good - COO and President
Jonathan Hughes - Raymond James
Paul Puryear - Raymond James
David Corak - FBR Capital Markets
R.J. Milligan - Baird
Good day everyone and welcome to the Jernigan Capital Incorporated Second Quarter 2016 Earnings Conference Call This call is being recorded today, Wednesday, August 3, 2016. At this time all participants have been placed in a listen-only mode. The floor will be open for your questions following management's prepared remarks. [Operator Instructions]
This call includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other federal securities laws, including statements regarding our future performance, our third quarter 2016 earnings guidance and full-year 2016 updated earnings guidance including related key assumptions, future value of investments, our ability to consummate additional A note sales, our pipeline and future investment closings and expected lease up trends with respect to self storage developments we finance.
The ultimate occurrence of events and results referenced in these forward-looking statements is subject to known and unknown risk and uncertainties, many of which are beyond our control. These forward-looking statements are based upon the Company's present intentions and expectations, but the events and results referenced in these statements are not guaranteed to occur. Investors should not place undue reliance upon forward-looking statements.
For discussion of these and other risks facing our business, see the information under the heading “Risk Factors” in our Annual Report on Form 10-K filed with the Securities and Exchange Commission and our other filings with the SEC from time to time, which are accessible on the SEC's website at www.sec.gov.
It is now my pleasure to turn the floor over to Dean Jernigan, CEO and Chairman of Jernigan Capital, Inc. You may begin, sir.
Thank you very much. Good morning, everyone. Thanks for joining us today for our call. As always, we expect that you've read our news release from last evening. So we won't spend a whole lot of time on that. I would like to spend first of all some time on the sector as always I like to do, talk about what I see going on in the sector, particularly as it relates to our Company, and then I'll turn it over to John Good, our President and Chief Operating Officer to talk specifically about Company performance.
As far as the sector is concerned, I know everyone is always asking me about supply, where are the concerns, what's happening with new supply and storage, and I'm happy to report that the answer is still about the same, not much yet. A lot of people out looking for sites trying to get them entitled, a lot of people looking for capital, construction financing specifically to build storeys, and don't get me wrong, there's a lot of activity but still yet what's going on out there today is having limited effect on existing supply.
So, you may have noticed in the last couple of weeks, the other REIT stocks in the storage sector trading down and I want to address that just for a minute, because I think we have a few investors out there jumping in shadows. We have one or two analysts I think are trying to call the top for storage, but if you look back over the years, specifically about 22 years since 1994 when we first started compiling good public information on storage REITs, there really hasn't been much of a top not one that lasted for very long anyway, and that's what I'd like to talk about.
We are so focused in the storage sector right now on fundamentals, specifically topline revenue growth, NOI growth and that's part of the equation and can it continue unabated with 7% topline growth and 10% NOI growth. Probably not, but you've heard me say in the past, I think last quarter, that when it does go back to a more consistent level, it's not going to be the 4% and 4.5% percent topline growth that we've experienced over the last 22 years. I think it'll be more or like 5% topline growth, 7%, 6.5% NOI growth and as I've always said that compares favourably to all sectors out there.
So, fundamentals are still strong. We've had two companies report so far, one reporting today who got sovereign live storage, I think they'll report some very good numbers. And so the sector is still very healthy. New supply is not impacting the sector dramatically at all. And so I think we've got another year.
Can EXR and CUBE get another 40% this year? Maybe not, they've enjoyed about an 80% run-up in their stock price in the last two years. That clearly is not sustainable, but if you look back over the last 22 years, you'll see that year-in year-out on average, those companies have gotten to 17% increase or the whole sector has got to 17% year-over-year compound annual growth rate, which is second to none. And so the sector is healthy.
But one thing I'd like to point out is, we need as the sector start focusing on FFO, not just the fundamentals of revenue growth and NOI growth because as the cycle turns the development cycle turns into an acquisition cycle, which it probably will in two or three years as more properties get built, these public companies are going to have their balance sheet ready for capital and the opportunity to consolidate the sector even further.
And so in growing your FFO you have internal growth opportunities and you also have external growth opportunities. And so as the internal growth starts to retard somewhat down to that 5% topline growth number I mentioned, the acquisition cycle will kick in and then the external growth engine will kick in for the public companies to include ourselves. And so I am extremely optimistic as to the FFO growth opportunities for our Company at Jernigan Capital and the other REITs in the storage sector, and so I would say all is well.
While the REITs are trading down a little bit now is again jumping in shadows thinking that fundamentals are going to dramatically change and they're not in my opinion, they will come back some. But then external growth opportunities are going to kick in a big way and those FFO growth rates are going to continue to be mid-double digits at least I think for the public companies as the opportunities are going to be so great going forward from an external growth standpoint.
So with that, I'll turn it over to John, let him talk about Jernigan Capital.
Thanks Dean, and greetings to all of you. In my remarks I'd like to cover four main themes before we open the line for questions. The first theme, I'd like to cover is investment performance and its impact on our fair value.
Secondly, the management of our capital and its cost.
Thirdly, our pipeline and our ability. And finally, our ability to continue to grow without measurably increasing our G&A.
As you've heard, as you saw on our press release a couple of weeks ago during the second quarter, we saw our first four development properties opened for business and begin leasing up. We gave you some leasing statistics at the time and lease-up of these properties is significantly ahead of expectations and rents are, in several cases, exceeding the rents that we underwrite.
In the Dow, we gave you two Fridays ago, I think our leading property from a lease-up standpoint was 39% at that point in time and I'm happy to report that now that property is at 45% in one day last week leased 10 units.
So lease up is very robust. We think that the rent growth follows. In addition, all these facilities came in at or under budget from our construction cost standpoint. So the result of all this is that our development yields are coming in higher than what we expected therein more in the high 9% range versus our underwritten low 9% range.
Our profit participations are therefore higher than what we've underwritten and the profit participations are being reflected in our fair market value marks more quickly than what we had projected last quarter. This has resulted in the strong fair value increase that we reported in Q2 and for the significant guidance increase for the balance of the year.
In addition, our sector is seeing a significant compression of cap rates that if it holds could result in additional favourable value -- fair value additions for the rest of this year and on into next year. These results are strongly demonstrating the value that we can create for shareholders from this business model in what's proving to be a great environment for self-storage development.
We have two additional development properties that we are expecting to gain their certificates of occupancy this week and open for the weekend; one in Charlotte and one in Jacksonville; and then we have three more that are expected to achieve certificate of occupancy in the fall.
As you know, two Fridays ago, we announced our first A note sales on newly developed and occupied properties and followed that up five days later with our announcement of a major capital commitment from Highland Capital, which provides us with up to $125 million of match funding for our pipeline of development investments.
We also have a commitment letter for another A note sale on our facility in Charlotte that's getting to [Indiscernible] this week. To date, we've closed on or obtained commitments for the sale of A notes on eight investments that's raised for us approximately $34 million at an average borrowing rate of 3.9% that compares very favourably with what we reported in our IPO prospectuses are expected cost of funding from A note sales.
Maybe more importantly as we have a robust inbound demand for A notes from a number of commercial banks, which gives us a high level of confidence in our ability to access the A note market going forward as additional development properties get to the certificate of occupancy stage.
Our Highland Capital preferred stock commitment gives us the flexibility to effectively use the proceeds from these A note sales to fund additional development investments. So when you add the A note market to the Highland Capital commitment, we believe that we have a significant source of well priced capital to aggressively work our pipeline.
Now on to the pipeline, we are currently approximately $32 million shy of fully committing the available capital at the Heitman joint venture, and we have three investment transactions in the queue that are scheduled to close in August that will result in the Heitman JV being fully invested.
At that time, we will be free to close investment transactions on balance sheet with our new capital. We currently have 12 executed term sheets on development investments that would result in investments of approximately $107 million that we expect to close on balance sheet between now and the end of the year.
In addition, and this is very exciting to us we have approximately $630 million of additional development investment in various stages of underwriting. And while our conversion rate is never going to be a 100% nobody's will be, our track record would indicate that we would fairly quickly get to term sheet and ultimately close on a significant portion of these prospects, and this all points to successful deployment of all the capital that we currently have -- all of our additional A note capital that we'll be able to raise as we get additional investments to CO and then more in the future.
The continued robustness of the pipeline with no real signs of slowdown in the development cycle raises the obvious question of our ability to take advantage of the opportunity with our current corporate platform.
We are exceptionally happy with our team. Qualitatively, we believe that the team is strong as any you'll find in any REIT our size and then quantitatively, we feel like we have the right number of people to handle the opportunity with which we're currently presented and we don't see a significant increase in G&A on the horizon.
We believe that our G&A is very much right-sized. We're very proud of the work our team's done in guiding us through the post IPO ramp up, and now with sufficient capitalization we look forward to working really hard on the investment side to as quickly as possible create as much value as we possibly can for our shareholders.
Lastly, just a quick comment. We did repurchase approximately 213,000 shares during the second quarter at an average price of $14.79 per share and those purchases were at levels significantly below our book value.
Now, we'd love to take your questions and turn it over to the operator.
[Operator Instructions] Our first question will come from Jonathan Hughes with Raymond James. Please go ahead.
Hey good morning guys, congrats on the quarter. Dean, I appreciate the sector commentary it's always very interesting to hear your perspective there. This is maybe a question better suited for John, but could you just talk about the guidance bump and specifically the fair value increase. I just want to be sure that the underwriting process there hasn't changed from what you outlined in March in terms of how you recognize that value.
The underwriting process has not changed, Jonathan. And as we've stated in our public filings, the way that we record fair value is while a property is in construction, once it hits a 40% completion level, we start to accrete what our underwritten profit is in that deal and that underwritten profit is based upon the numbers that were in effect at the time of underwriting, lease rates, expected occupancy rates at various points in time and approximately a third of that profit is realized through fair value marks between that 40% time and the time we achieve certificate of occupancy.
Once we get certificate of occupancy on a property the valuation methodology changes to more of a discounted cash flow review and that necessitates every quarter us going and looking at what current rental rates are, how we're doing on occupancy, taking those numbers and making forward projections of value and discounting that back and that's really the reason why we had the significant bump.
This quarter, we had four properties that got out of that slow ramp phase between 40% of completion in CO and moved into CO. And given the fact that rents have increased across the board pretty significantly since we underwrote those properties and the fact that they're leasing up really well, it resulted in a larger fair value mark than what we had anticipated back at the end of the first quarter.
Hi Jonathan, let me jump on it. I think the answer was no. John gave you the whole methodology of it. But the answer is no, it hasn't changed. But I do want you may have noticed a sense in our news release maybe that cap rates have certainly compressed. We're underwriting these properties at cap rates between 5.5% and 5.75% and as well as we do that, they have compressed pretty significantly since then.
And so that's something we're going to look at this quarter. We're going to do a study to see exactly where the cap rates have moved to, but the answer is no, Q2 over Q1.
Okay. That's very helpful. I appreciate that. I have a question. Could you just discuss the Highland transaction, how that was sourced, did they come to you, you reached out to them. Just trying to get a little bit more background on that deal?
Well, Highland has been a shareholder since April and we around the end of May decided to go down this route of sourcing private capital. We went to a number of different parties. We had Raymond James banking us, we had a number of people that just reached out to us inbound without bankers. Highland being someone who had kind of kept in touch with us for a couple of months there, but the bankers reached back out to them and they presented a proposal like five other parties that presented proposals, and their proposal was compelling.
Okay. I've got Paul Puryear here with me. He's got a question as well.
The question being are you seeing anything in the market that's challenging your deal economics, either from the capital source or lending source?
Only in a positive way, Paul, in that we have this pipeline, because the developers challenge from a lending standpoint to source construction lending for storage as a high velocity commercial real estate product. These banks are having to take 150% reserves owning these assets and it's just doesn't work for them from either a yield standpoint or from a regulator standpoint. These regulators are all over many of these banks.
And so their challenge which gives us the opportunity but from our standpoint, the challenges are consistent from day one and that is the developers getting entitlements, which is in some ways a positive for us because that does keep a limit on overbuilding out there.
So I'm really hoping with good visibility on starts around the country as to where those starts are and how big the properties are, and with the kind of lid on construction I think in this cycle from a lending standpoint and continued not my backyard zoning attitude if you will, I'm hoping we're going to have a soft landing here two or three years out, but we're not -- we see no challenges today that we didn't see first time I sat down with you year and half ago.
So as far as the banks are concerned in other sectors, we feel like we're seeing the banks pull back from development lending. Do you sense that or they're not doing a whole lot of take it on self-storage to start with?
Yes, there is actually a little silver lining in there for us as well. Clearly they are not distinguishing between sectors when they're pulling back from construction lending on real estate because that's being pushed upon them by the regulators.
I just saw and e-mail we managed to get from traffic on CMBS delinquencies are up again this month. And so there's a lot of pressure on banks to rein in their construction lending of all real estate product types, which is going to include us. They're not going to make an exception for storage, I assure you. So I think that continues to bode well for Jernigan Capital.
So do you think your ability to cut deals at these economics is the same, better or worse than it was when you started?
It is better for sure. If you look at when we started sourcing loans really prior to going public, these folks had ideas of going to the bank and getting 4% money and so that's kind off the table for them now.
So clearly, we have developers coming back to us now who had that thought and tried to source construction lending and now are coming back to us, and so now it's clearly better, Paul.
Yes, and I'll add something to that, Paul. I see it from a different perspective and that's trying to negotiate the deals. And I'll tell you that a year ago when we'd issue a term sheet, term sheet would be out for a week or two and you would have several iterations coming back and fought back and forth within negotiating certain points that could have been economic points and now we're sending the term sheets out, they're signing them and we're getting them back in a day or two.
Okay. Will jump off, thanks guys, nice
All right. Thank you very much John.
Operator: We’ll take our next question from David Corak with FBR Capital Markets.
Hey guys, could you share where the actual bank appraisals came in on the four CNO deals or at least where they came in comparison to your initial underwriting?
Yes, they are not our appraisals, David. We don't have the exact numbers. We haven't seen the appraisals. We've just seen the appraised values, and so we don't have any other information and it's really not our information to share.
Okay, fair enough. Then turning to the lease up velocities, it looks like ACOI [ph] is pushing 50% at this point. If you were going to be aggressive there, when do you think as the earliest that that could stabilize?
Hi, there. It’s Dean. It's all about rental seasons and when people are moving and that 50% of our customers or people moving and most of them move during the summer time and we put the hay in the barn, so to speak in May, June and July. I think this property will be stabilized by this time next year.
Today is August 3. So August 1, really starts the downtrend if you will, the REITs gain far less and sometimes start to loosen in August, especially if they have a lot of students. So I would really think by this call next year that probably will be stabilized.
Okay, that makes sense. And then the timing in deploying the Highland Capital, I mean you still have some cash left and then some proceeds from the A notes, but what should we expect in terms of your first drawdown, maybe like mid-4Q?
Yes first drawdown, it may not be mid-4Q, late October, maybe early November and then from there, it's going to be purely a function of how quickly we can close investments. If we close investments quickly, if we can convert this pipeline we'll grow a lot of that money real quickly and we feel like we're going to be able to do that.
The beauty of it is, as you guys all know how our development investments fund and we'll be able to take that capital, call those deals, fully commit it from a capital standpoint, but then actually fund them as we need funds to fund the various development draws.
Right. Okay. And then overall plan with the buyback program today in light of where you're trading. I mean you are still trading at significant enough discount to warrant some share buybacks, where do you see that going?
Well, we closed the quarter with our book value at just over $17 a share, I think. And so I see this morning, we're trading at $16.40. We're going to use that capital appropriately. Just to be frank and answer your question is, I don't think that margin is wide enough today to exercise that tool but certainly they're [Indiscernible] if the stock price comes back. So we are pleased with how we are trading this morning, so I don't think you can see much activity if it remains at this level.
Makes sense. All right, guys. Great quarter, its all from me.
Operator And we’ll go next to R.J. Milligan with Baird. Please go ahead.
Hey good morning, guys. At the time of the IPO and following the IPO, there was somewhat of a delay in between the timing of signing deals with partners and deploying that capital, and I was wondering if that timeline has changed at all?
Good morning, R.J. Yes, it has. Well just the way it works is our partners go out and top a piece of ground, it's almost always subject to some kind of entitlement process, re-zoning, site plan approval or whatnot.
And so the sellers of the ground will normally give the developer plenty of time to get the entitlements done but then when design is complete, they want to be paid their money, notwithstanding the fact that developer may have another 60 or 90 days after that to get all their plans in order and get their construction documents complete where they can go pull a building permit.
Well what's happening, what our developers are doing and with some guidance from us, they are getting a lot smarter on that. They're trying to buy a little bit more time from their sellers after closing, but also what they're doing is they're understanding better about the probability of getting their entitlements and they're starting to spend some money prior to getting the entitlements on getting some drawings complete at least to the concept drawing level.
And so it is tightening. We have a deal that's closing this week maybe two deals that are closing either this week or next week where the construction is ready to start immediately thereafter.
So, it is -- and plus I'll say our biggest problem was Miami-Dade County, we don't have that consistent problem across the country as far as the building departments being so overburdened with construction activity.
So, I forgot to mention a few minutes ago in an earlier question, the silver lining in commercial real estate lending, pull back is also silver lining. We have one here in time to permit and that is these departments with the slowdown, especially in multi-family development, they're not overworked or overburdened with reviewing plans or whatnot.
So they're getting through quicker, but also to answer the question, I think I answered a while ago, we're starting to see sites now with the pullback in multi-family construction developments, especially we are starting to see sites that our developers can afford that really aren't available to them before because they were being taken away by the multi-family developers.
So, they're getting smarter, building permit departments are getting -- are less overworked, and we're helping them with better advice on how to negotiate for low extra term with their sellers too.
Thanks for that color, Dean. In terms of the A notes and selling those, what is the appetite out there for those A note pieces? I know it's going to be once these properties get CO, how much of that -- how many A notes in terms of volume do you think you could sell over the next 12 months in terms of the source of capital?
Well, over the next 12 months, it's a function of how quickly we get properties to CO. We feel like based upon our experience over the last couple of months that we can sell A notes on CO properties within 45 days after we get to CO.
In the case of the Charlotte property, which should reach CO this week, we actually will close on that A note transaction on August 15. So we'll close on that roughly 10 days after we go to CO. So that's a very quick.
As I've said in my prepared remarks, we've had a large volume of inbound calls and Dean's comments about the banks pulling back from construction lending, they still have a robust appetite for real estate loans, particularly at the community bank level and the small regional bank level and what we've seen so far is there's enough appetite out there to take every A note that we could sell on every deal that comes to CO within a fairly short time after we get to CO.
So it really becomes a function of how quickly we get these properties up and running. Our next group of properties that will come to CO will be in the Heitman joint venture and we'll explore with Heitman whether that program is acceptable to Heitman and our other large partner in that joint venture as a means of returning capital pursuant to our partnership agreement for the joint venture.
Thanks. And my last question is, just as you look at that shadow pipeline that you guys have, is there any specific geographic concentration or is it more urban locations, secondary markets, just trying to get a feel for where some of that new supply, where people are getting land entitled and getting their hands on these parcels?
Yes, it continues to be -- some of that pipeline is with our existing developers. We've got about 15 or 18 developers right now that, they're back in for their second, third and fourth deals with us. So, they're developing in their backyard, but we are sourcing other developers just over the last few months, have sourced a great development team, father son team in California.
So we will be doing deals in California. California, for example, I'll use California as an example. The Bay Area is almost impossible, extremely difficult to develop in. Orange County is the same way, and so what you have in California is you've got a lot of markets 125 -- cities, small towns with 125,000 to 150,000 people. They are outside the MSA, but who live off the MSA. They commute into the MSAs and whatnot.
And so we see some really good opportunities in markets like that. So we always talk about the Top 50 markets, arguably Westchester County, New York is another one where again same situation, people commuting in the city but they commute outside the MSA, living in these charming cities of 100,000 people. The rents are $20, $24 and so our developers are seeing opportunities there.
We are still somewhat hesitant being very, very selective on going into some markets where the depth is not there, markets where is there is too much activity. Denver, we'll probably going to do three, maybe one more properties and then we are out of Denver. So it's all across all across the board, R.J. but we are developing with some developers in markets that are outside the Top 50, but they still live off the MSAs, the Top 50.
Okay, thank you guys, good quarter.
All right, thanks R.J.
And it appears we have no further questions at this time. I'll return the floor to you Mr. Jernigan for closing comments.
Okay, thank you very much for your interest. Thanks for your support. Look forward talking to you next quarter if we don't see you before then. Good day.
Thank you. This does conclude today's conference call. Please disconnect your lines at this time and have a wonderful day.
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 www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: email@example.com. Thank you!