Jernigan Capital, Inc. (NYSE:JCAP) Q3 2018 Earnings Conference Call November 1, 2018 11:00 AM ET
David Corak - SVP, Corporate Finance
Dean Jernigan - Executive Chairman
John Good - CEO, COO & Director
Kelly Luttrell - SVP, CFO, Secretary & Treasurer
Jonathan Perry - President & CIO
Jonathan Hughes - Raymond James & Associates
Timothy Hayes - B. Riley FBR, Inc.
Todd Thomas - KeyBanc Capital Markets
Tayo Okusanya - Jefferies
Greetings, and welcome to the Jernigan Capital Third Quarter 2018 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded.
I would now like to turn the conference over to your host, Mr. David Corak, Senior Vice President of Corporate Finance for Jernigan Capital. Thank you. You may begin.
Good morning, everyone, and welcome to the Jernigan Capital Third Quarter 2018 Earnings Conference Call. My name is David Corak, Senior Vice President of Corporate Finance. Today's conference is being recorded Thursday, November 1, 2018. At this time, all participants are in a listen-only mode. The floor will be opened for your questions following our prepared remarks.
Before we begin, please remember that management's prepared remarks and answers to your questions may contain forward-looking statements as defined by the SEC in the Private Securities Litigation Reform Act of 1995 and other federal securities laws. Actual results could differ materially from those stated or implied by our forward-looking statements due to risks and uncertainties associated with the company's business. These forward-looking statements are qualified by the cautionary statements contained in the company's latest filings with the SEC, which we encourage you to review.
A reconciliation of the GAAP to non-GAAP financial measures provided on this call is included in our earnings press release. You can find our press release, SEC reports and audio webcast replay of this conference call on our website at www.jernigancapital.com.
In addition to myself on the call today we have Dean Jernigan, Executive Chairman; John Good, CEO; Jonathan Perry, President and Chief Investment Officer; and Kelly Luttrell, Senior Vice President and CFO.
I'll now turn the floor over to Mr. Jernigan. Dean?
Okay, thanks, David. Good morning, everyone. Thanks for joining us. I plan to limit my remarks this morning basically to the succession plan that we executed this week. I can tell you, it was seamless at Jernigan Capital, and I hope it was with you as well. This is something that has been in the works for about two years now; not the exact timing, but the process. And I couldn't be more pleased with where we are today with having this succession plan executed this week.
For all of you to know, John and I have been making every important decision together now for the past two years, and I suspect we will continue that process indefinitely. John and Jonathan and I are investment committee members, and I can tell you that we only have unanimous votes on investments. We talk it all out until we all get to the same point. And so that will continue as well. I love playing the role - my role on the investment committee. I love playing my role as kind of helping set the vision for the company. And I love playing the role in executing any efforts that John might need me to execute going forward as the executive chairman. I do plan to be very active, but let there be no mistake about it, John will be running the company on a daily basis with the capable help of all of his people around him, and most particularly those people that David just called out who are on this call.
So I can't stop talking without commenting on what a great quarter it was. I could not be more pleased with that either. And so John, I'll turn it over to you, and let's talk about the quarter.
Okay, thanks, Dean, and good morning, everybody. We continue, as Dean said, to be extremely pleased with our 2018 performance. We're excited to report another solid quarter of executing the business plan that we've consistently articulated to you guys over the past 3.5 years. We often talk about our goal to ultimately own the self-storage development projects in which we've invested, and during the quarter, we made another step in that direction by acquiring our developer's interest in our initial Charlotte development investment. With that purchase, we now wholly own six of the initial 11 on-balance-sheet development investments funded with our IPO proceeds. We've also consolidated this 6-property portfolio at an average estimated yield of 8.6%, which we determined by dividing the estimated aggregate stabilized NOI of approximately $5 million on that portfolio by an all-in-cash investment of approximately $58 million. We're very happy with that long-term return on that portfolio.
During the quarter, we also demonstrated the optionality inherent in our development investments by choosing not to exercise the right - our right of first refusal to buy the self-storage facility that underlay our initial Tampa Bay area investment. After determining that that property didn't fit our property style and demographic profiles that we've consistently followed with respect to our other owned properties, our development partner chose to sell the project to an institutional third party. In that transaction, in addition to our receiving full repayment of the construction loan we had made to the developer, our 49.9% profits interest was also monetized at a value that was approximately 8% higher than the fair value to which we had marked that investment on our books as of June 30 of 2018.
We also continue to be quite pleased with the incremental leasing of the development projects in which we've invested. Our developer partners opened nine new stores during Q3, with another three opening since the beginning of this quarter. Our developers have now opened 36 of the 68 development investments in which we either have or have had profits interest, with another 32 in various stages of construction. Most of these facilities are being managed by CubeSmart, who's continued to perform at a very high level during a period of new supply of which you people are all aware. The self-storage properties opened since the end of the second quarter added an average of 630 basis points of occupancy from the end of June through this past weekend. We think this is an impressive feat as we enter the slower part of the leasing year, the fall being where seasonality results in occupancy drop-offs.
We currently have five additional on-balance-sheet project completions slated for the fourth quarter and eight slated for the first quarter of 2019, four of which are expected in the first half of the quarter. We've commented routinely over the last few quarters about delays in back-end inspections and the issuances of certificates of occupancy on projects as building departments nationwide appear to be understaffed and the number of projects of all types appears to be at cyclical highs. We think this is a consistent story being told throughout the self-storage sector, but our developer partners continue to attack this problem head-on, and we think they're doing a good job of managing that. That said, we are also vulnerable, as is everyone else, to slips in construction schedules in some of these markets.
While our developers are building projects as quickly as they can build them, factors outside of their control, mainly labor shortages and inability to get inspectors on site, could cause some of the expected fourth quarter deliveries to slip into the first quarter of 2019. But we also, likewise, could see some of the first quarter deliveries open early in the fourth quarter.
Looking forward, our investment pipeline stands at approximately $370 million today. As previously communicated, we've reduced our pipeline intentionally as the development cycles well into its fourth year. We remain meticulous in our underwriting and deal selectivity, and we're focused exclusively on select deals in high-density, low-supply submarkets that face fewer new supply deliveries. As the acquisition cycle takes shape, today we're more focused on developer buyouts and growing our wholly owned portfolio. As mentioned earlier, we own six properties today and we aim to grow that number significantly over the next few years.
On that note, we're seeing an increasing number of opportunities to bring properties onto our balance sheet from our development investment portfolio. Our developers continue to come to us at a certain stage of development and inquire as to our interest in buying them out.
Finally, we continue to believe that we have substantial unlocked value in our existing portfolio of 68 very high-quality-generation-fee storage facilities in which we have profits interest. Through the end of the third quarter, we had only recognized approximately 23% of our prospective fair value on projects we've financed, providing us with significant potential for future earnings and book value growth.
With that, I will turn things over to Kelly to discuss financial results for the quarter.
Thank you, John, and good morning, everybody. Last night, we reported third quarter earnings per share of $0.57 and adjusted earnings per share of $0.75, both of which were at the top end of our quarterly guidance ranges. We continued to experience strong revenue growth with total revenues increasing 170% quarter-over-quarter and 161% year-over-year.
There are a few points we believe warrant further discussion. First, NOI on our wholly owned assets came in above the high end of our guidance, in part due to the acquisition of the Charlotte property. However, even without the benefit of this asset, NOI for the previously owned five properties came in above guidance as the revenues were higher than we anticipated while the expenses were in line.
Second, in conjunction with our developer's sale of the self-storage facility underlying our initial Tampa investment, we received a little over $6 million in cash proceeds. $5.3 million went to pay off our construction loan, $106,000 of that was for the prepayment fees received in conjunction with the early repayment of our loan, and the remaining $619,000 was a realized gain on the extinguishment of our profits interest.
At the end of the second quarter, we had recognized, over the whole life of this investment, $671,000 of unrealized gain. These unrealized gains represented the value of our entire investment, so both the debt, including the prepayment penalty, and the value of our profits interest. The $725,000 that we received above and beyond the repayment of our loan principle represents a profit of about $54,000 over the previous cumulative fair-value marks that we had taken. We have repeatedly stated that we believe our fair-value marks are reasonable and reliable, and we believe that this transaction demonstrates that point.
Third, interest income was above our guidance range for the quarter. This was due in part to the average overall standing principle balances on our loans being higher than expected, thus resulting in higher-than-expected interest income. This was also due to the receipt of the previously mentioned prepayment fees we received from not only the Tampa loan but also the repayment of one of our last two operating property loans.
Finally, our overall change in fair value, consisting of both the realized gain on the Tampa investment and the unrealized gain on our overall portfolio, was slightly above the midpoint of our guidance range for the quarter.
Also, as I'm sure you all noticed in our release last night, we reaffirmed our full year '18 guidance ranges for EPS and adjusted EPS. These ranges reflect our best estimates at this time, but as John noted in his remarks, we have several properties scheduled to deliver around year-end. And given all of the challenges that we've discussed that arise near the end of every project, which result in uncertainty as to timing of delivery, and in our fair-value accounting, the timing of fair-value recognition, we thought it was appropriate not to narrow or change our guidance at this time.
Turning to the capital front. We have now deployed 100% of the proceeds from our June common stock offering, and at the end of the quarter we issued the final $15 million of our Series A preferred stock to Highland Capital. We also, during the quarter, attained $24.9 million of term debt secured by three of our wholly owned properties, further supporting our belief that the commercial banks have a strong interest in financing self-storage facilities that are in lease-up. All of these capital activities have fortified our balance sheet and have provided us with ample dry powder for future growth, and notably, our line of credit remained untapped at quarter-end and leverage as measured by net debt to gross assets stood at zero at the end of the quarter.
And looking forward, we believe we are entering '19 from a position of strength in terms of capital. Our table of capital sources and uses on Page 16 of our supplement reflects ample capital to meet our commitments for the next year. And as we have done since inception, we will always continue to prudently seek to match our funding obligations with the sources of capital that best add to the value of the company.
That is all we have in the form of prepared remarks, so we will now turn it over to Q&A.
[Operator Instructions]. Our first question comes from the line of Jonathan Hughes with Raymond James.
So maybe a question for John: Your last slide deck from September showed your estimate of peak deliveries this year, and then a glide down. The next two, given the continued permitting delays that you talked about earlier, could we maybe see a scenario where peak is this year, and then we have similar supply levels in 2019 and 2010? I'm just trying to get some more color into the supply picture beyond next year, because I think the 2019 delivery expectations are largely understood at this point.
Yes, Jonathan, thanks for the question, and that's a great question. Keep in mind that we're focused on and tracking only the top 50 markets. So it's - we really can't comment as to the nation at large. What we've seen is, over the last year, a significant trend down in prospective projects, and we've also seen a significant trend down in construction lending in the top 50 markets. So taking the back part of your question about what does 2020 look like, we feel like those trends very, very much tend to support a thesis that 2020's going to be dramatically less. When you look at 2019, based upon the data that we've reviewed, it looks as if starts peaked in the middle of the summer of 2017 and it looks like deliveries peaked in the middle of this summer. So we continue to believe that 2019 deliveries should be a little bit less than they were in 2018. I don't think it's going to be a dramatic drop-off, but it's going to be a noticeable drop-off, and I think that's consistent with, perhaps, what you've heard from the other REITs on their calls. Keep in mind that these numbers are based upon the best data available, and that data's still in a period of evolution. The verification process is still evolving. And so, yes, the tracking is not perfect, but we're gaining more and more confidence every quarter that goes by as we continue to see consistency in the data as it's presented to us. And so, while you could see projects slip from Q4 of '18 into '19, which could cause '18 and '19 to be maybe a little closer to a twin peak, we feel like after 2019 there continues to be every indication of a fairly decent drop-off.
Okay. No, that's great color. Okay, and then maybe one for Jonathan, if he can comment, but I'd be curious to hear your thoughts on the bridge loan program, maybe the potential opportunities to expand that platform given your relationships. Obviously a lot of relationships within the whole company, but yours specifically. And then just how you're thinking about that as we kind of enter this peak of the development cycle and delivery cycle.
Hey, Jonathan, let me answer that and let Jonathan add on as he wishes, because I was here when the - when we first launched this as an investment alternative for developers and owners out there. As you - as we developed this particular financing alternative, what we saw last fall was, particularly in the early delivery markets like Miami and Dallas, a potential desire on the part of developers to remain in projects to capture value as these projects went through the lease-up process, but also allow them the opportunity to take out construction lenders and also take out what proved to be in many cases fairly impatient private equity. And that was the basis for the Miami deal that we did. And we continue to have conversations with those types of developers.
What we've seen, though, is as we've moved through this year, so many of the deliveries occurred in 2017, and they're at a point in lease-up where those decisions aren't really having to be made, so we're thinking that as we move into 2019 you'll see more of that analysis being done by the developers. And frankly, it boils down to a decision on the part of the - a developer: Do I want to stay in and try to capture some more value in partnership with Jernigan Capital, or is there actually an active market out there for me to sell the property into? And that will really be our competition for bridge refinancings. It will be the acquisition market. And we're going to continue to have the conversations. We believe that this program has viability and it can provide a really solid opportunity for a developer to stay in and capture additional value, but developers are developers. I've long since tried to - long since quit trying to figure out the psychology of developers. And so, we'll, to - in many respects, be subject to their whims as we go through that. Jonathan, feel free to add on to that.
Yes. No, that's all - I obviously agree with all that. The - Jonathan, one of the - we continue to have conversations, and you tend to do a lot of listening during those conversations. It's challenging to put together a programmatic bridge program because every developer or - /owner's situation is unique. So, and they have multiple equity partners oftentimes, and you look for a solution that is a win-win for all parties involved, and you just need to really figure out what the motivation and the desirous outcome is for the developer. So there's definitely not one size fits all for that program.
Yes, okay. Fair enough. And then just one more from me for Kelly. I don't want to leave you out. But the Tampa property that you ultimately didn't want but - and sold, but curious if that sale's changed the accountants' view of how they look at that calculation and the cap rate estimate used to derive the fair-value income figure, since that traded 8% above the estimated value held on the balance sheet. Thanks.
I mean, 8% is of - as a percentage of the mark. I mean, we were pleased with that result. But when you look at this property and the type of property that it was, and then the dollar amount of that mark, I mean, it was actually, I think, helpful in further supporting the assumptions that we're using to come up with overall reasonable and reliable fair values of the underlying real estate and our investments.
Yes. Jonathan, just to add on to that, we - this is our judgment. Our accountants don't tell us how to do this. We're responsible for these numbers, and we have an extremely robust process every quarter whereby we effectively reunderwrite every asset. And we do the best we can to make the right assumptions. And yes, I think this just shows that we're doing a good job at going through that process periodically.
Okay, that's it from me. Thanks for the time, and congrats to you and Jonathan on the promotions and Dean on, maybe, some more free time.
Thanks very much.
Appreciate it. Thanks, Jonathan.
Our next question comes from the line of Tim Hayes with B. Riley FBR.
Congrats, John and Jonathan, on your promotions as well. My first question, it was obviously encouraged - it's encouraging to see another developer buyout. How has the number of potential assets that are ripe for buyouts increased? Has it changed at all since September when I think you had targeted roughly 20 assets? And as your pipeline continues to narrow, does that incentivize you to accelerate the pace of these acquisitions, or is it really driven by where they're at in lease-up or the sentiment of your developers?
Yes. Thanks for the question, Tim, and that's a - there are a lot of questions in that one question, so I'll try to address all of those points. But if you look at our portfolio right now and exclude the six developers whom we've already bought out, we right now have 30 projects that are in lease-up and we expect another 27 or so projects to open by year-end 2019. So that gives us a potential universe of 60 projects that will be in some phase of lease-up over the next 12 months or so. Now, of that 60, 11 are in the Heitman joint venture, with 10 of those being in lease-up and - already, and one expected to open in the first quarter of 2019. If you look at history and you look at the six that we've bought thus far, we've generally bought those at about the 18-month process post-certificate of occupancy. And so that can kind of give you an estimate or give you a basis for estimating the pace at which we'll do buyouts. It's largely been developer-driven, and there's been no shortage of developers coming to us at the earliest time they feel comfortable in doing so. So we feel like we'll continue to have those discussions. But suffice it to say, with 60 projects in lease-up over the next couple of years, that's going to provide a very nice number of projects that are ripe for acquisition by us. We'll give more color on that, and more definitive numbers on that, as we get later into these lease-up cycles. But I think that the statement of the opportunity is pretty clear when you just look at kind of the way things have gone thus far and the number of projects that we're going to have in a stage of lease-up over the next 12 months.
Yes, I appreciate those comments, John. Very helpful. And then you'd mentioned you didn't close any loan commitments in the quarter, but I believe on your last conference call you highlighted $25 million of term sheets that were expected to close. And just wondering what happened there, if they kind of fell out to another competitor, or maybe the deals just didn't - or ones you might have done a year or two ago and just don't fit your narrower scope, or if they got pushed out into 4Q. Any comments around that would be helpful.
Yes. I don't think any - we haven't lost anything to a competitor. I think there - as we talked about on prior calls, I think our developers have gotten smarter as we've gone through the cycle and they realized that permitting processes take longer, and they've tried to more closely match closing of projects with the timing of permitting, so they don't end up with many months of interest carry on those projects. So it's probably more of a delay in closing than it is in a reduction in the number of deals that we have to close. Jonathan, maybe you could comment on that.
Yes. No, that's - yes. No, that's accurate, and actually, those deals haven't necessarily fallen out. Actually, the number subject to a term sheet has actually increased. So currently we sit at roughly $40 million. And you would expect movement on those either this quarter or early Q1.
Okay, got it. Appreciate that. And then as it relates to the $41 million of remaining capital needs, do any potential capital sources seem more attractive to you today than others? And more specifically, how do you view using the equity ATM with the stock trading at a decent premium to book?
We're going to do what we've always done. We have a very underleveraged balance sheet right now, and we have a credit line that's out there at a lower cost than any other type of capital. And we can access that to match fund really to - almost to the day our construction commitments. So we'll continue to monitor all of this. That $40 million that you referenced is really out into 2020, so we have plenty of time to make those decisions. And we'll just continue to be opportunistic. We do continue to have availability on both the common ATM as well as the preferred ATM that we can access when we believe the time is right. But we also have a lower cost of capital out there in the debt that we also feel somewhat compelled to utilize sooner than later.
Our next question comes from the line of Todd Thomas with KeyBanc Capital Markets.
Just first, following up there on the loan program itself, just curious, what's the competition like today from other lenders, both bank and non-bank lenders? And are developers shying away from the structure of JCAP's program with the environment growing a little bit more challenging in any way?
Todd, I don't think our answer to that question is any different than it's been really for the last two years. We don't see meaningful new competition to what we're doing. Yes, there've been rumors of new entrants to the non-bank lender space, and we haven't really seen them on any deals and haven't seen them materialize. From the standpoint of bank financing of development, as we've said for the last three years, developers can go to local relationships and get generally one project financed, and that financing is still out there, but if you track the data, and Yardi, I think, is really focused on tracking construction loan starts over the last 12 months, and construction loan starts from the bank level seem to be very much down. So that would indicate that the competition really hasn't ramped up. I think the commentary is more a factor of what we talked about at the very beginning of the Q&A, and that's the supply - the new supply and the pipeline of new development. And we're late in the cycle.
Sites, particularly in our markets and submarkets, are much harder to find. If you're looking to build in an urban core area that has high density and low square footage per capita with good incomes and good population growth, whereas 2.5 years ago you're picking low-hanging fruit, or in some cases picking fruit off the ground, now you're really looking for needles in haystacks. And so we feel like that's being supported by a drop-off in construction lending. We also feel like developers are finding it much more difficult to get deals to pencil. You have increases in interest cost, interest carry, from banks particularly. The short-term rates have gone up 100 basis points in the last 12 months. You have labor shortages and, in real numbers, increases in labor costs. You have longer construction periods, as evidenced by these longer permitting and longer back-end inspection processes. So we feel like that's probably more of the explanation for the decline in number of development projects than competition. And finally, as we said a minute ago in response to Tim's question, we're really focused on these opportunities to acquire developer interests over the next couple of years. That's our most accretive investment activity going forward.
Okay. That's helpful. And then a question just regarding sort of the management roles here and the transition for Dean. And I'm just curious, as we think about the changes there, does this have implications for the internalization of the management company at all? I mean, what should we be thinking about with regard to that process, which, according to the terms of the agreement, should - would really kind of get started in late 2019?
Dean, do you want to answer that?
Yes, sure. Good morning, Todd. I didn't think I was going to get a question until John let me answer one here. Todd, nothing's changed, but yes, I guess, is part of your answer. John is - will be perfectly - is perfectly suited to be the CEO of an internally managed and internally advised equity REIT in our storage sector. As we go forward, your timing is right; those discussions start next fall. And as we've always said, it's clearly laid out in all of our documents as to how that takes place and we expect that to happen in a normal-course-of-action period of time. In other words, somewhere within that - between 18 months from now and whatever the end of the process is. So all of it adds together, as you're guessing there, with John being the CEO of the company. We will get the process started next fall and see how it goes. But it's all laid out, and we expect it to go smoothly.
Okay. And just lastly, I guess maybe for Kelly, how should we be just thinking about G&A in '19? Putting the internalization of the management company aside, but just given some of the changes here, some of the new additions with Jonathan, and the model's obviously a little bit sensitive. Can you just help us sort of understand what 2019 might look like from a G&A standpoint?
Right. I mean, if you look at just our G&A excluding any fees to the manager, I mean, the recent changes in management should have no impact on our G&A. And then looking forward, I mean, we're not anticipating any significant increases. I think all of that's been factored into our guidance for this quarter. And we will have normal increases as we're a growing company, but I think consistent with what we saw this year, I mean, the overall growth of our investment activity and such will significantly outpace our costs, which we expect to be kind of in-line, inflationary-type increases.
[Operator Instructions]. Our next question comes from the line of Tayo Okusanya with Jefferies.
With just one quarter left to go, as you guys mentioned, the guidance range is still fairly wide. I'm just curious if you could just help us quantify, or just kind of put some numbers around the idea of - if there is - if there are development delays which did have a $5 million impact to fair-market value, or just to kind of get some type of sense of what dealers would ultimately kind of do, to what kind of FMV marks you have for the full year? And also, if any concerns about rising interest rates also play into the idea of uncertainty around fair-market values for the rest of the year.
Hey, Tayo, I'll take the question on the - I'll take the question on delays, and I'll let Kelly answer the question on interest rates. And thanks for your question. As we have - as we've stated for three years now in describing our fair-value process, we are able to take fair-value marks on roughly 1/3 of our profit during the construction period. And that is based off of our underwritten profit, and that's a fairly steady - and in fact, it's more or less a ratable increase as we fund construction draws. But a very significant event is substantial completion of the project, and substantial completion is subject to a lot of things. You have weather, you have labor items, you have the inspections. And inspections, particularly in some of these real busy construction markets, has proven to be a very unpredictable element of the completion of projects.
So we have a number of projects that we have in active discussions with developers, and we have these discussions on a weekly basis. We get status reports, we have inspectors out on site on a very regular basis, and when you start to put in the uncertainty of some of these variable things that are outside of our control and outside of the control of the developers, and you're looking at that one event to take a significant amount of fair-value mark into account, we just felt uncomfortable in the last quarter narrowing that number. We could actually do very well and be at the top end of what our guidance range has been, and we could have some projects that might not get to the finish line by December 31 and slip into the first month of next year. And it's strictly timing. It's a matter of the mark being in December of 2018 or January of 2019. I think the much more important consideration there is that it doesn't have any impact on the amount of the fair value. It's just a matter of it moving from one period to the next period.
Yes, the recognition time, yes.
And then in regard to the interest rate impact, so when you think of - I mean, the construction progress is the significant driver of the fair value, but when you look at the - I mean, our investments are comprised of both the debt component and the profits interest component, and when you value that debt component piece, the interest rate environment today and every quarter when we revalue those, obviously has an impact. It's - there's some inherent offsets, though, in the investment, in - by virtue of the profits interest piece of it as well. So - and so I think there's - the impact of interest rate, while not immune to it, it's not as near significant an impact. And then you just have to keep in mind that our construction loans, as you get closer to those maturing, they're going - I mean, we're going to ultimately receive our full principle back at the end of the day of our debt. So along the way, there may be some ups and down relating to the market environment at a particular balance sheet date versus the market environment when we made the loan, but ultimately we're going to get our full principle back. And in the final waterfall that gets played through will be indicative of the underlying real estate.
Thank you. Mr. Good, there are no further questions at this time. I'll turn the floor back to you for any final comments.
Okay, thanks, everyone. And thanks for the great questions. And we greatly appreciate your support and we look forward to talking to you next quarter and seeing you at Nareit next week. Thank you very much and have a great day.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.