Preferred Apartment Communities, Inc. (NYSE:APTS) Q3 2021 Earnings Conference Call November 9, 2021 11:00 AM ET
Paul Cullen - EVP, IR
Joel Murphy - CEO
John Isakson - CFO
Conference Call Participants
Jason Stewart - Jones Trading
Good day, and welcome to the Preferred Apartment Communities' Third Quarter 2021 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
I'd now like to turn the conference over to Mr. Paul Cullen, Executive Vice President of Investor Relations. Please go ahead, sir.
Thanks for joining us this morning and welcome to Preferred Apartment Communities third quarter 2021 earnings call. We hope each of you had an opportunity to review our third quarter earnings report, which was released yesterday after the close of the market.
In a moment, I'll turn the call over to Joel Murphy, our Chief Executive Officer, to share some initial thought. And then, John Isakson, our Chief Financial Officer, will share additional details about financial metrics and capital markets. Then Joel will return to conclude our prepared remarks. Following Joel's remarks will be pleased to answer any questions you might have.
I'd like everyone to note that forward-looking statements may be made during our call. These statements are not guarantees of future performance and involve various risks and uncertainties. As you know, actual events and results may differ materially from these forward-looking statements, and the company does not undertake a duty to update any forward-looking statements. These risks and uncertainties include, but are not limited to the impact of COVID-19 pandemic on our business operations, our customers, the economic conditions in the markets in which we operate, the global economy and financial markets, and our ability to mitigate the impacts arising from COVID-19 and those include in our SEC filings.
For a discussion of these and other risks and uncertainties, you should review our forward-looking statement disclosure in yesterday's earnings press release as well as our SEC filings. Our press release and other SEC filings can be found on our website at pacapts.com.
The press release also includes our supplemental financial data report for the third quarter 2021, with definitions and reconciliations of non-GAAP financial measures to most directly compared GAAP financial metrics and other terms that may be used in today's discussion, and the reasons management uses these non-GAAP measures. We encourage you to refer to this information during a review of our operating results and financial performance.
Unless otherwise indicated, all per share results that we discuss this morning are based on the basic weighted average shares of common stock and Class A partnership units, outstanding for the period.
I would now like to turn the call over to Joel Murphy. Joel, go ahead.
Thank you, Paul. Good morning, everyone, and thank you for joining our third quarter call today.
Third quarter was a tremendously busy, highly productive and transformative quarter for PAC. After closing on the sale of the vast majority of our office assets during the quarter, we quickly executed on our already envisioned strategic and tactical plan to redeploy the net proceeds from PAC sale and from several other capital recycling initiatives that I'll highlight in a moment.
To that end, during the quarter, we completed the redemption of approximately $306 million of our preferred stock offerings. We completed $269 million of multifamily acquisitions, and we originated a new $23 million multifamily real estate loan investment. Subsequent to quarter-end, we've originated two additional multifamily real estate loan investments, totaling $26 million. All of these new capital investments were made in high quality Class A multifamily communities in our target Sunbelt markets.
In addition to these strategic and tactical transactions, we posted another quarter of solid operational performance across the entire platform. There are more details in our supplemental, but here are the highlights of these capital redeployment investments.
In July, we acquired Alleia at Presidio, a 231 unit Class A multifamily community in the Dallas Fort Worth MSA.
In August, we originated a new real estate loan investment of approximately $23 million in connection with the Club Drive Apartments development, a planned 352 unit Class A multifamily community in the Atlanta MSA.
In September, in the space of just one week, we acquired three separate Class A multifamily communities in three separate transactions adding an additional 797 units to our portfolio. The Anson, The Kingson, and Chestnut Farm represented key additions to our presence in the Nashville, Washington DC, and Charlotte markets.
Subsequent to quarter end in mid-October, we originated a new real estate investment loan of approximately $17 million in connection with Menlo II, a planned 337 unit Class A multifamily community in Jacksonville, Florida. By the way, Menlo II is adjacent to the Menlo a 332 unit community that we acquired in December of 2020.
And just last week, we originated an additional real estate loan investment of approximately $9 million in connection with a 246 unit Class A multifamily community also in the Atlanta MSA.
In the aggregate, these seven transactions represent approximately $318 million of capital investments in our multifamily business. And over the last 19 months, we have acquired nine Class A apartment communities in our target Sunbelt markets totaling over 2,500 units. We've also sold two non-core multifamily assets. So we have added about 1,800 units or said differently 18% of external growth to now having us over 12,000 units across our Sunbelt multifamily portfolio.
Now more details are contained in our supplemental. But here are the highlights of the major components of the sources of our capital for these new multifamily investments. In July, as previously discussed, and disclosed, we sold five office properties and one office real estate loan investment to Highwoods Properties for gross proceeds of $645 million. Also in July, we sold Vineyards, a 369 unit multifamily community located in Houston, Texas, and the oldest asset in our portfolio for gross proceeds of $62 million.
Then, in September, we completed the sale of the Armour Yards sub-portfolio for gross proceeds of $79.5 million. You'll remember and as previously announced, we purposely structured our agreement with Highwoods, so that we could withdraw the Armour Yards sub-portfolio from the Highwoods transaction, because we felt that we could draw a higher price for the sub-portfolio through a separate offering to a different pool of investors. Since this style of what is known as creative office would appeal to a different pool of investors versus the traditional core office buildings that we sold to Highwoods. We exercise that right. And we closed on that sale on September 8th, at a price nearly 11% higher than the price in the Highwoods agreement.
And finally, we received payoffs on multiple of our real estate loan investments across six properties, totaling approximately $104 million of principal and $10 million of accrued interest. In the aggregate, the sale of these nine non-core assets, and the payoff of these seven previously initiated real estate loan investments, generated $407 million of net proceeds after repayment of property level debt and closing costs. And these asset sales were purposely planned, and they were well executed with excellent counterparties and very good pricing.
Taken together with our multifamily acquisitions and newly originated multifamily real estate loan investments, these well executed transactions, demonstrate our ability to recycle capital into high CapEx, low-growth assets and redeploy capital into low CapEx, high-growth multifamily investments, while also improving our balance sheet through the execution of strategic calls of our Series A preferred stock.
So over the last few years, we have overhauled our portfolio composition, a rotating investment at non-core student housing and non-core office assets and into our core multifamily business. These significant and sequential strategic initiatives were carefully planned in scope and scale, and were all executed with first class counterparties at excellent pricing.
We crafted a well-planned redeployment strategy, and we executed rapidly and effectively. These steps built upon one another and it resulted in a transformative change of our company through simplification, capital rotation, realignment of our balance sheet, and increased focus on our core Sunbelt multifamily business. These complex strategic transactions and initiatives did not distract us from achieving solid operational performance. And I'd say to the contrary, our strong operational performance allowed us to make these strategic moves quickly and with conviction.
So let me summarize where we are today. We believe that our 1,200 unit multifamily portfolio is the youngest in the public REIT industry with an average age of only 6.1 years. Our grocery-anchored portfolio is anchored by market-leading grocers such as Publix, Kroger, Harris Teeter, and ATB. Our performance throughout the pandemic is a testament to the high quality nature of our assets with rent collections at or above the top of our multifamily and retail peers.
In short, we own great assets, operated by a first-class team of associates, and located in vibrant and growing Sunbelt suburban markets.
Now since the inception of our company, just over 10 years ago, we have chosen to focus on the Sunbelt, because of the long-term fundamental tailwinds we see here.
First, with regard to migration patterns, Sunbelt markets have enjoyed solid growth for decades, benefiting from business-friendly regulatory structures, lower cost of living and lower taxes, and drawing in people primarily from the Northeast and the Midwest. We expect these trends to continue as the rise of remote work and remote learning have enabled people to move to lower cost areas with more space for living. These population inflows should continue to drive sustained demand for new housing construction as well as for the retail assets that are needed to support that larger population. For the last several quarters, I've shared with you examples of third-party research pieces about these and other macro trends affecting our markets.
You'll remember in the first quarter, I've talked about the North American Van Lines 2020 Migration Report CBRE's analysis of postal data. In the second quarter we talked about U.S. Census Bureau CoStar, Clarion Partners and Freddie Mac, particularly about the housing shortage. So this quarter, I want to share some insights from ULI and PwC Emerging Trends in Real Estate Report that was just issued this past October. The following language that I'm going to share with you is pulled directly from this report.
First, the dramatic escalation in the number and frequency of people working remotely during the pandemic looks to become permanent, a sizable share of the workforce. Freed from a daily commute, remote workers will enjoy a broader range of potential residential locations, with profound impacts on individual Metro areas and property markets. At the same time, the pandemic has accelerated some existing trends in favor of greater suburban growth and vitality. The permanent move to work-from-home, whether remote or hybrid working is perhaps the trend with the greatest impact, enabling numerous workers, many of them are fluent office workers to consider a broader range of residential locations, for many of them; the choice will be more suburban.
Second, as to the housing shortage and again quoting from the ULI and PwC Emerging Trends Report, housing analysts calculate the current level of long-term under billing in a range from $2 million to excuse me $2 million to $5 million total housing costs. Costs of both for sale and rental housing are rising much faster in secondary and tertiary markets as people moving away from pricier gateway markets bid up residential prices in the smaller destination markets.
Millions of potential homebuyers are priced out of the market because home prices are higher than they can afford in a large and growing number of markets and prices continue to rise faster than wages. Prospective homebuyers are also burdened by the down payment of housing as prices continue to rise. With so many prospective homebuyers priced out of for sale market, and thus continuing to rent, upward pressure on rents will likely continue.
Third, and again quoting from this Emerging Trends Report, the popularity of large gateway markets continues to wane in favor of generally smaller small markets that extend across the Southern half of the country. Until recently dismissed as secondary investor markets, these Sunbelt Metro areas account for the eight top rated U.S. markets to watch and overall real estate prospects in this latest Emerging Trend survey. Of the eight top rated markets, PAC owns assets in six of those eight. So I really do urge you to take a look at this detailed and well researched report that is issued annually. It is always an interesting and informative read.
So now turning to our Sunbelt focused portfolio. Our operations remained strong and steady. For our multifamily portfolio, third quarter 2021 average physical occupancy rose to 97.2% up 160 basis points from the third quarter of 2020 and up 40 points sequentially from the second quarter of 2021. Year-over-year, our same-store revenue grew 7.5% and our year-over-year same-store NOI was up 8.8%. Same-store revenue increase is right up towards the top of the class of the multifamily REITs. This year-over-year same-store NOI increase is not only solidly in the upper end alongside our multifamily peers. But also want to point out that this year-over-year comparison is against our slightly positive third quarter 2020 same-store NOI number that was also quite good on a relative basis against our peers in the third quarter of 2020. This combination taken together pointed out not only the resiliency of our portfolio in times of stress, but the opportunity and ability we have to grow rent and NOI, when conditions are more favorable as they are now.
In our second quarter release, we began sharing some rent growth statistics. Now for the third quarter, we'll share those again in that we achieve rent growth for new leases up 24.1% for new leases and 8.8% for renewals for a blended 15.6% increase. This positive trend for the quarter is continued into October. And these numbers have actually grown to 25.6% rent growth for new leases and 13.3% renewals for a blended 18.6% increase.
We believe that this third quarter and October rent growth performance and numbers are at the very top of the multifamily REIT sector.
We also believe that our suburban Sunbelt grocery-anchored retail portfolio is primed to benefit from the strong tailwinds taking place in the grocery-anchored sector and in the Sunbelt generally. Our portfolio continued its strong momentum during the third quarter. Demand for space in our centers has continued to increase every quarter, as we executed, over 40,000 square feet of new leases and approximately 98,000 square feet of renewal attractive spreads. Year-to-date, we have signed approximately 108,000 square feet of new leases and 355,000 square feet of renewals.
Our renewal spread trend has increased sequentially each of the last four quarters as we continue to capitalize on our portfolios strong fundamentals. Our existing tenants and new concepts that are seeking space in our necessity-based centers recognize the benefits of having a high performing market dominant grocer anchoring their center.
Further our leasing pipeline of new tenants that are at lease or in active NOIs has never been larger with significant NOI set to follow once these leases are signed and these tenants get open for business.
Our core retail portfolio has a very high percentage lease, which you can see of 95.4% as of September 30th. And you may have noticed that this is a 50 basis points decrease from last quarter. This decrease was almost entirely driven by one 19,000 square foot tenant, which comprises less than 1.5% of 1% of our core portfolio that vacated one of our centers. This departure was actually underwritten that acquisition and that should create a strategic backfill opportunity for us as it replaced a dated concept with a stronger tenant or tenants that will drive significantly more traffic to that center.
Our results year-to-date in both multifamily and grocery-anchored retail have exceeded our internal budgets, and along with an improved outlook for the remainder of the year, contributed to our upward guidance revisions that John will detail later in the call and those are contained in our supplemental.
Overall, I have to say we could not be more pleased with our team's execution through these complex strategic transactions and initiatives. All while in the midst of a global pandemic. And I want to thank every member of the PAC team for their contributions. Not only did they help us navigate a broad organizational shift to unlock value, but they continue to drive results at the ground level and deliver exceptional performance on leasing and capital reinvestment activity every quarter.
So as we sit here today, we feel better than ever in the strength of our platform and look forward to growing our cash flows and creating long-term value for shareholders into 2022 and beyond.
So now let me turn the call over to John. John?
Thank you, Joel.
I'm going to start with our high-level third quarter results, then will discuss FFO, core FFO and AAFO in more detail. And finally, I'll walk through our updated guidance that Joel mentioned.
For the third quarter of 2021, PAC generated revenues of $111 million, FFO of negative $0.31 per share, core FFO of $0.28 per share, and AFFO of $0.40 per share.
I would like to remind everyone that our sale of the student housing portfolio last November, as well as our office sale in July, that Joel just talked about, were the primary reasons for the decline in revenues from 2020 to 2021 on both the quarterly and year-to-date basis. As we noted in our supplemental, revenue would have been almost 8% higher without the sale of the student housing and office assets.
With respect to core FFO, the third quarter 2021 result of $0.28 per share compared to the prior year quarters $0.26 per share reflecting the impact of several items. As previously mentioned, FFO was lower by $0.14 per share due to the sale of our student housing and office assets, which flows through to core and AFFO. Lower preferred dividends accounted for a $0.13 per share improvement in core FFO. Finally, improved property operations accounted for a $0.06 per share improvement this quarter.
With respect to AFFO, we generated $0.40 per share for the third quarter of 2021, as compared to $0.07 per share for the third quarter of 2020. Beyond the items listed above for core, there was an aggregate of $0.22 per share in purchase option termination income and accrued interest received. This quarter is an excellent example of the lumpiness we have discussed in the past, related to our real estate loan investment program, and our receipt of accrued interest and purchase option income.
As a reminder, our accrued interest and purchase option termination income related to these loans is received when the deal sells to a third-party, or we exercise our purchase option. The timing of these can be hard to predict. While these factors can drive variability in our earnings from quarter-to-quarter, the purchase options and termination fees have been an integral part to our strategy to-date, and the loan investment program remains our most accretive investment sleeve.
Our lending strategy has not only helped to generate attractive returns, but also provides us with a pipeline of potential multifamily acquisitions due to the purchase options we have and the associated discounts so that the company does options to-date, as well as great visibility into transaction activity across our markets.
Generally speaking, as the multifamily market has improved and pricing has tightened for assets. We've seen a meaningful acceleration in payoffs and conversions of purchase options in our real estate loan investment program. Over the course of this year, we have seen four loans payoff that resulted in purchase option payments for the company totaling almost $10 million. In addition, we've seen three loans convert to owned assets through the execution of the purchase options or a right of first offer.
To highlight the profitability and accretiveness of the real estate loan investment strategy, let me offer some high-level statistics on the deals that have become full cycle this year. We've had real estate investment loans payoff this year for a total of approximately $160 million in principal and accrued interest balances. These loans supported eight multifamily properties, one office property, and one land acquisition bridge loan. The average IRR on the loans paid off this year was nearly 18%.
With respect to our balance sheet and capital stack. In the third quarter, we completed aggregate redemptions in calls of approximately $306 million of our preferred stock offerings. In the third quarter, we issued $37 million of preferred stock, resulting in a net reduction of $269 million for the quarter. Since the closing of the student housing portfolio last year, we have called or redeemed over $620 million worth of our preferred Series A stock or over 28% of the total preferred equity outstanding as of September 30, 2020.
Our continued intent is to balance our capital needs with our stated intention to reduce our outstanding balance of preferred stock, which ideally would continue to result in negative debt issuance on a quarterly basis. This quarter we also issued common stock under our ATM program. While not a large capital raising effort, it is important to remember that we have access to the public markets through a variety of different channels and feel good about our ability to raise capital going forward to fund the variety of efforts we are undertaking.
Raising common equity even at a small level has the added benefit of continuing our effort to rebalance our preferred and common stock ratio. And we will continue to use common stock raises if and when they're attractively priced and/or strategically valuable. The ATM program is also particularly efficient from a cost standpoint as the company pays significantly less than we would in a fully marketed offering.
In addition to the equity side of the ledger, we've been equally focused on our property level debt maturities and structure. Over the course of the last 24 months, we refinanced 11 assets, which has reduced our average interest rate on those assets by 60 basis points. In addition, we've been able to pullout more than $100 million in additional proceeds at our lowest cost of capital. These refinancing's reflect the growth in our assets and the strength of the portfolio that Joel mentioned.
We have pushed our maturity schedules with these refinances, and currently have only $79 million of permanent debt maturing in the next 24 months and less than 25% maturing in the next five years. Given the concerns of our interest rates with respect of inflation rising, we're very well-positioned to enjoy the rising rental rate market in multifamily and feel comfortable that our downside is protected with latter debt maturities, and a largely fixed debt portfolio.
Let me now turn to our outlook for the balance of 2021. We're revising our guidance today to reflect the impact of the third quarter's performance and milestones. We now expect core FFO per share in the range of $1 to $1.07 for the full-year 2021, reflecting a general increase in our expectation and a tightening of the range as we close in on the end of the year.
Underpinning this guidance are the following updated assumptions. Same-store multifamily NOI growth of 5.5% to 7%, we're raising this range from our prior guidance of 5% to 7%. $300 million to $400 million of acquisitions of multifamily properties, which is unchanged from previous guidance and new real estate loan investment originations of $50 million to $100 million, which is also unchanged from previous guidance. This guidance continues to include the impact of purchase option termination revenues and CECL reserve reversals as a result of our real estate loan investments being repaid, which in combination with the accelerating growth in the multifamily portfolio is helping to offset the dilution of the office portfolio sale in the short-term. As I mentioned earlier, the increase in purchase option revenue represents a significant acceleration of payoffs and acquisition of properties that were originally contemplated in 2022. This acceleration will have a material benefit to our results in 2021, to the detriment of the results in 2022. These one-time items will be very difficult to replace going forward, as we have fewer purchase option termination revenue opportunities in our loan investment portfolio today.
In addition, as we discussed last quarter, our largest loan investment in San Jose California is scheduled mature in Q1 2022. There is a possibility; it will pay off in Q4 of 2021, which would have a dramatic impact on both 2021 results to the positive and 2022 results to the negative. Ultimately, this is simply an issue of timing and while our results may be skewed by the timing of the payoff, the profitability of the loan and the earnings that company receives demonstrate the strength of the investment strategy and the overall market. We'll be monitoring the aggregate impact of these items on our 2022 outlook and expect to provide fresh guidance on our fourth quarter earnings call.
I would like to now turn the call back to Joel for his final thoughts. Joel?
Thank you, John. Thanks for that great breakout of our financial results.
Now before we open up for any Q&A, five thought I'd like to leave you with.
First, we have shown our desire, intent, and ability to create a more focused multifamily platform with the objective of improving our long-term access to capital, to facilitate and enhance sustained growth.
Second, our markets continue to enjoy outsized growth in population and in jobs. And the structural shortage of quality housing, particularly acute in the Sunbelt provides an excellent macro backdrop for our investment thesis.
Third, in the last 12 months, since the student housing sale, we have redeemed over $600 million of our Series A preferred shares, which we believe will provide greater flexibility to our balance sheet, and enhanced access to capital.
Fourth, we continue to demonstrate our intent and capability to advance our capital strategies by executing well-conceived, complex disposition and capital redeployment transactions and strategies, all while maintaining our focus on key operational metrics.
Fifth, we're not only positioned for growth, but we've demonstrated organically through our strong operational performance and externally by sourcing and controlling accretive multifamily opportunities in our Sunbelt markets.
So we look forward to keeping you updated on additional progress through the balance of the year. And of course, we always appreciate your interest in PAC.
Now, let me turn the call back over to Paul, Paul?
Thanks, Joel. Operator, let's go ahead and start our Q&A session.
Yes, sir. We will now begin the question-and-answer session. [Operator Instructions].
And the first question will come from Jason Stewart with Jones Trading. Please go ahead.
And thank you for taking the question. Congratulations on a great quarter and continued execution of the strategy that you've been talking about for some time. I wanted to ask a question about the mezzanine loan program and sort of where you think about where, when you talk about passing on opportunities. And you think about cap rates and you think about acquisition opportunities, just sort of where your pencil hits the paper in terms of where that program goes?
Hey, Jason, we cut out just for a second on that? Could you repeat that for us, please?
Yes, sir. So first, congratulations, Joel, great strategy, great execution. My question was on the mezzanine loan program, and where you think pencil hit the paper in terms of cap rates and where you think about deploying capital?
So hey, Jason it's John. The mezzanine loan program still remains our most attractive and accretive investment sleeve and is active and is attractive as that market is. I mean, we're going to continue to push smart, sound investments in that sleeve.
The shrinking cap rates are not really, no, no, that fundamentally doesn't hurt us in terms of exiting the mezz loan program, because it just makes those assets more attractive. But it does -- it does create more competition for capital. And we certainly have seen an increase in competition for our mezz loan programs. So that that offsets it a little bit. But overall, we feel great about the mezz loan program and about our pipeline.
And John, if you could put a pencil to paper in terms of where you think ROEs were, where would it sort of shake out right now?
That's hard for us to say, as the mezzanine lender, I don't know what the developers ROE is, for us, I talked about our IRR on those loans is almost 18% of the ones that paid off this year.
Yes. Also Jason, when you think about their returns, I guess and really thought about it this way, but it is perhaps unintentional, but benefit in some of these, this lowering cap rate is that if -- the developers to look at our mezzanine loan program, okay, well, that is a piece in the capital stack, but it's a fixed piece of return. So as cap rates have declined, and the upside is bigger, does the developer as opposed to traditional equity deal versus our mezz loan, they're going to make more money on our mezz deal than they would, they had traditional equity partners in their side of the deal. So in a kind of strange way works to our benefit, where it doesn't work to our benefit is look we like to buy these assets, I think of the five assets acquired this year, four of them came out of our mezz program.
So we love the embedded portfolio. Of the ones we didn't acquire, certainly one for lack of liking them, guess what a lot of other people liked them. And all of a sudden, we still have to look at the overall thing in the cap rate and say, you know what, and just have the investment discipline to just say, okay, well, let's take our return, and move on and let somebody else own it. But we do like, the obviously the nature of this embedded portfolio and pipeline that we have.
Got it. Okay, thank you. And look, you guys deserve a lot of credit for the discipline and execution that you've put together. So I appreciate that. Thank you.
Thanks, Jason. I appreciate that note.
Thank you, Jason.
This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Paul Cullen for any closing remarks. Please go ahead.
Thank you for joining us today and your continued interest in Preferred Apartment Communities. Have a good day.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.