Preferred Apartment Communities, Inc.
Q3 2019 Earnings Call Transcript

Published: 5 Nov 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Preferred Apartment Communities Third Quarter 2019 Earnings Conference Call. After today's presentation, there'll be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.I would now like to introduce your host Lenny Silverstein, President and Chief Operating Officer. Please go ahead sir.

[Lenny Silverstein:]

Thank you for joining us this morning and welcome to Preferred Apartment Communities third quarter 2019 earnings call. We hope that each of you have had a chance to review our third quarter earnings report, which we released yesterday after the market closed. In a moment, I'll be turning the call over to John Isakson, the company's Chief Financial Officer to share a detailed description of our third quarter operating results. Dan DuPree, our Chairman and CEO will share his thoughts on the state of the company.Following the conclusion of our prepared remarks, we'll be pleased to answer any questions you might have. Also with us this morning is the senior executive team of our company, Jeff Sherman, Executive Vice President and Managing Director of our Multifamily Business Unit; Joel Murphy, CEO of New Market Properties and CEO-Elect of PAC; Boone DuPree, President of Preferred Office Properties; Paul Cullen, Executive Vice President and Managing Director Preferred Campus Communities; Mike Cronin, our Chief Accounting Officer; and Jeff Sprain, our General Counsel.Before we begin, 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 and actual results may differ materially. There's a discussion about these risks and uncertainties in yesterday's press release. Our press release can be found on our website at pacapts.com. The press release also includes our supplemental financial data report for the third quarter 2019 with definitions and reconciliations of non-GAAP financial measures and other terms that may be used in today's discussion.We encourage you to refer to this information during your review of our operating results and financial performance. Unless we otherwise indicate 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.A key component of our success has been our strategically designed and highly successful Series A and mShare preferred stock-capital raising program. Through our broker-dealer preferred capital securities we raised almost $134 million in gross proceeds from our preferred stock sales during the third quarter alone.As these offerings come to a close over the next few months we will launch our next preferred stock capital-raising strategy designed to enable us to continue our solid growth objective. The success of our preferred-capital raising programs has enabled us to acquire an aggregate of approximately $289 million in new assets and originate almost $15 million in new real estate loan investments during the third quarter of this year.As of September 30 this year, we now own an aggregate of 101 Class A multifamily, student housing, grocery-anchored shopping center and office properties in 15 states and 56 markets primarily in Southeast Mid-Atlantic and Texas; and have real estate loan investment commitments outstanding of almost $416 million. Through our 700 associates we continue to emphasize our goal of becoming the preeminent publicly-traded REIT in the industry with particular focus on our operating performance, the training and development of our associates, our culture and our philanthropy of giving back to the communities in which we operate. We're extremely pleased with the successes we've achieved in these areas and look forward to continuing this momentum.I now would like to turn the call over to John Isakson. John?

[John Isakson:]

Thanks, Lenny. For the third quarter 2019, PAC generated revenues of just over $120 million; FFO of $0.31 a share; and AFFO of $0.12 a share. You will note that, our revenues are up over 15% compared to the third quarter of 2018 owing to the continued growth in all of our property verticals and our FFO is up over 10% from the same period last year as well.For the third quarter, our preferred stock dividend increased by over $7 million to $29.4 million and our common stock outstanding was up by almost 4.5 million shares over the third quarter of 2018 to 44.7 million shares.In reviewing our financial statements, you may note the decrease in operating income despite the growth in top line revenue. It is important to note that this line item includes gain on sale of real estate and we had a significant sale in Q3 of 2018 and no sales in Q3 of 2019. Excluding the gain on sale, our operating income was up 70% over the same period 2018.Our AFFO can be highly variable and from quarter-to-quarter or year-to-year, we can have dramatic swings. The variability in our AFFO can be attributed in large part to two line items; accrued interest income received and amortization of purchase option termination revenues. You will note that for the third quarter this year compared to last year, we had almost $4.3 million less in accrued interest income received. While we book accrued interest income every quarter, the actual cash payment of this interest comes in when the borrower under the real estate loan investment has a capital event. Meaning either a sale or a refinance of the property.Sometimes our developers pay us early from cash flow and sometimes we receive the cash payments upon one of these capital events. This quarter, for example, we did not have any accrued interest income payments. The variance in this line item accounts for more than the total variance in our AFFO.For the third quarter 2019, we paid a dividend to our common stockholders of $0.2625 per share, almost 3% greater than the dividend paid to our common stockholders for the third quarter of 2018.As we have previously discussed, we continue to focus on increasing the float of our common stock. During the third quarter this year, for example, we issued an aggregate of over one million shares of our common stock in connection with redemptions of our preferred stock and the exercise of warrants previously issued under our Series A preferred stock and unit offerings.From a capital markets perspective, we have seen some interesting developments in the market. Interest rates again declined in the third quarter and currently sit almost 160 basis points off the recent peak in Q4 of last year, although that spread has narrowed in recent trading sessions.We continue to believe that interest rates will be volatile at the end of 2019 with global and domestic pressures presenting unpredictable conditions. Given the recent volatility and uncertainty in the environment, we have continued to take a cautious approach for acquisition and portfolio financing strategy. Almost 96% of our permanent property level mortgage debt has fixed interest rates or variable interest rates that are capped.Our borrowings under the line of credit as of today are zero, and we believe the current capacity of the line will serve us well for the foreseeable future including the additional $100 million accordion feature we have in the current facility. The accordion feature allows us to expand the facility up to a total of $300 million.For our multifamily portfolio, Freddie Mac and Fannie Mae remain our primary lenders. We enjoy preferred borrower status and have excellent relationships with both agencies.As we noted last quarter, there was considerable concern over the caps for the GSEs and their production volumes going forward. In the third quarter, FHFA, Freddie and Fannie's regulator announced a new cap structure that will allow the agencies to produce $100 million each from Q4 2019 to the end of 2020. This generally sets the bar at the current production levels the agencies have been generating and takes considerable pressure and uncertainty out of the market.Due to the environment and the above-mentioned concerns, GSE spreads have widened significantly recently as the transaction volume remained strong and the ability for the agencies to do uncapped business had become more difficult.With this new cap structure, we expect spreads to contract somewhat but in a measured way over a period of months. Life company debt for multifamily assets continues to be attractive and competitive. Ultimately the balance between spreads and loan volume will be dictated by the pace of transactions, which shows no signs of slowing down.The lender pool for our grocery-anchored retail product remains deep and the demand for our debt remains strong. We have recently seen a contraction in spreads for these deals as the competition for grocery-anchored debt has increased. Our office transactions are also financed through life companies with terms that are generally comparable to retail and multifamily, although the maturities may be longer.These are typically larger deals and the lender pool is smaller than the one for our grocery-anchored retail deals, which are a more manageable size. Nonetheless, we have seen strong lender demand for our office acquisitions and our deep relationships in the lending community continue to serve us well.Let me now turn the call over to Dan DuPree. Dan?

[Dan DuPree:]

Thanks John. As we have discussed previously, each of our business units has a very specific strategy for creating value. Our multifamily business is focused on more recently-developed Class A largely suburban properties and markets typically with greater than 1 million people and good growth.Nearly three quarters of our multifamily assets are in three states

[Operator:]

We'll now begin the question-and-answer session [Operator Instructions] And our first question will come from Michael Lewis with SunTrust. Please go ahead.

[Michael Lewis:]

Great. I wanted to ask how you decide how much asset management and G&A fees you waive each quarter. Is there a formula for that or target? Or is that kind of a decision made by management during or at the end of the quarter?

[Dan DuPree:]

Well, it's on a case-by-case basis Michael. The key is we want to invest accretively. And it has been determined by the owners of -- the manager that we would subordinate our fees in order to ensure that we're investing in an accretive way. You know, as we go through this process of exploring internalization one of the nice side benefits is we no longer will have the load of those fees when we're trying to evaluate the viability of an asset it would be nice to have that behind us.

[Michael Lewis:]

Right. Okay. And then on the dividend coverage, I understand the lumpiness of the AFFO and the accrued interest buildup that you have. I wanted to ask about -- you're reporting about $2 million, a quarter of maintenance CapEx. When I looked at the cash flow statement, you've kind of consistently been around $12 million per quarter of improvements to real estate. I guess the question is just given the lumpiness of the AFFO I mean, how should we and investors kind of look at the cash flow coverage of the dividend? And how comfortable you guys are with the level of the dividend here?

[Dan DuPree:]

Yes. What I would tell you on that I'll give you a classic example. In the third quarter, we had none of our mezz loans pay off in the third quarter. It's not something that we frankly control. Already in the fourth quarter, we've had two mezz loans pay off and there's a good chance we'll end up having a couple more this quarter.It is a -- it is our mezz loan business has been a real driver for the company. But it creates this lumpiness on -- because we don't control when they're going to pay off. What I think is important is the fact that -- and it's continuing to increase. All of our mezz loans today appear to us to be very healthy. And we have $27 million of accrued interest that we have not yet captured. And that will get spread out in a lumpy fashion probably over the next -- that $27 million is probably over the next year, 1.5 years, two years providing more than adequate coverage of our dividend.

[Michael Lewis:]

Okay. Thanks. And then just one last one for me, I wanted to ask about the internalization decision and process here and ultimately the outcome. It looks like when I look in your filings and kind of follow the formula and therefore, the internalization fee, it looks like that could be quite high. Is there a risk here that you have to -- that there's an internalization fee of $100 million or $200 million that takes kind of $4 a share out of this company? Or am I kind of over -- am I overestimating or over thinking that?

[Dan DuPree:]

Well, let me frame it a little bit different way. The best investment, first of all, I don't know -- I mean we're not at a point of making any announcement about internalization. It's a protracted process that both we and the Board -- we the manager and the Board want to get right. That's first and foremost. I think what we have done relative to deferring fees and other things indicate a real respect for our shareholder in that regard.But I can tell you, at almost whatever price the best long-term investment -- the best long-term investment the company will make this year or any year will be the internalization of the manager. Regardless of what the near-term impact is -- and I'm not suggesting that it's going to be the numbers that you've suggested. I'm just saying that regardless of the number it will be the best investment that the company will make. John, did you have something you wanted to add to that?

[John Isakson:]

Hey. Michael whenever you look at the payment one of the things to think about is the company's capitalization isn't just the common stock, but obviously the preferred stock as well. So, when you start talking about that $4 a share, that's a little misleading. I mean the company from an equity standpoint is well over $2 billion now.

[Michael Lewis:]

Okay. Thank for answering my question.

[Operator:]

This concludes our question-and-answer session. I would like to turn the conference back over to Dan DuPree for any closing remarks. Please go ahead sir.

[Dan DuPree:]

Yeah. Before we get off the phone, we allowed Joel Murphy to get a free ride on this call. And I can assure you that any of the questions that we just answered, would have been answered far more astutely by Joel and you can look forward in the future to Joel leading this call. I think all of us, on our side of this call, are excited to have Joel taking over the reins on January 1. And as I mentioned in my comments, Joel is going to do a terrific job.So, with that, let me say thank you all for participating this morning. We're available, mostly Joel to answer questions that you have following the call. Again, thank you. You all have a good day.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may disconnect.