Preferred Apartment Communities, Inc.
Q2 2017 Earnings Call Transcript

Published: 1 Aug 2017

[Operator:]

Good day and welcome to the Preferred Apartment Communities Second Quarter 2017 Earnings Conference Call. All participants will be in 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 would like to now turn the conference over to Lenny Silverstein, President and Chief Operating Officer. Please go ahead.

[Lenny Silverstein:]

Thank you, operator and thank you for joining us this morning and welcome to Preferred Apartment Communities second quarter 2017 earnings call. We hope that each of you have had a chance to review our second quarter earnings report which we released yesterday after the market closed. In a moment, I’ll be turning the call over to John Williams, our Chairman and Chief Executive Officer for his thoughts. Also with us today are Dan DuPree, our Vice Chairman and Chief Investment Officer; Mike Cronin, our Executive Vice President and Chief Accounting Officer; John Isakson, our Chief Capital Officer; Joel Murphy, the Chief Executive Officer of New Market Properties; and others from our executive management team. Following the conclusion of our prepared remarks, we’ll be pleased to answer any questions you might have. 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 is 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 second quarter 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. I’d now like to turn the call over to John Williams. John?

[John Williams:]

Thanks, Lenny. I’m very pleased to report that we had another very strong quarter. As you’ll hear in a moment from Lenny, our second quarter financial results reflect the outstanding numbers as compared to the second quarter of last year. These financial results have allowed us to pay ever-increasing dividend to our common stockholders, while at the same time continuing to maintain a low core FFO payout ratio. Since our first common stock dividend payment following our IPO in April 2011, we have increased our dividend 10 times and produced an annualized dividend growth rate of 14.8%. As we announced at our quarterly stockholder call this past May, we increased our second quarter common stock dividend another 6.8% to a total of $0.235 per share. From a common stock perspective, we continue to focus on increasing our public float. From our IPO when we had roughly 5 million shares of common stock outstanding, we now have over 32.4 million shares outstanding at June 30th. Year-to-date, we’ve sold approximately 5.4 million shares of common stock through both an underwritten offering and through our ATM program. And on top of all of this, we’ve issued 1.8 million shares of common stock through the redemption of shares of our non-listed Series A preferred stock and exercise of cash warrants previously issued with our Series A preferred stock, all of which were sold to the independent broker dealer and RIA [ph] channels. During the second quarter, we added another 5.2 million shares to our outstanding float. Our capital raising activities have enabled to pursue a robust property acquisition strategy. Not only do we have very high standards, but we also focus on acquisitions that we believe will be accretive to our stockholders. In addition, we continue our strategy to acquire each asset in a separate legal entity like a silo with no cross collateralization of property mortgages and no upstream guarantees to PAC or our operating partnership. We think this creates a fortress like balance sheet. Along with acquisitions, we’ve sold, three of our oldest multi-family communities this year for an aggregate $157.6 million in gross proceeds. More impressively, our average total return on investment for these communities was approximately 26.5%, which by any measure is impressive. As of the end of the second quarter, the average age of our multi-family portfolio was slightly over 6.5 years, which we believe is one of, if not the youngest portfolio in the industry. So, with that, let me call on Lenny to walk you through our numbers. Lenny?

[Lenny Silverstein:]

Thanks, John. Overall, we once again produced very good operating results for the second quarter, in line with our internal bucket and tracking with our guidance. Revenues for the second quarter were almost $70.9 million or 55% greater than the revenues for the second quarter last year. Our FFO for the second quarter 2017 was $0.31 per share compared to $0.18 per share for the second quarter 2016. This represents a 72% increase on a quarter-over-quarter basis. Our core FFO for the second quarter this year WAS $0.37 per share compared to $0.31 per share for the second quarter last year. This represents a 19.4% increase in core FFO per share on a quarter-over-quarter basis. Based on our year-to-date results, we’re narrowing our core FFO guidance range for the year to a $1.42 to a $1.48 per share. For the second quarter of this year we paid our common stockholders and unit-holders a dividend of $0.235 per share, representing a 16% per share increase over the dividend we paid to stockholders in the second quarter of last year. In addition, our second quarter 2017 dividend payment represents a core FFO payout ratio of only 68.3%, which we believe again highlights the operating strength of our Company. Switching to other financial segment metrics. e continue to add quality assets to our portfolio in a meaningful way. As of June 30, 2017, our total assets net of depreciation were approximately $2.6 billion, representing an increase of over 50% compared to the same period in 2016. In addition to increasing total assets, our cash flow from operations for the six months ended June 30, 2017 was $42.3 million, which represents a 29% increase in cash flow compared to the first six months of operations for 2016. At the end of the second quarter, our leverage on assets based on undepreciated book value was 54%. If however, we measured leverage against the market value of our assets instead of undepreciated book, we believe our leverage ratio would be substantially lower. A key component of our strategic plan is our investment program. I’d now like to call Dan DuPree to provide some more color on our acquisition activity, our loan investment program, and our pipeline. Dan?

[Dan DuPree:]

Thanks, Lenny. We continue to actively and aggressively pursue our objective to create, grow and manage our best-in-class portfolio of Class A assets with the primary focus on multifamily properties including student housing and a secondary focus on grocery-anchored shopping centers and select Class A office buildings. In pursuit of this strategy and in addition to carefully considered acquisitions, we continue to originate real estate loan investments that provide both attractive current returns and the opportunity to acquire outstanding properties at a discount to stabilized value. During the second quarter of this quarter, we acquired a multifamily community in Louisville, Kentucky, representing 242 units and we acquired two grocery-anchored shopping centers in Atlanta, representing an aggregate of 182,000 gross leasable area. Joel Murphy will speak to those in a moment. We also closed a land deal [ph] in San Jose California for a projected mixed use development consisting of 551 multifamily units and 37,000 square feet of retail space. As of the end of the second quarter, we owned and managed 27 multifamily communities, representing 8,518 units in 19 cities across 10 states. This reflects the sale of our Enclave at Vista Ridge multifamily community in Dallas this past May, plus the ownership of two student housing communities. Under our real estate investment loan program and including the San Jose loan, we now have outstanding 34 loan investments aggregating $460 million in commitments. This program continues to generate excellent cash flow that few other investments could duplicate, and creates a tremendous pipeline of new multifamily purchase options. These opportunities add aggregate over $1 billion in estimated market value and represent a potential significant embedded value due to discounted purchase options PAC receives at the time of origination of the real estate loan investments. This year, we expect to exercise options to acquire three or four multifamily communities originated through this program. After the close of the quarter, we acquired Luxe Lakewood Ranch, a 280 unit multifamily property in Sarasota and originated mezzanine loans for a 382-unit multifamily project in North Atlanta and just yesterday a 258-unit multifamily project in the Lindbergh submarket of Atlanta. With that, let me now call on Joel Murphy to discuss our grocery-anchored shopping center efforts in more detail. Joel?

[Joel Murphy:]

Thanks, Dan. As you know, we acquire, invest in and operate grocery-anchored centers that fit our investment criteria in suburban submarkets within the top 100 metro areas in the Mid-Atlantic, Southeast and now through Texas. We target centers that have market dominant grocery anchors that maintain a number one or number two or market share in that particular market and that have high and growing sales volume stores in the particular center. With all the recent headlines about retail and retail store closings in addition to clarifying our shopping center strategy, what it is that I just described, I’d also like to detail what it isn’t? We’re not in a mall sector; we’re not in a category killer big box sector; we’re not in the higher end apparel retail sector; and we’re not in the unanchored strip center sector. We are in the Sunbelt grocery anchored shopping center sectors, as I described earlier. Every one of our 34 centers is anchored by a grocery store. The recent announcements of massive store closing’s by Macy’s, JCPenney, Sears, H.H. Gregg, Payless Shoes and others, and other bankrupt or at risk retailers such as Claire’s, Nine West, Gymboree, Rue21, while interesting are not relevant to our focused grocery-anchored and necessity based strategy. They’re exactly zero of these particular stores in our portfolio. We do remain focused on the operating results of our portfolio, including tenant retention, new leasing, leasing renewals, and capital improvements to our centers. Our core portfolio excluding two centers, Champions Village and Independence Square, which are each in different phases of value add activities is 95.6% leased at the end of the second quarter. We’re particularly pleased also with the momentum of our lease renewals thus far this year and at attractive rent spreads. Combination of these positive trends have allowed the new market subsidiary to upstream outstanding results to PAC for the second quarter. We did complete two acquisitions during the second quarter. The first is an approximately 80,000 square-foot Publix anchored center in the Atlanta MSA, located in the high growth corridor of Georgia 400. Our centers continue to receive a warm reception from quality life insurance company lenders. We’ve financed this acquisition with a non-recourse 10-year loan at 3.99% from Principal Financial Group. The second one is approximately a 102,000 square-foot center, also in the Atlanta MSA, anchored by very high volume, 68,000 square-foot Kroger. We finance this acquisition with a non-recourse 10-year 3.73% loan from Prudential. Both of these loans are consistent with our overall companywide strategy of no cross defaults, no collateralizations, and no guarantees including carve out guarantees up to PAC or to PAC’s operating partnership. After the close of the quarter, in fact last week, we acquired an approximately 99,000 square-foot Kroger-anchored center located in the Columbia, South Carolina MSA. Kroger store sales are very strong at this location where they have sales growth trajectory over last several years. We financed this acquisition with a non-recourse 13-year 3.94% loan from Nationwide. We now own 34 grocery-anchored centers in seven Sunbelt states, totaling approximately 3.6 million square feet that has over 500 independent operating leases. As a result of our growth and scaled earnings stream and operational performance, we’ll continue to build our organizational capabilities by attracting and hiring new talent across our platform. We’re also very active in the marketplace and have a deep pipeline of new, accretive acquisition opportunities but we do plan to remain inside our tight, Sunbelt grocery-anchored strategy while also being disciplined about our due-diligence and our pricing. Now, let me turn the call back to John Williams.

[John Williams:]

Thanks, Joel. As we look forward to the balance of the year, we expect to continue our acquisition strategy coupled with disciplined hands-on operations. We feel confident. I’ll repeat that. We feel confident about our goals and plans for the remainder of the year. Although there continues to be supplier growth in the multifamily sector as a whole, we believe generally that the suburban-oriented type properties that we primarily target, are seeing less supplier acceleration and the urban-centric type properties. In fact, we’re definitely seeing a significant slowdown in starts in our markets, which probably has more to do with the overall tightening of money for developers. As our YieldStar revenue management system comes online for our multifamily communities, we’ve been transitioning from a manual up from a concession [ph] based leasing orientation to the YieldStar system, which concessions and the like are built into the actually gross rent amount. We this transition has had a temporary negative effect on our revenue. In connection with our grocery-anchored strategies, I think it’s important that I let everyone know where we currently stand with respect to a potential spin-off or a similar transaction for New Market Properties. We recently met with a verity of advisors who have been helping us assess for a spin-off of New Market as a standalone entity would look like. In the end, the takeaway from all of them was that we believe we need to continue to increase PAC’s overall asset base and market cap as well as increase New Market’s asset base before we go down this past, if that’s the past we choose to pursue. The goal is to make sure that both PAC and New Market follow spin-off type transaction are both on solid footing from both the stockholder return basis and a market cap basis. Our goal for any transaction of this type is that the transaction must be beneficial for all PAC stockholders as well as the future stockholders of New Market following the transaction. As a result, I do not expect us to pursue any measure activity in this area in the near future, a spin-off activity. In the meantime however, we’re very pleased with New Market’s operating strategy, its solid financial performance and as you’ve heard from Joel, we look forward to continue to grow this part of our business. Before I turn the call over to the operator, there are several questions that have been sent out to me in anticipation of today’s call. The first question was, we noticed that PAC recently refinanced two multifamily properties and please explain and how. And I’ll call on John Isakson to respond. John?

[John Isakson:]

Thanks, John. We pay a lot of attention to the financing of each of our properties as well as the financing for our collective portfolio. We constantly monitor the market and our various loans to see where we might be able to generate a better result. In the case of Stone Creek, we assumed an existing HUD loan at acquisition. By obtaining a green certification and improving the operations of the property, we were able to refinance the HUD loan to a new HUD loan with a 35-year maturity, lowered the all-in interest rate to 3.47% and borrowing an additional $4 million for which we’re paying [indiscernible] debt service. All in all, we were able to lower our full borrowing cost down to 75 basis points. In the case of Avalon Park, we initially financed the acquisition at closing with a short-term closing rate bridge loan from Prudential. Following completion of our amenity improvements at the community and our enhanced financial performance of the asset, we were able to finance also [ph] the bridge loan with a seven-year Fannie Mae loan bearing a fixed interest rate of 3.98% with a 30-year amortization. We were also able to pull out additional 1.5 million proceeds in connection with the new financing. These kinds of opportunities we constantly look for as we manage both the operations and the financials of all of our assets.

[John Williams:]

Thank you, John, and thank you for doing such a great job with that transaction. The next question is, how do you think Amazon’s announcement that is if it signs an agreement to buy Whole Foods will affect the grocery store market? Let me call on Joel to respond to that. I think he has answered these questions maybe a 100 times. Joel?

[Joel Murphy:]

Yes, it has been a topic. In June, obviously, in June Amazon announced they had reached agreement to acquire Whole Foods for $13.7 billion. And we believe this to be very much a net positive to our grocery-anchored strategy. And really it validates the brick-and-mortar delivery model for the grocery sector. Amazon is widely regarded as one of the most technologically advanced and savvy retailers. And their $13.7 billion investment in a brick-and-mortar distribution network validates the unique challenges to try and execute a pure online strategy for grocery delivery. This is the way that we felt when we saw, and after really digesting and thinking about it, and obviously this same thing has been reinforced by numerous investment analysts that follow the sectors. Most of the growth in ecommerce around grocery is focused on the last mile or getting the goods in the stores to the homes of the consumer. Our grocers have partnered with third parties, Publix for example with Instacart, they formulate internal solutions with Walmart and in-store pickup and Kroger with ClickList, to help advance this segment of their business. It has become clear in the past few years and really reemphasized in this transaction that traditional grocers must be proactive in pursuing online solutions in combination with their brick-and-mortar physical stores. We do believe that this transaction could and likely will result in increased margin pressure on grocers and that will likely accelerate sense of difficulties at some of the weaker players.

[John Williams:]

Thanks, Joel. Next question, are you seeing cap rate compression? And if so, how is this affecting acquisition program? Dan, can you respond to that?

[Dan DuPree:]

I can. Cap rates on multifamily properties remain compressed at or near 2016 levels, which recreates challenges for us to make accretive transactions and acquisitions. Fortunately, for us, we have other arrows in our quiver. As we mentioned before, our real estate loan investment program is running at full speed and its embedded purchase option discounts create value opportunity for us. Secondly, we have a measure of product diversity that gives us choices on how to spend our available capital.

[John Williams:]

Next question, are you able to replenish your real estate loan investment portfolio as you exercise purchase options? Dan, will you also take this question?

[Dan DuPree:]

Yes. So, we’ve noticed a significant increase in the interest in our real estate loan investment program from developers, as banks deal with increased pressure from the fed to lower their loans to value. So, over the past 12 months, we’ve initiated loans with two new development groups and we expect to add a couple of more over the next 12 months. Because of this, we anticipate our gross loans outstanding will be fairly stable and perhaps even slightly increased.

[John Williams:]

Thank you, Dan. I’d like to turn the call back to our operator and to open the floor for any other questions or thoughts you may have.

[Operator:]

We’ll now begin the question-and-answer session. [Operator Instructions] The first question comes from John Benda with National Securities Corporation. Please go ahead.

[John Benda:]

So, quickly, I know this is a smaller component but still relevant. On the debt refinancing that happened in this quarter. Are you going to be able to realize some more of that across the portfolio? It seems like it stays in 60, sometimes a 100 basis points on different loans. Is there more of that we had across the portfolio and what really drove those two refinancings?

[John Williams:]

I think those are two sort of lay ups because we knew that we wanted to do something with those two properties that we knew we could refinance to a better situation. I’m going to ask John, as he [indiscernible]. I think we’ve done such a wonderful job financing that there is not many more opportunities. Once there are opportunities for us to continue to source our HUD financing, which gives us extremely long duration, 35 years and low interest rates, we think that is a very, very important program that we’ve already taken advantage of and we want to do more coming down the pipe. But, John, would you like to add to that.

[John Isakson:]

John, I think, John Williams is right. There are probably a couple more opportunities here and there. And if the interest rate market moves in our favor, it might create an opportunity. But, because we do that silo financing upfront and because we’ve been relatively effective at it since inception, there are a ton of opportunities. But, there are couple of few more out there.

[John Williams:]

John, another thing that’s pretty important about our program, we really don’t take interest rate risk when we buy a property. We close on appropriate permanent loan at the time of our closing. So, we lock in our spread from day one, we don’t take interest rate risk, not us.

[John Benda:]

Okay. And then quickly, it seems like also very topical in the news of late or some of the issues that developers and office properties and multi-tenant properties are facing with millennial tenants. So, could you talk a little bit more about student housing and how that kind of fits into the overall portfolio of multifamily and what you guys see what the progression would be as that continues to grow?

[John Williams:]

We will continue to acquire and grow our student loan and investment portfolio. We think it’s a great business; it’s a complement to our multifamily business. And as a matter of fact, we’ve actually been surprised that really the innovations that we see on the student housing side, we can take and transfer to upgrades in our core Class A multifamily portfolio. So, it’s been a great positive effect for us. Millennials, the one change that I’ve seen over more than 15 years is we do not see the millennials move out to buy houses like we would normally see back 20, 30 years ago. The quality of the apartments are so great, that people -- and the locations are so good, the people are willing to live in the apartments for much, much longer before they consider buying a home.

[Operator:]

Next question comes from Frank Ammirato with Nationwide Planning. Please go ahead.

[Frank Ammirato:]

I was just wondering a quick question. Are there any plans to increase the dividend going forward, on the common?

[John Williams:]

We’ve increased the dividend 10 times so far. We generally do not increase the dividend as this Board meeting come up in next few days. But historically, we’ve always increased the dividend with the meeting in early November. So that might give you some guidance as to what could happen in the next few months. We believe that investors like our property of our commitment to continually increase our dividend and return value to our shareholders.

[Operator:]

There’re currently no more questions inside the queue. At this point, I’d like to turn the conference back over to John Williams for any closing remarks.

[John Williams:]

I want to thank you for joining us again today, and thank you for enjoying with us what was a really fantastic quarter. So, we’ll see you next quarter. Thank you.

[Operator:]

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.