Preferred Apartment Communities, Inc.
Q3 2017 Earnings Call Transcript

Published: 1 Nov 2017

[Operator:]

Good morning ladies and gentleman and welcome to the Preferred Apartment Communities Third 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 introduce your host for today's conference call Lenny Silverstein, President and Chief Operating Officer. Please go ahead.

[Lenny Silverstein:]

Thank you for joining us this morning and welcome to Preferred Apartment Communities third quarter 2017 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 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 third 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:]

Thank you, Lenny. Good morning everyone, despite the challenges from hurricanes Harvey and Irma, I'm pleased to report that we had another very solid quarter, which sets us up very well for our projected full year results. In a moment Lenny will review our third quarter financial results followed by Dan DuPree and Joel Murphy who will also review our acquisition and real estate loan investment activity and our grocery-anchored shopping activity respectively. As you may have seen from our press release last week our third quarter financial results and projected fourth quarter results have allowed our Board of Directors to declare a $1.50 per share increase in dividend payable to our owners of common stock as well as the of the close of the business on December '15. Resulting in a quarterly dividend payment of $0.25 per share. This will represent almost 15% increase in the aggregate dividends per share payable to our common stockholders for 2017 compared to 2016. Our stated goal for 2017 as you know is to increase our aggregate common stock dividend for a share by 10% as well as our earning. We’re obviously quite pleased to report that we will more exceed this goal. However, despite the continuous flows in our common stock of dividend, we are also pleased we are able to continue to maintain an even more of our core FFO payout ratio. Since our first common stock dividend payment following our IPO in April of 2011, and including the dividend increase was just amounts for the fourth quarter we increased our dividend 12 times which will produce an annualized dividend growth rate or 15.5% per share. From a common stocks perspective, we continued our focus on increasing our public trust. From our IPO, where we had roughly 5 million shares of common stock outstanding, we now have almost 35.6 million shares outstanding, as of September 30th. On a comparative basis this was have been some increase approximately 10.9 million shares from the period of September 30th, of last year and increase of 9.1 million shares of the common stock for the first nine months this year alone. Our capital raising activities have enabled us to continue to pursue a robust property acquisition strategy both through our third-party acquisitions and as they result by real estate loan investment program. This strategy has allowed us to focus on acquisitions that we believe will be accretive to our shareholders. We have continued to acquire each asset in n a separate legal entity like a silo with no cross-collateralizations of property mortgages and no upstream guarantees to PAC or our Operating Partnership. Although this financing technique is more promising than simply acquiring assets under our global credit facility, we absolutely believe this creates a fortress life balance sheet for the benefit of all our stockholders. As of the end of the third quarter the average age of our multi-family portfolio was an outstanding 5.9 years, which we believe is the youngest portfolio aged in the industry. In fact, we believe that the very young age of our portfolio the quality of our constructing to construction of our assets and the various third-party insurances we have previously have secured for our Texas and foreign communities were significant factors in this in helping us to work through [indiscernible] hurricanes Harvey and Irma. So, before I turn the call over to Lenny, and first we want to thank all our associates and industry of our associates located in our Texas and Florida communities for the amazing and personal sacrifices they gave in the face of hurricanes Harvey and Irma. In Texas, for example, we had associates who made their way to our Stone Creek Community in Port Arthur both off as they have after Hurricane Harvey and despite experiencing damage and flooding to their own homes and in some cases the location of their own families. In fact, we had one associate who hitchhiked a ride on two boats just to get to our whole alpha community to take care of our residents. We also had associates in our Texas and Florida properties stay outside of the site on their own violation. [Indiscernible] oversee any need assistance for our residents and in a position to immediately implement property-level remediation activities. We also had purchased at all levels and from foreign lives convertors in one Texas and Florida communities affected by the hurricane to assist either banks or each other out. In our eyes, our associates are true company heroes. We're very proud of them. So, with that, let me call on Lenny to walk you through our numbers. Lenny?

[Lenny Silverstein:]

Thanks, John. Overall, we once again produced solid operating results for the third quarter, which is in line with our internal budget and tracking with our full-year guidance. Revenues for the third quarter were $74.9 million. This represents an increase in revenue of $21.4 million or almost 40% greater than the revenues for the third quarter last year. Our FFO for the third quarter this year was $0.36 per share compared to $0.31 per share for the third quarter last year. This represents a 16.1% increase on a quarter-over-quarter basis. Our core FFO for the third quarter this year was $0.38 per common share; this was the same as the third quarter last year despite having 10.9 million more shares of common stock outstanding for the third quarter this year compared to the third quarter of last year. In addition, our core FFO payout ratios in our common stock for the third quarter this year was only 64.5% which we believe clearly represents the strength of our company's earnings. Based on the year-to-date results we're narrowing our core FFO guidance range for the year to a $1.43 to $1.46 per share. For the third quarter 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 third quarter of 2016. Switching to other financial statement metrics we continue to add quality assets to our portfolio in a meaningful way. As of September 30, 2017, our total assets net of depreciation were approximately $2.9 billion, representing an increase of $800 million or 37.9% compared to the same period in 2016. In addition to increasing total assets, our cash flow from operations for the nine months ended September 30 was $28.1 million, which represents an increase of approximately $7 million or 33.8% compared to the first nine months of operations for 2016. At the end of the third quarter, our leverage on assets based on undepreciated book value was 54.3%. 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. This is even more meaningful when you remember that we acquire a number of our assets at contractual discount through our real estate loan investment program. A key component of our strategic plan is our investment program. I’d now like to call on Dan DuPree to provide some more color on our acquisition activity, our loan investment program, and our pipeline. Dan?

[Dan DuPree:]

Thanks, Lenny. Our investment objective is to create growth and manage our best in class portfolio of Class A multi-family assets together with a targeted strategic 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 a pipeline of attractive acquisition options, off market and at contractual discounts, while providing compelling returns during construction. This is a meaningful part of our business. At the end of the third quarter our real estate loan investment portfolio consisted of 23 projects totaling 6,083 units and 6,509 student housing beds; this represents the opportunity for us to acquire assets costing over a $1 billion at discounts if we exercise the options that are embedded in each line. Here in the third quarter of this quarter, we acquired four multifamily communities two located in Atlanta and one each in Sarasota, Florida and Kansas City Kansas. Together these four acquisitions represent an aggregate of 1012 units. It's interesting to note that the two Atlanta communities we acquired are well as result of discounted purchase options mentioned above. Separately we also required four grocery anchored shopping centers during the third quarter located in Atlanta, Charlotte, Raleigh and Columbia, South Carolina, representing an aggregate of 376,000 square feet in a gross leasable area. Joel Murphy will speak to these in a moment. And in addition to our acquisition activity during the third quarter we originated four multifamily real estate loan investments and one student housing real estate loan investment, representing an aggregate principal commitment of $94 million. Two of these multifamily communities will be located in Atlanta with the other two located in Charlotte and Fort Myers, Florida. The student housing community will also be located in Atlanta, collectively these five real estate loan investments create a pipeline in additional 1424 multifamily units and 816 student housing. On a more global basis as of the end of the third quarter we owned and manage multifamily communities totaling 8374 units across United States, additionally we own two student housing properties totaling 1319 beds, one at Florida State University in Tallahassee and the other Arizona State University in Arizona. And these also reflects the sale of three multifamily communities earlier this year. Subsequent to quarter end and impact just as past Friday, we acquired a 98% interest in joint venture that owns the newly build 792 beds stadium village student housing community located near the Kennesaw State University campus in Atlanta. This was a project for which we originated real estate loan investment for its development. Kennesaw State student enrollment is the third largest university enrollment in Georgia. With all of that let me now call Joel Murphy to discuss our grocery-anchored shopping center efforts in more detail. Joel?

[Joel Murphy:]

Thanks, Dan. We remain intensely focused on the operating results of our portfolio including tenant retention, new leasing, leasing renewals and capital improvements to our centers. We have continued our solid leasing results again this quarter and our overall portfolio lease percentage is now 94.2% up 70 basis points from the end of the second quarter. Year to date we have moved this number up 120 basis points from the 93% at the beginning of 2017. 13 of our 30 shopping centers are 100% leased. And we're 100% leased its four centers we owned in Florida. We're particularly pleased with minimal of our lease renewals thus far this year and an attractive branch. Combination of these positive trends allow the new market subsidiary to upstream outstanding results to back. We’ve two centers which are each in different stages of value add phases as part of our remerchandising strategy or be more selective on which tenants we renew, so actually moving some operators out and electing to extend some tenants only on shorter term arrangements. This will allow us to maintain maximum flexibilities and work to improve the tenant mix in these centers and execute it on our value add strategy at both of them. The core portfolio excluding these two properties is 96.2% leased at the end of the third quarter an increase of 50 basis points over the end of the second quarter. As Dan mentioned, we completed four acquisitions during the third quarter having an aggregate investment of approximately $74 million including acquisition expenses. Three of these anchored on high volume Kroger stores and one is anchored by high volume Harris Teeter store. These centers are located in the MSAs of Atlanta, Colombia, South Carolina, Charlotte North Carolina and Raleigh North Carolina. So, as you can see, we are continuing to expand our geographic diversity throughout the Sunbelt. All of these centers are excellent examples of our focused strategy anchored by a market leading grocer that is high sales per square foot store and located in a solid sunbelt submarket with excellent demographics. All the loans are paid in connection with these acquisitions are consistent with our overall companywide strategy of no cost default, no cross collateralization and no guarantees including curve out guarantee up to the PAC or the PAC OP level and our centers continue to receive a warm reception from quality, life insurance company lenders. Within our 37 grocery anchored centers in 7 Sunbelt states in 17 markets totaling over 3.8 million square feet with nearly 600 independent operating leases. We do remain active in the marketplace on new acquisition opportunities, but we are also very diligent on staying in tight in our tight geographic and product type strategy while also being disciplined at our due diligence and our pricing. Now let me turn the call back to John Williams. John.

[John Williams:]

Thanks, Joel. One of the things I want to circle back is the impact for Hurricanes Harvey and Irma has on our operating expense. As you may have seen in our financial disclosures from last night, our operating expenses were higher than normal. Embedded in these expenses are higher property tax especially as we value our multifamily communities on a much more regular basis including annually. Also embedded in these costs are higher costs we incurred related to hurricanes. For example, the increased personnel and overtime policy, incurred to help to prepare our communities for the hurricanes. In addition to the damages we sustained in our Stone Creek multifamily community in Port Arthur, Texas in the third quarter which required us to allow approximately $6.9 million in the pre-stated assets. We expect our property insurance to cover all of the losses. Our income for the three months period in ended September was impacted by approximately $217,000 million, these insurance deductibles loss and other related cost, which were added back for purposes of calculating core FFO. Hurricane Irma also impacted our portfolio of multifamily and grocery anchored shopping centers in Florida. We anticipate cost associated with this storm to total approximately $300,000, $500,000 which will be recognized in the fourth quarter 2017. And will be added back for purposes of calculating core FFO for these periods. As we look forward to the balance of the year, we expect to continue our acquisition strategy, coupled with disciplined hands on operation. We feel confident about our development plans over the remainder of the year as evidenced by the narrowing of our full year guidance. Although there are in contingence of the supply growth in the multifamily sector as a whole, but we are still seeing a slowdown both in terms of starts and deliveries in our markets, which following has more than to with the overall tightening of money for developers and excess qualified workers. We remain pleased with New Market's grocery anchored shopping center operating strategy and its solid financial performance as you heard earlier from Joel. Although only a small piece of our business we're also -- remain pleased with the solid financial contributions provided by our office property and student housing divisions. We look forward to continuing to grow these parts of our business. On another note since our IPO our common stockholders annualized returns on investment is 28.7% as of September 30, 2017, assuming the automatic reinvestment of all dividends. Also beginning in 2018 we intend to report our financial results on a traditional FFO method, as adopted by NAREIT many years ago. Before I turn the call over to operator there's several questions we've been asked in anticipation of today's call. First question please explain the financial impact of hurricanes Harvey and Irma on your results of operations? I'll call on Bill Leseman. Bill?

[Bill Leseman:]

Thank you, John. First, I don't want to trivialize the impact these hurricanes have on the folks living in Texas and Florida. These hurricanes especially Harvey in Texas created a lot of chaos; from our perspective we have three multi-family communities located in Houston mainly in the North and North/Northwest corridor and one community in Port Arthur, Texas. Our recent properties frankly did not suffer any significant damage from hurricane Harvey but it did receive an ancillary benefit of increased occupancy. Prior to Harvey our occupancy for these three communities was approximately 95.4%, subsequent to Harvey occupancy increased 2.7% to approximately 98.1%. Please also understand that this increase in occupancy following hurricane Harvey is all in context of our decision to maintain ramps at those properties at a pre-Harvey level until just recently and waving many of the upfront application type fees we typically collect during this time period. As for our Port Arthur community the first four of each of our buildings received flood damage as well as leasing office. From a finance perspective as John noted earlier we have enough flood insurance as well as supplemental catastrophe insurance coverage that includes business interruption insurance and lost rental income coverage. All in all, we think we'll be fine once we through all the insurance related issues. As for Florida, most of the damage per properties there was not nearly as significant and focused generally more on landscaping issues and some minor roof, socket and window leaks. We had minor physical damage to our Naples property where the hurricane Irma hit, where the eye of the hurricane Irma hit. That asset newly constructed and is primarily constructed out of concrete. Again, we have insurance coverage and we believe will help ameliorate any material financial impact on those Florida properties. Thank you.

[John Williams:]

Thanks, Bill. Joel, how did our Florida and Texas grocery-anchored shopping centers hold up during hurricane Harvey and Irma?

[Joel Murphy:]

Yes, overall, we had very minimal damage to our centers in Texas and Florida, we did have some roof leaks resulting from the intense rain all of which we've now addressed and we had zero flooding.

[John Williams:]

Thanks. The next question, are you seeing cap rate compression and if so how is this affecting PAC after this program. Dan.

[Dan DuPree:]

Yes, sure. Cap rates on multifamily properties remained compressed at or near 2016 levels and yes this does make it more challenging for us to make accretive acquisitions. Fortunately, we have several other arrows in our quiver. We have our real-estate loan and investment program and it's been better purchase options discounts and current interest rates during construction and secondly, we have a measure of product diversity that gives us choices on how to spend the available capital in the most efficient way.

[John Williams:]

Thanks. Next question you had significant increase in your outstanding shares of common stock this year. Do you expect this to continue? Lenny?

[Lenny Silverstein:]

Well, finally you are correct. We've increased our outstanding shares of common stock and 9.1 million shares this year with a corresponding positive increase in our trades and volume in the stopping shifts. We've try to continue to increase our common shares outstanding which we can accomplish in multiple ways including stock sale under our ATM program, sales mainly in connection with overnight box transaction like the one we completed last quarter which is by demonstrating and sales made in connection with the exercise of outstanding cash warrants that are issued in connection with sales of our series A redeemable first stock.

[John Williams:]

Thanks Lenny. Next question is, what is your role played in investments portfolio looks like going forward as you exercise existing purchase options? Dan?

[Dan DuPree:]

Yes, we continue to notice a significant increase in the interest in our real-estate loan investment program from developers as banks feeling increased pressure from HVCRE heightened regulations to lower loans to value. Over the past 12 months we have initiated loans with two new development groups and we expect to had a couple of more over the next 12 months and these groups are groups with whom we have had long standing relationships and I know how they are going to behave in good times and in bad. Because of this we anticipate our gross loans outstanding to be clearly stable and look perhaps really going forward some slight increase.

[John Williams:]

Thanks Dan. With that I'd like to thank you for joining us on our earnings call. I'd like to turn the call back over to the operator to open up the floor for any other questions where callers you may have. Operator?

[Operator:]

[Operator Instructions] Our first question comes from Frank Ammirato with Nationwide Planning Associates. Please go ahead.

[Frank Ammirato:]

Yes, very impressive I must say for the quarter. You guys did a great job down there. I want to ask you the average -- if you can tell me the average in leased terms I know they are different for the multi-families as it is for the shopping centers but what would be the average leased terms you have on those properties?

[John Williams:]

I think Dan, you would be able to tell that. The multi-family properties are generally one year but we have and we have [Indiscernible] our figures, but Dan do you want to talk about the other?

[Dan DuPree:]

I mean that's right, I mean one of the great things about having several products as an understanding that multi-family is the mother ship for us, where we have our shorter-term leases, we can respond to changes in the market more nimbly. Our retail fits nicely with us because the anchored tenants on long-term leases they represent generally about half of the GLA and half of the revenue in our projects and the smaller sample office that we have, we been able to make every acquisition, I think with average lease term excess of nine years remaining. So, it’s a blend that that allows us to really look out into the future at lease maturities.

[Operator:]

Our next question comes from John Benda with National Securities Corporation. Please go ahead.

[John Benda:]

So just quickly, on the Stone Creek impairment, where is that reflected in the financials, the $6.7 million that was written off and when do you guys expect that profits to be back, in general revenue?

[Mike Cronin:]

This is Mike Cronin, basically with the loss of the first floors in all the buildings, we wrote off the depreciated book value related to those floors and basically set up a receivable from the insurance company, the expectation being obviously that they will get all details with the insurance proceeds. What is the P&L being deductibles, and cost that Bill Leseman mentioned related to landscaping issues and some of the repairs related to roofs soft etcetera. And additionally, unrecorded loss revenue around a $100,000 for the quarter that we expect to get back in the future that is not set up yet on the receivables under GAAP. Collectively those numbers total rough to about $217,000 and that’s what we've added back to core FFO.

[John Benda:]

My next question was going to be about Kennesaw State, the JV that was formed, does that the intent going forward on some of the purchase options you exercised from JV, I mean fortunately we have 98% interest you can consolidate it is not a separate P&L item but are we going to see that structure on more deals forward or is this kind of one off time.

[John Williams:]

Before I answer that, Lenny wants to make further comment on the hurricane write off.

[Lenny Silverstein:]

Yes, the hurricane write off charge, that information if you go back and to the third quarter results, you will see what Mike Cronin just laid out for you and it's pretty clear on that front. With respect to the structuring of the transaction at Kennesaw State that had a couple of opportunities available to us especially with respect to trying to maintain the cash bases on the assets and it's not something that we're going to necessarily do for every transaction every transaction as opposed to a straight acquisition, it a transaction-by-transaction structural determination, and we just look at it to maximize value for PAC and our stockholders.

[John Williams:]

Let me comment on that, as you know one of the challenges we have, we have a very high call portfolio, and in fact of looking at opportunities to increase our taxes at every chance. The structure of allowing there to be a small piece of the developers who maintain an interest allows us to not necessarily reflect the sales in the traditional sense. I hope no tax assessors are listening to us, but essentially, what this allows us to be is not having to file something that we flag out property for increase taxes. Only for we seen community and very aggressive from taxes that we evolve this pattern. So, I think it's a we perhaps will use it again but it will be pay us to very specific expectations. And Dan wants to make a comment.

[Dan DuPree:]

Yeah, I'll just make an editorial comment. The KSU, Kennesaw, is one of the most successful projects that we ever been involved with. It's 100% leased at the start of the school year we had 195 additional applications on file on our wait list.

[John Williams:]

And I going to be you could not have a more successful property.

[John Benda:]

Okay. And then lastly kind a of follows up all these questions. As you compare the 2Q, '17 release and 3Q '17 release and look at the purchase option windows, there is about 3 properties other than Stadium Village that matured either 9-1 or 10-1. So, can you talk about what decision, what drove the decision to exercise Stadium Village, but maybe not even 8 or 12 or 18, 19 something like that. How do you kind of decide which property you are going to take down of all the windows that are open?

[Joel Murphy:]

Well, a little bit relates to the developer. Frankly, the developers are trying to make sure they're getting capital gains treatment on the turnover. And the truth is we will probably exercise another four transactions in the fourth quarter one on [indiscernible]. So, we don’t set up so that we have a pattern evolved who follow up, [indiscernible] relates to the tax rate for the developers, it relates to which one will take the asset of these ownerships. The truth is we get paid very handsomely for the properties that stay in mezzanine loan program. The mezzanine program generally includes 8.5% pay rate and another 5% or higher of fully growth that we think when we buy it. So, we're try to manage those earnings pretty seriously.

[Daniel DuPree:]

Yeah those are options. And there maybe a variety of reasons why we decide from time-to-time it's not best interest to exercise the option. We may decide we don't like the market, maybe things that we've discovered during the development process. Or it can even be a situation where the asset was so good that it was diluted if we did acquire. So, variety of things and factors going into the decision.

[John Benda:]

And do you have a flexibility to push out the purchase option windows on basically every loan that’s made. Is that flexibility kind a built into everything you guys can underwrite?

[John Williams:]

Generally, we did. Even though we have specific takedown period we can renegotiate if it's favorable for the developer or maybe favorable for us. So far, the developers we used have been very amenable for us to work with them on the delivery date.

[Operator:]

This concludes our question-and-answer session. I'd like to turn the conference back over to John Williams for any closing remarks.

[John Williams:]

Thank you for joining us and thanks for sharing another great quarter with PAC.

[Operator:]

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