Preferred Apartment Communities, Inc.
Q2 2013 Earnings Call Transcript

Published: 6 Aug 2013

[Operator:]

Good morning ladies and gentlemen, and welcome to the Preferred Apartment Communities Second Quarter 2013 Earnings Conference Call. All participants will be in a listen-only mode. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Lenny Silverstein, President and Chief Operating Officer. Please go ahead.

[Leonard A. Silverstein:]

Thank you operator and thank you very much for joining us this morning, and welcome to Preferred Apartment Communities Second quarter 2013 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 a review of our performance for the second quarter and his thoughts for the remainder of 2013. Also with us today are Mike Cronin, our Executive Vice President and Chief Accounting Officer; Dan DuPree, our Vice Chairman of the Board and Lead Independent Director; Bill Leseman, our Executive Vice President for Property Management; and Paul Cullen, our Chief Marketing Officer. 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 on our website also includes an attachment containing our supplemental financial data report for the second quarter with definitions and reconciliations of non-GAAP financial measures and other terms, which 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. First let me say how pleased we are with the company’s operating performance for the second quarter. We believe our cash flow from operations and our AFFO were exceptional. Through the conversion of our Series B Preferred Stock this past May, we more than doubled our capitalization. We now have over 11 million shares of common stock outstanding. In addition, our leasing activity for the quarter in terms of rent increases and occupancy exceeded our expectations, and we are now starting to harvest the values created by our mezzanine loan program as seen with the acquisition of Trail II, which should be a solid contributor to our organic growth. For the second quarter, we reported net cash provided by operating activities excluding the effect of approximately $125,000 of acquisition costs related to the acquisition of Trail II this past June of approximately $2.6 million. This represents an increase of approximately $1.7million or 200%, over the net cash provided by operating activities for the second quarter 2012. Our second quarter 2013 AFFO attributable to common stockholders and unit holders was about $1.9 million, an increase of almost $1.1 million or 129% compared to our AFFO results for the second quarter of 2012. We reported FFO for the second quarter of 2013 at a loss of approximately $5.5 million, which reflects deductions for a one-time deemed non-cash dividend of approximately $7.0 million related to the conversion of the Series B preferred stock to common stock this past May. And the acquisition costs of $125,000 related to Trail that I just mentioned. Excluding the effect of the one-time deemed non-cash dividend related to the conversion of the Series B Preferred Stock, our FFO would have been approximately $1.5 million in the positive or an approximate 153% increase over our FFO for the second quarter of 2012. Our Same Store net operating income which reflects the operating result of our multifamily communities that we have owned for at least 15 months increased approximately 11.2% for the second quarter of 2013 compared to the second quarter of 2012. Total revenue increased approximately 5.4% and total operating expenses decreased approximately 3.5% on a period-over-period basis. As of June 30, our total assets were approximately $260 million compared to about $123 million as of December 31, 2012. For the second quarter of 2013, we declared a dividend on our common stock of $1,660,000 or $0.15 per share, which was paid on July 22 to all of our common stockholders of record as of June 26. As we’ve indicated before, we’ll continue to seek to have our dividend be cash sufficient, which as you are aware in large measure is aided by continued acquisition activity. And speaking about acquisition this past June, we acquired a 96 unit town home style multifamily community in Hampton, Virginia, for approximately $18.1 million. This community which we call Trail II is located adjacent to our existing Trail Creek community that we acquired in 2011. The construction of Trail II was partially financed by our $6 million mezzanine loan that we financed about 2 years ago on which we received a 12% IRR. At the time we acquired Trail II we also refinanced the Trail Creek mortgage by entering into a new mortgage secured by both phases of Trail for an aggregate loan of approximately $28.1 million bearing fixed interest only payments of 4.22% per annum through June 2020. Trail Creek previously was financed with variable rate debt. As a result of this acquisition, we now own 1789 units in our portfolio as of June 30, in addition to the potential additional 1640 units available under our mezzanine loan program. Now I would like to turn the call over to John Williams for some additional remarks and thoughts. John?

[John Williams:]

Thank you, Lenny. Overall we continue to believe our mezzanine loan program is an outstanding financial structure that should create significant accretion for the company. In addition to focusing on AFFO as t primary driver for measuring performance of our company I would like to confirm that other than our $30 million revolving line of credit facility, we incurred no debt at the company or operating partnership levels. None of our individual property mortgage financings are cross collateralized with each other and none have any recourse liability upstream to the company or to our operating partnership. In other words except for our revolver our debt resides at a positive level and is isolated in separate limited liability companies we’ve established on each of these properties. In connection with our branding efforts, we continue to receive positive feedback from current and prospective residents. In particular the PAC Concierge, PAC Rewards and PAC Partners programs continue to appeal to our residents and help distinguish us from our competitors. Since an overwhelming percentage of our current and prospective residents utilize laptops and mobile devices, they search and gain information about PAC and PAC communities, we continue to refine the robustness and ease of use of our website across all platforms. The PAC stockholders and others who follow us, I encourage you to visit our website, which we’ve designed and levered to be transparent, user friendly and highly informative. In addition as we enter into mezzanine loan transactions, we provide the developers with a binder containing our specifications for certain construction elements and branding that we feel are important. We expect the developers to use these guidelines to build outstanding and uniform projects that will enhance our brand identity which in turn assist us in determining whether to exercise our options down the road to develop these properties. Our primary strategy continues to be to grow PAC through acquisitions for which we will need capital, at least for the foreseeable future. We routinely assess the various capital raising markets to identify what we believe is the most reasonable way to provide additional capital based on our needs and plans. As I mentioned earlier, we have more than doubled our outstanding common stock to the automatic conversion of our Series B preferred stock into common stock this past May, which we expect will benefit both our liquidity and trading activity on NYSE market stock exchange. Last month SEC also declared effective our shelf registration statement pursuant to which we were able to offer up to 200 million of securities. This registration statement should help make our future capital raising efforts more official. Fortunately we believe that our pipeline to continue to allow us to make prudent investments as we raised capital. In summary industry experts continue to reports strong demand for newer programs as we see ourselves. As job growth picks up which is historically the important factor for our program success we believe we will see increase household formation which will drive apartment occupancy. Although production of new apartments has increased as of late it is still far below historical norms. As a result we believe the apartment business continues to be on the upswing with the wind on our backs. We will continue to actively manage our communities, and as usual, do our best to balance vacancies with direct growth while at the same time provide superior service to our residents. In addition we will continue to look at alternatives on how to fund PAC’s growth prospects in light of the current economic climate. With the goal being to always make prudent and safe investments. Before I turn the call over to the operator there are several questions that have been submitted in anticipation of today’s call. Here is the first question. With the acquisition Trail II in June, can you comment on the value you believe it created for the company and the stock holders? I will ask Dan DuPree to answer this question for us. Dan?

[Dan DuPree:]

Yeah John, it increased the accretive value for the company in several ways. First, it increased the size of the project from 240 units to 300 units, and with scale we achieve efficiencies and market presence. And as Lenny mentioned earlier, doing that transaction allow us to consolidate and fix the rate on the debt for the project at attractive rates. During the development we received 8% interest paid monthly during construction, and just prior to closing we were paid the accrued interest of approximately $280,000, which brought our total earned interest on the project to a compounded 12%. It should be noted that we have booked across our various mezzanine loan projects currently and to-date $1.67 million of similarly, easy for me to say, accrued but not recognized AFFO interest. Maybe on a more significant note on our eight outstanding loans, we are currently accruing between $600,000 and $750,000 of accrued interest each quarter. Accrued interest is now recognized in AFFO until we exercise our purchase option on the loans or our own loans are otherwise paid off. Clearly this represents a significant store of earnings going forward. Finally, and perhaps most importantly a key element to our mezzanine loan program is the option that we have to purchase the stabilized projects at a meaningful discount-to-market. In the case of Trail we believe that we were able to acquire this asset at a cap rate that was 25 to 40 basis points better for us than if we had had to make the deal in market. In this case because it was a small mezzanine loan, the discount was probably worth in the range of $700,000 to $1.2 million where we need to go out and resell the project which we are not going to do.

[John Williams:]

Thank you, Dan. Next question that was previously submitted to us, why were your same-store result so strong? Well, thank you for that question. Same-store numbers I think were probably amongst the best in the apartment REIT industry. We had a strong 5.9% rental income increase and overall income increase of 5.44. The 5.9% rental increase is the primary driver of our success. We actively hands-on management with our portfolio, our rent levels were reviewed almost on a daily basis but senior management on a weekly basis. Most of the apartment companies that are out there use a revenue model that is generated by a computer. And we have seen over the past that this revenue model produces basically average results and I think if you go look at the other REITs that are out there, you will see a relatively standard 3% to 4% rental increase, and I think that is the driver from these LRO systems that are computer generated. Also we did an excellent job of controlling expenses this past quarter, given us an outstanding 11.2% NOI increase. So, overall, I think it is hands-on management that really gives us a distinct advantage. The next question that was submitted is, you mentioned that your FFO for the quarter was negative. Would you explain this again? I’m going to ask Lenny to tell us more about FFOs.

[Leonard Silverstein:]

Thanks John. This is a question that we received actually several inputs on, and it was not just the FFO question but it also tied in to the net loss attributable to our common stock holders. First, I just would like to remind everyone that we are a real estate company in an acquisition mode. And as a real estate company one of the drivers through acquisitions is it generates a significant amount of depreciation and amortization. And in fact for the quarter, we had almost $5 million of depreciation and amortization. In addition affecting both of those separate numbers our FFO numbers and our net loss attributable to common stockholders, but the fact that we had under GAAP about a $7 million deemed non-cash dividend to the preferred stockholders who had bought our Series B back in January which then converted automatically in the middle of May. On top of that we have prepayment cost on Trail when we aggregated both phase I and phase II to finance the two projects together. We believed it was better in this economic environment to go with a fixed rate loan as opposed to continuing the variable rate loan that we had on phase I, and in order to do that, that created about $600,000 of prepayment cost as well as just the acquisition cost for Trail II which were $125,000 which will be similar to what some people refer to as 141R expensive. Therefore if you took these types of items which really were not necessary reflected at our operating results you basically ended up going on a net loss attributable to stockholders of a negative $10.3 million to a positive $2.3 million income to the common stockholders. So they had had a huge swing when you back out these other types of cost which really are not operating cost. On an FFO basis we reported FFO of a negative 5.5 million, but again if you add back in, the acquisition cost of Trail II of $125,000 and our deemed on cash dividend to the preferred stockholders of seven, we would result with about $1.9 million of positive FFO which is a huge increase of where we were a year ago at this point.

[John Williams:]

Thank you Lenny. And I would now like to point that the cost of depreciation and amortization and the loss that we reflect it gives us the ability to actually have tax deferral on our dividends, and we will perhaps ask someone to comment on what we expect for the year, but I think that it means that our dividend should be essentially dividend efficient for this year. I will also – let me call on Bill Leseman because we would always ask what the leasing trends look like. So, Bill, who actively manages close to 30,000 apartments throughout 17 states has a great handle on what is going on with leasing business. And Bill, why don’t you tell us what’s going on from a leasing stand point.

[William Leseman:]

Thank you, John. As we speak to all of our markets, not only overall markets but as well as our preferred markets the leasing trend remain very strong throughout the US, and within the markets. And they are either at or above our budgetary expectations. When we take the leasing trends and combine them with our efforts to control turnover, and we see turnover going down at our properties, those get combined and enabled us to lower availability and achieve growth in both occupancy and rental rates in most cases above, even above our budgetary expectations. So we see those as a working debt or be very strong.

[John Williams:]

Thanks Bill. And as a follow-up question to leasing activity, the question came in, can you give us your thoughts on projected win increases for the balance of 2013. And essentially we are very optimistic about win increases. Our occupancy as reported in our supplemental has been very strong for the first six months of the year. And in fact in July we saw our leasing reports look about as strong as anything I have seen in the last 10 years. We had very few vacancy and very few notices, and puts us in a great position to continue to raise rents which we will do very briskly. So we think that we are in a great position for the remainder of the year. And, now operator open up to see if there are other questions from our listeners. Operator?

[Operator:]

(Operator Instructions) Our first question comes from Wilkes Graham, Compass Point.

[Wilkes Graham:]

Hi good mornings. I just have a couple of three quick questions. First, can you comment at all on if you have seen change in cap rates in the markets that you are in given the 100 basis point or so rise in tenure?

[John Williams:]

Well, we really haven’t seen much of increase in cap rates. I think that in my 40 plus year history there will be an increase, but it easily lags the increase in interest rates. We are actively looking at a number of potential acquisitions and we think that our cap rates have stabilized, they are certainly not falling, but we haven’t seen much upward pressure either.

[Wilkes Graham:]

Is your appetite for acquisition strong as it was a couple of quarters ago?

[John Williams:]

Yes we would love to make some additional acquisitions, and the numbers basically worked for us, the difficulty we have is our current stock price. We don’t want to cut our stock price and to the extent that we would have to sell common stock to buy assets that’s not as appealing to us as it could be we would like to see our stock price up a little bit. But, no, there is a wonderful accretive transaction available if you are able to buy the cap rate at six, and you are able to put 4% debt on property, it generally means that it should be an accretive transaction for us. And so we are actively looking throughout the Southeast primarily in Texas for acquisitions.

[Wilkes Graham:]

Okay just two I guess housekeeping questions. Can you give us any of the terms on the $6.9 million mez loan to get a steady housing development? I mean what the current and accrued yields are.

[John Williams:]

Yeah, I will ask Dan to make a comment. But essentially it’s our standard deal which is an 8% current pay, 6% deferred pay which we collect at the time we closed, and a negotiated cap rate option that we can acquire the asset after stabilization. Dan, do you want to make a comment on that?

[Daniel DuPree:]

I think you covered it.

[John Williams:]

The other thing that is important with our terms are that we give the developer essentially a spec program specification that he has to honor and we have a very experienced fellow in our organization that does monthly inspections and we carefully review the draw request that are being turned into the senior lenders. So we carefully monitor those programs pretty closely.

[Wilkes Graham:]

Okay, thanks. And then last question, the Note receivable line item went up by about $5 million, can you comment on perhaps what that what is backing that note and what the interest rate is.

[John Williams:]

I think it’s a land loan.

[Unidentified Company Representative:]

Look at that in CPA line of credit, decreased over the quarter.

[John Williams:]

Let us go to another question, and we will research that and get back and tell you before we end the call.

[Wilkes Graham:]

Okay thanks.

[Operator:]

Our next question comes from alright a second, Larry Raiman at LDR Capital Management.

[Larry Raiman:]

Good morning team, great job on the quarter. I had a couple of quick questions for you. First, as far as (inaudible) mentioned and you all mentioned with regards to a student helping project that you provide finance for, total different thing your heritage and being a premier apartment and multifamily owner. Could you just describe the focus there on incremental basis, is this something that will be more core to the company or is this more of kind of an offshoot of what you are doing?

[John Williams:]

Well, first, we believe that the strategy is the same multifamily student housing, very similar construction, standards are very similar. And we still consider it under the umbrella of multifamily. It just gives us, Larry, another arrow in the quiver. It appears to us after two three years of studying that – and student housing sector is not quite cyclical and the only issue that we will continue to monitor is CAPEX. And, in our budgets where we underwrote the property we actually added additional CAPEX to our normal apartment development. But, from our standpoint we consider it multifamily, we consider it under the umbrella of multifamily. We don’t want to get off straight from our core capable of the construction, the management is all very similar, and it just – we think it gives us another arrow in the quiver. Dan, would you like to make a comment?

[Daniel DuPree:]

Yeah, I would just add that we were taking a look at this product type, the numbers are compelling. They are more compelling on paper than even the traditional apartments by may be a 100 basis points which gives us some room to deal with CAPEX and other issues that we think might be there.

[John Williams:]

So not straying from our core capabilities, but a toe in the water to look at something that might give us higher yields and maybe some additional stability.

[Larry Raiman:]

Okay, and yeah thanks for that explanation and just a quick question on your income statement. There is a line item I just wanted to take clarification on it. There is an expense for management fees to affiliate and I just was – I am not clear what that represents, to management fees to related party. Can you just kind of explain what that line item is on your income statement?

[Unidentified Company Representative:]

Yeah, two things. One we have the normal – the property management fees are to Preferred Residential Management which is our property level management company. And we have PRM set up as an independent subsidiary, LLC organization for liability purposes, because we don’t want to have the risk of a potential slip and fall or anything else going up stream to PAC or to the manager itself. And as a result of that since PRM is part of the (inaudible) that’s why it reflects as an affiliate relationship.

[Larry Raiman:]

That is a wholly-owned entity of the company, it is actual subsidiary.

[Unidentified Company Representative:]

PRL itself is not a wholly-owned subsidiary of either the manager or PAC. It is affiliated through common control. You will also have management fees to the related party which are the normal management fees payable to further property advisors as our external manager.

[John Williams:]

Thank you Larry, any other questions Larry?

[Larry Raiman:]

No, thanks so much.

[John Williams:]

And there was a question about the additional notes payable on – notes receivable on the financial segment, and that is for a – essentially a bridge later on where we have where we have first mortgage on the land for a property in midtown Atlanta, 13 Street. We are still looking at the pro forma and the numbers to see if this will work for us as a mezzanine loan, otherwise it will be essentially paid off and it will be treated as a loan, it will just be repaid.

[Operator:]

My next question comes from Bill Gibson at Legend Merchant.

[Bill Gibson:]

Hi, just one easy one. Any estimate as to the current net asset value?

[John Williams:]

Well, we have not run it in a long time. The last time we took a look at it, and will be using my formula, just take the assets and putting a typical cap rate on it. I came up with something notable, $11. Dan, have you run it lately?

[Daniel DuPree:]

Now, the trick on that is, is trying to value the mezzanine loans. I gave you a little bit of flavor early on what our accrued interest is. But, you know, we believe – I am sorry, we believe that their significant value in the purchase option because we know our purchase option give us the divided discount, but the more obvious part is the accrued interest that is not reflected in our earnings right now and is a significant number between $600,000 and $750,000 a quarter. So, rather than put a number on NAV, I mean we have got our own ideas of what the value of the mezzanine program is. But it would be speculative.

[Bill Gibson:]

Okay, thank you.

[Operator:]

Our next question from Wilkes Graham at Compass Point.

[Wilkes Graham:]

Hey John, thanks for the detail, can you – just for modeling purpose, do you know when that – that extra notes receivable in Atlanta, when it would mature if it just remained a note.

[John Williams:]

I think it will mature during the month of October.

[Wilkes Graham:]

Okay. Is it 10%?

[John Williams:]

It has an 8% current coupon, where they retch it up it goes up to as high as – we will take the overall yield up to as high as 18%.

[Wilkes Graham:]

Okay. And then last question. You know, looking at the purchase option windows or the acquisition windows for t mez bonds, I think the nearest term, now that you are all (inaudible) is Madison Rome and 2015, is that right?

[John Williams:]

Well, those are dates that are put in our options. Generally take us out for some hypothetical stabilization date. We can always go as we did with Trail II, back to the developer, and try to negotiate an earlier purchase. Obviously, since there is substantial money accruing, the developer would be keen to talk to us about an early maturity, and therefore the dates that are in there do not necessarily work. For instance, the Rome Shopping Centre, Publics is fixturing their store and we are going to say Publics will open the first week in October. We think the whole shopping center will be completed, maybe 30 to 45 days after that the developer will be under I think some pressure to come to us and say why do not we pay this off and we would probably look pretty favorable at it. And we also have Summit 2, it is the property here in Atlanta that was finished up maybe about a month ago. Bill, I think that property is about 85% to 90% leased.

[William Leseman:]

That is correct.

[John Williams:]

We are about 85 to 90% leased, we would expect a bit stabilized perhaps in October and generally Fannie or Freddie require 90 days to stabilization before we would be able to put a permanent loan on the property. So that would probably give us a target date sometime during the first quarter that Summit would be taken out as an acquisition. And then…

[Wilkes Graham:]

I apologize. I meant to say Summit 2, and based on what you are saying it seems like Summit 2 may be the next that you could afford…

[John Williams:]

I think Summit 2 will be the next one we acquire, but the next one that pays off more than likely will be the Rome Shopping Centre.

[Daniel DuPree:]

Yeah. That is what…

[John William:]

Dan, any comments on that or is that…

[Daniel DuPree:]

No, I think the 13 Street round will pay off first and…

[John William:]

The 13 Street Round will pay off in October, probably end of the year, January, I would guess January for the Rome Shopping Centre and probably February or March for Summit 2.

[Wilkes Graham:]

And you don’t think that the Madison Rome will convert to a mez loan with a purchase option?

[John William:]

No, I don’t think we will acquire – that gets back to Larry’s question earlier about our focus. I don’t think that we will acquire that shopping center. I think probably sold to a third party.

[Wilkes Graham:]

That’s all. Appreciate it.

[John William:]

Thank you.

[Operator:]

(Operator Instructions) Seeing no further questions I would like to turn the conference back over to Mr. Williams and the management team for any closing remarks.

[John Williams:]

Thank you, operator. I want to thank everyone for joining us for the call. We are very pleased with our performance during the second quarter. We are looking forward to third quarter and we hope you will join us again in early November for our next call. Thank you so much for joining us.

[Operator:]

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