Bluerock Residential Growth REIT, Inc.
Q4 2017 Earnings Call Transcript

Published: 14 Feb 2018

[Operator:]

Good morning, ladies and gentlemen. And welcome to Bluerock Residential Growth REIT’s Fourth Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I now would like to introduce your host for today’s call, Christopher Vohs, Chief Financial Officer of Bluerock Residential. Mr. Vohs, please go ahead.

[Christopher Vohs:]

Thank you, and welcome to Bluerock Residential Growth REIT’s fourth quarter 2017 earnings conference call. This morning, prior to market open, we issued our earnings press release and supplement. The press release can be found on our website at bluerockresidential.com under the Investor Relations tab. In addition, we anticipate filing our 10-K within the next week. Following the conclusion of our remarks, we’ll be pleased to answer any questions you may have. Before we begin, please note that this call may contain forward-looking statements as they are defined under the Securities Litigation Reform Act of 1995. There are a variety of risk and uncertainties associated with forward-looking statements and actual results may differ from those set forth in such statements. For a discussion of these risks and uncertainties, you should review the forward-looking statements disclosure in the earnings press release we issued this morning, as well as our SEC filings. With respect to non-GAAP measures we use in this call, including pro forma measures, please refer to our earning supplement for a reconciliation to GAAP. The reasons management uses these non-GAAP measures and the assumptions used with respect to any pro forma measures in their inherent limitations. And with that, I’ll turn the call over to Ramin Kamfar, Chairman and CEO of Bluerock Residential Growth REIT for his remarks.

[Ramin Kamfar:]

Thank you, Chris and good morning everyone. In addition to Chris, with me today are several additional key members of our executive team, Jordan Ruddy, our President and Chief Operating Officer; Jim Babb, our Chief Investment Officer; and Ryan MacDonald, our Chief Acquisition Officer. I will focus my remarks on our key strategic accomplishments and financial highlights from the quarter, and we’ll close with some internalization and the capital markets commentary. Afterwards, I’ll ask Ryan to provide you with additional operational, transactional and outlook detail. 2017 was a noteworthy year in BRG’s evolution with a number of significant accomplishments that I’d like to highlight. The first of these is our internalization, which we completed at the end of October. Internalizing our management was a goal that we had laid out at the time of our IPO, and we’re pleased to have completed this milestone. And we expect the transaction to have a number of benefits, including reducing our G&A growth as we go forward and continue to grow to eliminate any perceived potential for complex in terms of alignment of management with our stockholders and to provide us an opportunity to expand our institutional shareholder base. The second highlight is our ongoing portfolio enhancements in growth. During 2017, we deployed approximately $339 million of equity in real estate transactions. This included $208 million in acquisitions – in equity for acquisitions of 12 well-located, high-quality, highly amenitized properties and knowledge economy growth markets comprising over 4,400 units, and $124 million for 8 mezzanine and preferred investments in development properties comprising over 2,000 units. And with our expertise and relationships, we were able to book source-attractive prospects and be opportunistic in our investment strategy. Our activity this year is a good representation of our investment strategy, which is to seek out high-quality operating assets with value creation opportunities as well as selective development deals and where we can limit Bluerock’s risk exposure, but earn compelling returns through our mezzanine and preferred investments. During the year, we completed approximately $219 million in dispositions, generating IRRs between 22% and 38%. This demonstrates both our ability to create value as well as the discipline to sell at the appropriate time and to recycle that capital into assets that further enhance our portfolio and growth profile. Our third highlight is an enhancement to our balance sheet through implementing a $150 million bank line of credit, which provides us with increased flexibility to grow our portfolio and with more efficient cash management abilities. We also continued our opportunistic use of our Series B 6% preferred offering, which offers us access to cost-effective capital. In terms of operational performance, our fourth quarter results reflect the fact that we were continue to invest our available cash through late in the quarter. This positions us well as we go into 2018, but also it means that investors will see the full earnings capability of our investment starting in the first quarter of 2018 versus the current quarter. Furthermore, we anticipate that our performance should accelerate into the back half of the year as we implement our operational expertise and restabilization in our recently purchased assets. Now turning to our fourth quarter results on the revenue front. We were continuing to achieve meaningful growth. Our top line revenue for the fourth quarter was $36.5 million, which is a 54% increase from $23.7 million in the prior year quarter, largely as a result of our significant investment activity since Q4 of 2016. I should note that our revenue growth was impacted by our asset sales in the second quarter and expect the reinvestment of those proceeds will produce a full run rate starting in the first quarter of 2018. Net loss attributable to common stockholders for the quarter was $1.87 per share as compared to our net loss of $0.34 per share for the prior year quarter. For the quarter, our adjusted funds from operations attributable to common stockholders or AFFO was $3.1 million compared to $3.7 million in the prior year quarter. On a per-share basis, AFFO came in at $0.13, which exceeded our guidance of $0.03 to $0.06 per share. Moving on to property operations. Property NOI grew to $20.2 million in the quarter, which is a 37.6% increase from $14.7 million in the prior year quarter. Same-store NOI was down 60 basis points for the quarter versus the prior year quarter. This was impacted by the asset mix in our same-store pool changing due to recent asset sales and also by market challenges at two assets in Frisco and Fort Worth. Ryan is going to provide you with additional detail on that. Our asset base continues to grow. Our growth assets are over $1.6 billion, which is up 10% on a quarter-to-quarter and 36% on a year-over-year basis. On the acquisition front, during the fourth quarter, we closed on four operating properties totaling over 1,600 units for approximately $96 million in BRG equity and mezzanine loan investments in three development properties totaling over 700 units for approximately $84 million in BRG equity. And finally, on the investment front, we consolidated our ownership in five assets during the quarter by buying out minority interest with an $8 million investment. Again, Ryan will provide additional detail for you. Shifting to capital markets. During the fourth quarter, we completed sales totaling $46.7 million of our Series B 6% preferred shares. This preferred offering is an important part of our growth strategy because it continues to offer us access to cost-effective accretive capital, while at the same time minimizing potential dilution because it is convertible into common stock at a future price after a two-year lockout. So it enables us to access the markets without dilution at current equity prices. Our Series B raise will be lower in the first quarter of 2018 because our primary offering expired at the end of December, and we are kicking off the follow-on offering which takes time to build momentum. We expect that the quarterly run rate will reaccelerate back to a steady state level in the $45 million to $50 million a quarter range over the next couple of quarters. Moving on to the internalization. On October 31, following the approval of stockholders at our annual meeting, we closed the internalization of the external management function previously performed by our manager to further align the interest of our management team with those of our stockholders. 99.9% of the consideration was paid in equity. In December, the board approved an adjusted common stock dividend policy with an annual dividend rate to be set at $0.65 a share, which we expect to be covered on a run rate basis in 2018. Finally, I’m pleased to announce that the board has authorized a share repurchase program of up to $25 million. This share repurchase authorization is an important component of our capital allocation plan as it is accretive, both from an NAV and AFFO point of view and underscores our conviction and the value of the equity and our commitment to creating value for our shareholders. We intend to utilize this program opportunistically and with consideration of a number of factors, including prudently managing our leverage, our stock price and our other investment alternatives. On a personal level, given my unwavering belief in the value of the company’s equity and its outlook, I recently purchased a significant amount of additional shares and units, as you can see details in the Form 4 filing that occurred last week, increasing again my personal ownership of BRG. With that, I’d like to turn the call to Ryan. Ryan?

[Ryan MacDonald:]

Thank you, Ramin, and good morning, everyone. I’d like to start off by noting that from a same-store perspective, this quarter continued to be a transitionary period for us as we finished reinvesting the substantial capital on our balance sheet into growth-oriented assets whose performance will not be captured in the same-store pool for some time. Today, our same-store pool consists of 11 properties versus the total operating asset base of 28 communities. Portfolio-wide, across BRG’s assets, average occupancy for the fourth quarter of 2017 was 94%. Same-store revenue increased 2.8% over the prior year period, driven by a 2.7% increase in average rental rates versus the prior year period and a 20 basis point decrease in occupancy. Same-store expenses increased by 8.6%, of which almost half of them from increased real estate tax accruals and the remaining from an increased R&M and turnover costs. I would like to point out, however, the nominal growth dollar change was fairly limited at approximately $430,000, given the smaller subset of the same-store pool versus our total operating portfolio. And as a result, NOI in the quarter decreased by 60 basis points. Like the prior quarter, I want to note that our same-store performance was disproportionately impacted by negative performance from two assets in the DFW MSA. And particularly, our Frisco asset, which remains challenged with new supply and where we expect the operational volatility to persist through 2018 and starting in 2019, we are forecasting a dramatic drop in the number of new deliveries within the Frisco submarket, and we should benefit from more favorable supply demand characteristics. Excluding the two DFW assets, year-over-year, same-store revenue and NOI increased 4.6% and 1.4%, respectively. On the operational margin front, we experienced a 310 basis point decline in our margin to 59%. This decline is primarily attributable to our 2017 disposition and reinvestment activity, which will establish an attractive longer-term growth profile for the company. We exited mature cash flowing assets and recycled the capital into higher growth opportunities that typically take a couple of quarters to stabilize into steady operational state. During a period of high-investment activity, elevated turnover during an asset takeover is typical, and one-time upfront disproportionately distort margins. Shifting to the investment front, in the fourth quarter, we closed on four operating properties totaling over 1,600 units and approximately $260 million in gross asset value and $96 million in BRG equity. The business plans focus on executing our Core+ renovation strategy, which includes targeted capital improvements to the interior units and amenity areas so that we can migrate the assets to our standard, highly amenitized, live-work-play lifestyle product. Two of the investments were partially funded with draws from our new line of credit totaling $54 million. Our Hunter’s Creek purchase was funded with a $72 million fixed rate loan from Freddie Mac at 3.65%. The assets are projected to yield a year one cap rate of 5.3% and grow to a stabilized cap rate of approximately 6.5% versus market cap rates ranging from 5% to 5.25%. In addition to the four property acquisitions, we closed on the buyouts of minority ownership interests in five assets totaling $8 million in BRG equity and originated three development mezzanine loans with a combined BRG investment totaling $84 million. In terms of development commitments, the $84 million in originated mezzanine loans included the conversion of three common equity development investments to mezzanine loans. Prior to the conversion, we had funded approximately $50 million in common equity for investments in Crescent Perimeter and Vickers Village in Atlanta, Georgia, and the Metropolitan in Fort Lauderdale, Florida. As part of the conversion to mezzanine loans, we invested an additional $34 million in order to fully fund the $84 million commitment, all of which is earning a 15% annualized cash AFFO. Following the conversion of existing development, common equity and additional investment in the three projects outlined, the total BRG investment in development preferred equity and mezzanine loans is projected to be approximately $212 million. At year-end, BRG had $39 million available for investment through a combination of cash and availability on our bank line of credit. And finally, let’s turn to our outlook. We are optimistic about the year ahead and have an attractive portfolio, which will continue to deliver solid growth as the property stabilize. We are introducing full year AFFO per share guidance for the first time. And for 2018, we expect AFFO per share to be in the range of $0.65 to $0.70 per share. These guidance numbers reflect the benefits of realizing the earnings power from investing approximately $218 million in BRG equity throughout the last half of 2017. The ramp in NOI should continue throughout the year as we begin to realize the value-creation opportunities through stabilization of properties, operations during acquisition takeover and the benefits of our Core+ renovation strategies. For additional detail on our underlying assumptions, please refer to our earnings release and supplement. And with that, I will now return the call to Ramin to conclude.

[Ramin Kamfar:]

Thank you, Ryan. That’s the end of our prepared remarks. And with that, I’m happy to open it up for Q&A.

[Operator:]

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Rob Stevenson of Janney. Please go ahead.

[Rob Stevenson:]

Good morning, guys. Can you talk a little bit about how you guys are expecting to fund any stock repurchases that you wind up doing? So it’s going to be some corresponding dispositions. Are you guys willing to use the line or other stuff to other capital of the Series B preferred, et cetera, to buyback comment?

[Ramin Kamfar:]

How are you, Rob?

[Rob Stevenson:]

Good.

[Ramin Kamfar:]

It’s a good question. We have cash availability on hands between what we have on hand between the line and between the Series B to fund the $25 million and more. We think that, obviously, if it gets to a point, you can always sell assets because our – and buyback stock because what we can get for our assets in the market today at a 5% to 5.25% cap is significantly higher than our market-implied cap rate. So it’s – so it would be accretive to us. But we don’t plan to do dispositions at this point. I think part of our migration, we had a lot of movement in terms of our income statement and balance sheet in 2017 to set ourselves up with a go-forward portfolio that’s core for us. So we exited markets that weren’t core, assets that weren’t core, assets where we didn’t own the substantial majority, 90% or 100%. So we have a great portfolio going forward. And we anticipate what you’ll see is, hopefully, a lot less turnover and disposition activity as we focus on our one rate AFFO and growing that. So that’s a long – that’s a bigger picture answer than what you asked. But the short version is we’re not anticipating dispositions to fund that at this point.

[Rob Stevenson:]

Okay. And then given the different vintage assets that you guys have in the portfolio today, how many units do you guys currently have targeted for, either kitchen and bath upgrades or something more extensive? And how much of that do you expect to fund in 2018?

[Ryan MacDonald:]

Sure. This is Ryan. We have almost 4,000 units that we can renovate throughout the course of the life cycle of the asset. And I think this year, we have targeted about 1,400 units across the platform. So – and our average cost is about 6,000 unit and projected ROI is approaching 30%. So about $150 to $175 increase.

[Rob Stevenson:]

Okay. And then last one for me. You indicated that there was a sort of pause of the Series B expired and you guys are in the process of renewing that. When you take a look at the 50 basis points move in the tenure of the year, how much of a change in appetite are you expecting on there? And is there anything that you guys have sold previously being below the $1,000 par?

[Ramin Kamfar:]

So in terms of appetite, we don’t see a significant change in appetite for the Series B. As you know, it’s a 6% coupon. And that is significantly higher than you could get still in the treasury market – and it comes with a different risk return profile. People buy the Series B because of the stability and lack of volatility and price in addition to the fact that it has an attractive yield. So we haven’t – we don’t anticipate that there’s going to be a significant change in demand. And we’re not hearing that in the market. And was the second question that have we sold it at a – have we sold any of it at a discount? If I’m understanding the question right, the answer is no. And we don’t anticipate to.

[Rob Stevenson:]

Okay, perfect, guys. Appreciate it, thanks.

[Operator:]

[Operator Instructions] Our next question comes from Drew Babin of Robert W. Baird. Please go ahead.

[Drew Babin:]

All right. Good morning. Question on your markets. I think one market there, you have a decent concentration in Orlando. And looking down the list of your properties, it looks like they have some of the higher occupancy rates kind of across your portfolio, probably having to do with migration into Puerto Rico, which has happened in that market. Is there anything that you’re doing in Orlando to try to manage down occupancy at the margin and translate that to rate growth as we approach 2018?

[Ryan MacDonald:]

Certainly, Drew. Yes, we did increase occupancy heading into the end of the year, but we are forecasting it returning to a more normalized, call it 95%, rate and driving rental rates throughout the year. So I don’t envision it staying up around 97%, 98% across the board, but we are seeing some significant rent growth in Orlando.

[Drew Babin:]

Can you see that as being relatively sustainable, given the dynamics there? And maybe not just kind of a temporary lift?

[Ryan MacDonald:]

We do. I think we’re pretty confident with the forecast throughout the year. I think the jobs to supply ratio there has been pretty strong. And then long-term, I think we’re big on Orlando being an experiential entertainment hub that will continue to drive the long-term job growth.

[Ramin Kamfar:]

Drew, I think that, obviously, the in-migration from Puerto Rico has eaten up multifamily space in Orlando and some of the submarkets. It’s not really our assets. But obviously, as the market tightens up, we get a temporary lift. But that’s a small part of what we see in the Orlando picture. Our core strategy is to build these highly amenitized live, work, play apartment communities and next-generation knowledge economy markets. And these – now as we transition from an industrial economy to a knowledge economy, these are going to be markets that drive the next generation of job growth. And by that I mean health care, education, technology, finance, trade, high-value manufacturing, entertainment and energy. And Orlando, when you look at it as a market that has irreplaceable entertainments that you can’t replicate anywhere else. And as we move towards more of an experience-based economy, where people are paying up for experiences, this is the market that is going to continue to grow over the next decade, two decades, three decades. So it’s a core next-generation market for us. And I think we’ll look back at it in 10 years and see how incredibly it’s changed. I just went two days touring the market and touring our assets there, and we’re big believers in Orlando. So while Puerto Rico is giving us somewhat of a lift there or a longer-term job drivers in Orlando that will sustain that over years and decades in our point of view.

[Drew Babin:]

Thank you. That’s very helpful. And shifting to other markets. Obviously, sort of Dallas-Fort Worth has been some new supply. Obviously, demand is very strong in that market. And Ryan touched on Frisco supply kind of dropping off. Are there any markets close to Sunbelt where supply presents somewhat of the risk or somewhat of the headwind in 2018 that you might be watching a little more closer.

[Ryan MacDonald:]

Sure. Drew, it’s Ryan again. I mean, I think Durham’s been one that – again, we like long-term, but we continue to share a little bit of supply pressure in downtown Durham. But again, long-term, we think it’s got potential to be, call it, the 24-hour destination within the triangle. So that in particular is one. Charlotte has been a little bit soft, call it through the end of the year, early part of this year. But we expect job growth to reaccelerate in 2018 and then have some of the deliveries drop off. So those are two that come to mind.

[Drew Babin:]

That helps. I guess I’ll leave it with one balance sheet question. Floating rate debt kind of as a percentage of your overall debt is significant, I mean, with what’s happening with interest rates. I guess are you looking at any hedging options or anything that you might view as worthwhile, given forecast of increases in interest rates? I mean, obviously, that cost is still very low relative to what you invest at, but just curious if there’s any conversations happening related to that.

[Ryan MacDonald:]

Sure, Drew. I will tell you that we are migrating the portfolio fixed versus floating percentage up. I think we’ve got a couple of refinancings in the works that will drive that up, probably about 10% on average. And then we should be able to continue migrating the fixed versus floating percentage up further throughout 2018 as we focus on fixed-rate financing. So the percentage of floating will come down, I’ll say, immediately, but also throughout 2018 as we populate more fixed-rate financings. But yes, we are always looking at hedging options for our floating exposure as well.

[Drew Babin:]

Great. Thank you, great quarter.

[Operator:]

[Operator Instructions] And our next question comes from Paul Penney of Northland Capital. Please go ahead.

[Paul Penney:]

Can you give more color on G&A? And how you expect that to trend post – now being internally managed?

[Ramin Kamfar:]

Hi, Paul. G&A is obviously – when we were externally managed, it was blowing by 1.5% of our equity base, that was our management fee. That number, the growth is going to be significantly lower than that at about, let’s say, half to one-third of that going forward because you’ve got pretty much the senior team in place. And as we grow out, as we fill in underneath that, it is going to be at a significantly lower ramp, which is one of the benefits of the internalization. You can see the G&A numbers that we forecast in our outlook. We’re guiding to $11.07 to $11.08 on a cash basis, and that’s a significant benefit to where we would have been with externalization – with an external manager, I mean.

[Paul Penney:]

Yes, great. Thank you. And are there – I missed, maybe, the first part of the call. In terms of trends on cap rates, what are you seeing lately? And does it change your strategy going forward for the company in terms of your growth plans? And secondarily, are there any markets that are maybe as you reevaluate are non-core or non-strategic that you would potentially look to sell and redeploy?

[Ryan MacDonald:]

I’ll take the first part of that question on cap rates, Paul. Cap rates are pretty much the same as they were last year. There hasn’t been any gapping out from interest rate increases, and I think a lot of it has to do with capital flows into multifamily space. Us, as a company, we try not to buy assets on a marketed basis. So we’re always looking for an incremental spread when we buy assets relative to market, not only immediately but also, obviously, creating additional spread after we drive our Core+ renovation strategy. But as a whole, marketed deals, I think, generally, the pricing is pretty consistent with where it was last year, call it, pre-interest rate run. On the market strategy piece, I think post recycling of assets in 2017, we’re very comfortable with our portfolio footprint today. I mean, we are looking at additional growth markets all the time, whether it’s Denver, Phoenix, et cetera, but it has to be the right opportunity, right cost of capital, right value proposition for us. So – but the existing portfolio today, market-wise, we’re very comfortable long term.

[Paul Penney:]

Okay. And then last one for me, one last one. Are there any new strategic partners that you’ve added to the fold, like the tremors of the world? Are there any new partners that you’ve added that are partners with you guys in – for 2018?

[Ryan MacDonald:]

We haven’t added any additional in 2018, but we did add one called CWS Capital Partners in 2017. Again, great, well-established organization that’s been in business for over 30 years, and we partnered on a transaction, a portfolio transaction, together in Texas and are currently looking at new opportunities with them as well. So it’s been a good partnership thus far, and we look forward to more deals with them.

[Operator:]

[Operator Instructions] As we have no further questions, I would like to turn the conference back over to Ramin Kamfar for any closing remarks.

[Ramin Kamfar:]

Thank you, operator. And I want to thank everyone for giving us their time today. Look forward to reporting on our progress to you and showing our earnings capacity at the end of the first – at the – starting with the first quarter of this year. Thank you, everyone, for your support. Have a good day.

[Operator:]

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