Kelly Residential & Apartment Real Estate ETF
Q3 2019 Earnings Call Transcript

Published: 10 Nov 2019

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Front Yard Residential Corporation Q3 2019 Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] I would now like to turn the conference over to your host, Ms. Alysia Cherry, Head of Investor Relations. Please go ahead.

[Alysia Cherry:]

Thank you, Tiffany. Good morning and thank you for joining us for Front Yard third quarter 2019 earnings conference call. Joining me on today’s call is George Ellison, Chief Executive Officer; Miles Adams, Senior Vice President of Property Operations; and Robin Lowe, Chief Financial Officer.I’d like to guide everyone to the third quarter earnings slide presentation available through the Investors section of our website at www.frontyardresidential.com. These slides were created to accompany our remarks and provide additional information investors may find useful.I’d also like to inform you that our comments today may contain forward-looking statements relating to the future performance of our business, the company’s financial results, capital allocation and other non-historical information.These statements may involve risks and uncertainties that could cause the company’s actual results to differ materially from those discussed in the forward-looking statements. We describe some of these risks and potential differences in our earnings release, as well as the company’s filings with the SEC, including the Form 10-Q we filed today.We may also discuss certain non-GAAP financial measures. You can find additional information on these measures, including a reconciliation to GAAP within our earnings release and earnings presentation located in the Investors section of our website.I’ll now turn the call over to George Ellison, Chief Executive Officer. George?

[George Ellison:]

Thanks, Alysia. Good morning, everyone. This year has been one of the most ambitious years in our company’s history from reorganizing corporate governance, making changes to our Board to internalizing the operations of 15,000 homes. It’s only been 6 months, since many of these initiatives has been in place, but I ‘m proud to say this management team has been working nonstop to maximize shareholder value and prove the value of the company.The third quarter has two important stories, the first is organization, the second is how we’re positioning for our operational performance in 2020. On the organizational front, we’ve had many great successes this year. We reorganized the management agreement between the manager and the REIT, restructured the board, formed the strategic review committee and hired an advisor, Deutsche Bank, to explore our strategic options and ways to enhance our franchise value.On the operational front, as we discussed on last quarter’s call, we completed the transition of all externally managed homes to our own platform. And we discussed the opportunities and challenges that represented. Since we last spoke, our team has invested a material amount of time, energy and money to address the problems that arose from our rapid transformation to internal property management.We have been thoughtful in our approach to ensure that we implement long-term solutions, that enable us to operate and grow effectively. The good news is that there are many improvements underway in our operations and many green-shoots sprouting in the business. The downside is that in the short term, some of the metrics we use to judge ourselves have taken a temporary step backwards.Occupancy, rent increases and turnover metrics are again strong. Other measures, such as cash-to-cash times, collections and other income are rapidly improving. But spending more to get unit turns under control, which will accelerate leasing and get occupancy up, obviously, hurt NOI and FFO. This is only the second full quarter that we have internally managed 15,000 homes, and things have started to turn around.We’re about halfway through this process and remain very optimistic that the results are coming and will be worth the investment. We continue to believe that the workforce housing single-family rental business is as robust as ever, and Front Yard residential is extremely well positioned to take advantage of this opportunity.More and more Americans are choosing to rent, either because they can’t get mortgage credit, they want to remain mobile or they simply choose not to own. Workforce housing is the fastest-growing segment of the rental market. While the new supply of homes is not keeping up, the demand for our products and services continues to grow. As I said, we hit some challenges as we transitioned 12,000 homes on to our platform.We identified these challenges and attacked them. Let me now turn things over to Miles to walk through the incredible work he and his team are doing as we ride this ship. Miles?

[Miles Adams:]

Thank you, George, and good morning, everyone. This has been an extremely productive quarter. We’ve made important strides on all of our key initiatives to build an efficient, scalable platform to maximize the long term performance of our portfolio.As a reminder, during our last earnings call, we discussed three primary operating challenges that began to manifest at the end of Q2 that continued to impact our results for Q3. Prolonged days to re- resident due to excess homes in turn, which adversely impacted occupancy levels, elevated repairs and maintenance expense and collection rates below our expectations.Those issues were particularly pronounced in Texas and Tennessee. I am pleased to report significant progress in each of these areas. And I’m excited about the trajectory of several key additional operational metrics that started to show substantial progress by the end of the third quarter, was even more pronounced in October, as outlined on Slide 6 of our presentation.For unit turns and leasing, we experienced a backlog in Q2 due to the transition of an elevated number of vacant homes from third-party managers and turnover of key field-based personnel in Texas and the Midwest. This led to subpar leasing times in Q2 that hurt our occupancy at June 30 and into July of Q3.During the quarter, we significantly lowered the percentage of homes in unit turn, down from 4.5% in mid-July to 2.6% as of October 31, which should benefit our rental revenues in the coming quarters. However, this effort had a short-term negative impact on our turn expense as the increase in the volume of turn completions represented additional expense in Q3 beyond our normal turnover cost.We made a strategic decision to commit to this initiative to stabilize the occupancy of our portfolio. This effort and the team’s hard work propelled our leasing efforts in August and September of Q3 and in October of Q4, resulting in an increase in occupancy from 93.8% by July 31 to 94.3% by September 30 and 94.5% by October 31, 2019.These gains were driven largely by continued strong performance in Atlanta, our largest market, which grew 80 basis points to 97.1%. Additionally, we achieved very strong gains in occupancy in two of our key markets, including our second largest market, Memphis, which grew 310 basis points to 93.9%. And Indianapolis, our largest Midwest market, which grew 280 basis points to 93.7%.While work remains in this area in Texas, Nashville and other Midwest cities, we have the lease-ready inventory available to continue our progress towards our targeted stabilized occupancy levels in these markets. While we grew our occupancy, we did not sacrifice rental rate growth, demonstrating the high demand for our homes.Our blended rental growth rate of 3.9% during Q3 remained strong and was comprised of renewal rent growth of 4.2% and re-lease rent growth of 3.5%. These metrics were in line with or in excess of our public peer in almost every market where we overlap. In addition, we grew our occupancy at competitive lease-over-lease growth rates in the face of waning seasonal demand. We were particularly pleased with the re-lease and renewal growth rates in Atlanta, by far our most significant market at 7.6% and 5.2%, respectively.On collection rates, we discussed the disruption of the collection cycle that occurred with the transfer of homes. The final transfer of approximately 7,500 homes from 1 of our 2 third-party property managers occurred in Q1 of 2019 and was primarily located in the Texas, Carolinas, Tennessee, and Midwest markets, all markets in which our operational footprint was recently established.Our recent entry to these areas, when combined with market-specific personnel issues, resulted in collections that did not meet our expectations for these portfolios and that were not in line with the rest of our homes. As a result, our bad debt expense was elevated slightly during Q2 and elevated further during Q3 as we work to correct this issue.We made changes in property management personnel during the quarter, as needed, and worked tirelessly to improve this area. I am very proud of the progress we made and the effort our team expended to achieve the improvement needed here. As a result of this work, as of the end of October, our collection rates improved 300 basis points and are now at our targets at day 30, which should translate to lower bad debt expense in the fourth quarter as the benefits of this progress generally translate into financial improvements in 1 to 2 months after achievement. We expect to see further marginal improvement in our collection rates as we continue to fine-tune our collections processes.On R&M and turn costs, improved control of these expenses is being achieved through a greater percentage of work orders and turns being performed in-house. During our August call, we discussed our plans to add skilled maintenance technicians to our teams in certain markets to achieve sufficient bandwidth to meet our goals of in-house performance of work orders.We also discussed the exciting improvement in efficiency we’ve seen through the implementation of route optimization software for scheduling our maintenance teams. We initially deployed this software in Atlanta where we more than doubled our ability to perform cost saving work orders in-house from June to October, with each technician averaging more than 5 work orders per day.To date, we’ve implemented this software across nearly half of our portfolio, with plans to expand this across our entire platform. Through a combination of additional staff and route optimization, we’ve seen an increase in the volume of in-house performance of work orders of approximately 35% on a sequential quarterly basis and to over 50% in October. We aim to perform approximately 50% of our work orders in-house by year-end, which we believe, will lead to significant cost savings. In addition, as we have added team members, we have strategically staffed skilled techs, with specialties in HVAC, electrical and plumbing, that can provide us greater opportunities to not only handle more work order volume, but also to complete work orders that traditionally have a higher per unit cost.From a personnel perspective, we are excited about our new market leaders and key team members in Texas and Tennessee. We’ve spent a considerable amount of time with these teams over the past few months, and I’m very encouraged by their energy and effort. I’m confident, we are positioned to perform up to our potential in those markets and optimistic about what can be achieved by those teams.So let’s quickly recap. Occupancy is on the rise from 94.1% at June 30 up to 94.5% by the end of October. Blended rent rate growth remained strong at 3.9%. Turnover improved to 8.4%, down from 8.7% last quarter. Unit turn inventory is down by nearly half to 2.6%. The reduced turnover volume, combined with investments in personnel, will position us to self-perform a greater percentage of our unit turns, which will lower our per turn unit cost going forward.The number of R&M work orders performed in-house increased by 35% over the prior quarter, and we are on track to meet our goal of 50% by year-end. Collections have been dramatically improved during the quarter and in October, and bad debt is expected to decline significantly going forward.In summary, the third quarter was challenging and the results were impacted by our rapid growth. However, our team worked diligently to address those challenges. Additional work remains, but I’m pleased with the progress we made during the quarter and in October. I am confident, we will ultimately realize results commensurate with our expectations and goals.I will now turn the call over to Robin.

[Robin Lowe:]

Thanks, Miles. Good morning, everyone. Today, I will cover the financial results for the quarter, touch on balance sheet activity and provide an update on acquisitions and dispositions. GAAP net loss for the quarter was $36.4 million. This includes a $10 million net settlement of our last remaining securities action. Rental revenue was up 5% compared to the third quarter of 2018, with 14,311 stabilized homes, 1% less than a year ago. The drop in stabilized rental core NOI margin and core FFO reflected the operational challenges that Miles has discussed, as we’ve adjusted the transfer of approximately 12,000 homes onto our internal platform.As miles has indicated, we are seeing stronger operating metrics in October that we believe should drive better operating results in the fourth quarter. G&A costs for the third quarter were lower by $2.5 million as non-ordinary course legal and professional fees reduced by over $2.1 million and ordinary course G&A reduced by over $300,000.Turning to the balance sheet. 93% of our financing is either fixed rate or capped with a weighted average duration of 5 years. Of the fixed and capped rate debt 45% is capped, which means that there would be a benefit from any further potential LIBOR reductions. During the quarter, we acquired 28 homes at a purchase price of $3.8 million or an average cost of about $136,000. We sold 126 non-core homes that did not fit our rent criteria. Net sales proceeds were approximately $23 million, with a gain of $2.1 million of the GAAP carrying value.On Slide 17 and 18, we provide details of investment costs and home price appreciation by key markets that we believe provides support for a baseline valuation of our portfolio. I’ll now turn the call back to George.

[George Ellison:]

Thanks, Robin. So let’s summarize. In the second quarter, we took control over our entire portfolio for the first time. When 12,000 homes moved on to our platform, some regions of the country and procedures responded well, some less so. We quickly identified areas of concern. We found out what the issues were, and then we attacked them all of us. I’d like to thank the entire team for responding positively and aggressively to turn our ship around. Ercan Gurhan and his team, team India led by [Kishor Venkatesh] [ph], Rob and his group, and of course, Miles and everyone in property management, all are working tirelessly to get our business back up to our own high standards.As Miles pointed out, the results are starting to show

[Operator:]

Thank you. [Operator Instructions] Your first question comes from the line of Sam Choe with Credit Suisse.

[Sam Choe:]

Hi, guys. I’m on for Doug today.

[George Ellison:]

Good morning.

[Sam Choe:]

Yeah, morning. So, you guys mentioned that the Texas and Midwest environments, you saw increased turnover in field staff. What was that exactly? And I guess more generally, can you talk about the competition for hiring talent?

[Miles Adams:]

Yeah, so in both of those markets we had to replace the Director of Operations for both of those regions. There were also some office-based personnel that we had to switch out due to the issues that we encountered, particularly in the collections area.We are seeing, at least for the office-based personnel, there are still great candidates out there that are readily available and that are eager to work in this industry. I would say in the field for your maintenance technicians and folks that perform unit turns, it’s certainly more challenging to find good staff there, but we’re still able to attract good talent at rates that work for our business, but it’s certainly more challenging for field-based team members.

[Sam Choe:]

Great. Another one for me. I know we saw the seasonal increase in R&M cost. But just thinking about the implementation of technology, I’m just wondering how that’s been rolled out. And whether – I guess, just thinking about the general training process and how that affects R&M expenses over time, any color on that would be great.

[Miles Adams:]

Sure. Yeah, so, and this is something we’re really excited about, and we spent quite a bit of time. This was something that we utilized our whole team for. But George mentioned, our India team and finance and literally the – he mentioned every department and this is something that we all pulled together to put in play. So our India team schedules our technicians through the use of a software overnight as work orders come in previous day.And that allows us to get the most efficiency to reduce drive and wait times for our maintenance technicians that are out in our field. They wake up and look at their laptops and they have their day planned for them and a route that’s most efficient from their homes, in the basic loop around the city and the regions that they cover.It’s we’ve seen, as I mentioned, and almost, we’ve doubled the efficiency of our team there in Atlanta, just by cutting down all of the needless wait and drive-time. And so we started there. We’ve expanded it now almost a half of our portfolio. And everywhere that we’ve gone, we’ve seen tremendous success, and we believe strongly in the model. And I think that it has application across the entire platforms, so definitely excited about that.

[Sam Choe:]

Now, you said half the portfolio in Atlanta. I guess, how long does it typically take? I know it might be market dependent, but like is that something that can be streamlined?

[George Ellison:]

Yeah, I think we can – I think by the year-end, we have every market that is feasible to do that. I mean, we do utilize third-parties for certain smaller remote locations, where we don’t have our own personnel performing that work. So I don’t think we’ll get to 100%, but I think we can get to 85% to 90% of the portfolio and we can have that all implemented by year-end.

[Sam Choe:]

Okay. Great color. Thank you so much.

[Operator:]

[Operator Instructions] Your next question comes from the line of Mike Grondahl with the Northland Securities.

[Mike Grondahl:]

Yeah, good morning, guys. George, when you say the portfolio should be back in shape kind of early next year, are you saying that your core NOI margin, kind of that previous range you had, you can hit that sort of 1Q/2Q? Is that what you mean by that?

[George Ellison:]

Here is how I like to address that question. We can’t see, obviously, November and December yet. But the changes that we all spoke about, we really started implementing in July, August, September. And so, we did – July and August were pretty tough with a really slam and stuff through to get things back where we wanted them.September, Mike, felt like it was starting to bottom out, in October, we can see a lot of the work in the numbers. And so, October looks very strong. So I think when we look back a few quarters, this quarter that we’re reporting on will be the bottom. So that’s first what I’d like to say. And so I think the fourth quarter, we’re pretty confident, as long as it continues the way it started, next week we’ll be halfway through, it feels very good, a lot better than 3Q. So I would say 4Q will look – again, I can’t see 2 months, but it will look more like 2Q. So to get to your question more directly, that means the numbers that we talked about we still believe in. But I’d say, Rob probably pushed it out, Mike, a couple of quarters. And so by – like what I said, like really next year, we’ll have it back. I think, we’ll be back to where we were, when we got hit with all the homes onto our platform last spring. So we probably – when we look back, a little lost – the second quarter started to slip, the third quarter will be the bottom, 4Q comes back, 1Q 2020, I think the numbers should be back on track. And so then we’ll be on the same trajectory that we talked about last spring. Rob, would you agree with that?

[Robin Lowe:]

Yeah. I would agree with that. So I think to fully get back on track, Mike, we certainly need to go to that leasing cycle, which is first and second quarter next year. But to George’s point, third quarter is definitely the bottom of the cycle for us. Fourth quarter will be better than the third quarter, maybe back to the second quarter number. First quarter will be better next year. Second quarter, we’re better still. And so we’re on that trajectory back to achieve the potential that we know is in this business.

[Mike Grondahl:]

Got it. Got it. And the 28 houses, I think you acquired for $136,000 on average. Would you see that sort of what you set out to do? Or is the strategic process affecting that at all?

[George Ellison:]

No. No, the strategic review is sort of a separate work stream. Our responsibility is to run the company every day. We buy opportunistically when we see things, we like at the yield we like. As I mentioned on the last call, we saw a pretty good flow in the first half of the year. It’s gotten a little bit quieter. So the 28 we just picked up through normal process through the Charlotte team. And I think we are – this quarter should be closing on some more – another 100 to 150. So we – as we see them, Mike, we’re trying fill in where Miles wants us.As I’ve said before, we’re not going to go to new places right now. You need to fill in to make the numbers that he has stronger and stronger. So we found 28 we like through [ones and twos] [ph] that was fine. As I said, I think we’ll have a small pool this quarter, we’ll – the fourth quarter we’ll announce. We buy when we see yields, we like and cities we like.

[Mike Grondahl:]

Got it. And then lastly, you kind of implied or I think you used the words this strategic review results imminently. Does that mean we can measure it in days? Or should we be measuring it in weeks?

[George Ellison:]

We’re really not in a position to say what the unit measurement would be. But I would say we’re nearing the end of that process.

[Mike Grondahl:]

Got it. Okay. Hey, thank you.

[George Ellison:]

Sure thing, Mike.

[Operator:]

The next question comes from the line of Jade Rahmani from KBW.

[Jade Rahmani:]

Thanks very much. On the strategic review, did you give any sense of the timing, you said you expect to report results shortly?

[George Ellison:]

As I just said, we’re not in a position to say exactly the timing of when it will be finished. But as I said to Mike, we are nearing the end of that process.

[Jade Rahmani:]

Okay. And with the – in your prepared remarks, you mentioned a lot of emphasis on preparing for the long-term and operational improvements that could be made over the long-term. Does that suggest that a restructuring is more likely than a potential sale or a combination of the company? Anything to read into those remarks?

[George Ellison:]

No. I wouldn’t read that into it. I – we have the same tone every quarter for the last 5 years. Our job is to run these things as best as we can and position it for growth. I mean, we’re looking to drive the best intrinsic value for our shareholders. That’s the bottom line. So there’s no implication on one thing or the other. We’re trying to make this thing as strong as we can for the future. It’s our job to run it every day that way. We’ll see what comes out of strategic review, but there’s no veiled message.

[Jade Rahmani:]

Okay. In terms of the portfolio, there’s this big other category of around 3,000 homes. What are the concentrations within that? Are there any markets you could identify? And what percentage of those represent legacy NPLs that were converted to rentals?

[George Ellison:]

I think another way – I’ll start that. I think another way to say is we used to, a few quarters back, have 1,000 homes we wanted to sell, then it was 100 homes we wanted to sell, now I think it’s probably down to a few hundred we want to sell. So Rob, you can answer other. But what I would say is the percentage of things we wanted to sell out of other continues to shrink. And so now other, which we can give you more detail either here or maybe later, is really places where we are that we want to grow.And so for example, St. Louis is probably in other, I would guess, I’m looking at the list here. But it’s places, Jade, where we need more capital to fill in to make it more efficient. So where other used to be, you’ve been following this for a while, so your question about NPL is spot on. That category, other, used to be a lot of things we wanted to get out of and shrink. That process is almost over. And now it’s really, particularly in the Midwest, for example, although it’s true, I think, in all places, even in Florida, we want to grow out and keep filling in. And that’s really what’s in other now. Either of you guys want to add to that?

[Robin Lowe:]

Yes, I’d agree with that. And you can see, Jade, if you look at this page in the earnings deck, we show that there’s 42 kind of legacy proxies that we’re looking to sell and there’s 229 others, which is the kind of probably you’re talking about here. We can give you more breakdown of the thing after the call, but that’s the big picture.

[Jade Rahmani:]

Thanks for taking the questions.

[George Ellison:]

Thanks, Jade.

[Robin Lowe:]

Thanks, Jade.

[Operator:]

At this time, I am showing no further questions. I would now like to turn the conference back to the company for closing remarks.

[George Ellison:]

Thank you all for dialing in and your interest. We’ll chat with a lot of you throughout the day. Have a good rest of the day.

[Operator:]

Ladies and gentlemen, this concludes today’s conference. Thank you for your participation, and have a wonderful day.