Kelly Residential & Apartment Real Estate ETF
Q1 2019 Earnings Call Transcript

Published: 8 May 2019

[Operator:]

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

[Alysia Cherry:]

Thank you, Julie. Good morning. And thank you for joining us for Front Yard's first quarter 2019 earnings conference call. Joining me on today's call is George Ellison, Chief Executive Officer; Robin Lowe, Chief Financial Officer; and Miles Adams, Senior Vice President of Property Operations. I'd like to guide everyone to the first quarter earnings slide presentation available through the Investor section of our website at www.frontyardresidential.com. These slides were created to accompany the company's 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 2018 Form 10-K 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 Investor section of our website. I’ll now turn the call over to George Ellison, Chief Executive Officer. George?

[George Ellison:]

Thanks, Alysia, and good morning, everyone. It's been another very productive quarter at Front Yard Residential. The financial and operational results have continued to improve this quarter as projected when we spoke in February. The transition of our homes on to our platform is effectively complete month ahead of schedule. And we are pleased to announce today that another of our main strategic goals have been achieved. Front Yard Residential and Altisource Asset Management have agreed to a new contract. I will cover the details later, but the bottomline is that we've created a much simpler straightforward contract. One that controls G&A costs as we grow and drive key expense ratios to industry standards. Controlling G&A costs along with transparency and simplicity were key goals of this new deal. In addition to managing expenses the two sides work together to build a fair termination option into the contract. This feature along with just about every other component of the deal was vetted by both Boards and outside advisors to match or exceed industry conventions and to ensure that the new arrangement was a market deal. Now if you find as we walk through it, it compares very well to other externally managed REIT contracts. We promise to unlock shareholder value by building the largest public single-family rental REIT focused on workforce housing and that’s now had done. Internalizing the REIT property manager, done, and now simplify the relationship with the manager and REIT and that’s done. If you please turn to page four, we can run through the first quarter results. Rental revenue $52.6 million, stabilize rental core NOI margin 62.7%, core FFO $0.07 per share, blended rent increases 4.3%, 95.7% of stabilized rental were leased at quarter end, turnover for the stabilized portfolio 6.1%, over 14,000 homes are now internally managed and 92% of funding is fixed or capped and had a weighted average maturity of five and a half years. As mentioned on our last call, we sold portfolio about 450 non-core rental homes in the quarter, along with over 100 homes across several markets that had subpar metrics. While I will go over the numbers and show the positive financial results of these sales, which continue to amplify and underscore the unrecognized value that is embedded in our portfolio of homes. If you please turn to page five. We show some important company’s data over the last several quarters. The percent of stabilized rental that are leased took a strong jump this quarter, which set us up very well for the second quarter. Core rental revenue keeps going up and as you see turnover remains very low. I will now turn over to Robin.

[Robin Lowe:]

Thank you, George. Today we are reporting a GAAP net loss of $18.5 million for the quarter, a 46% improvement over the prior quarter, driven by improving operational metrics and strong gains from property sales. Revenues were marginally down sequentially, mainly due to the sale of 576 homes in the quarter and expenses reduced by 10% compared to the prior quarter, primarily driven by lower interest expense and a significant reduction in acquisition and integration costs. Interest expense was approximately $3 million lower than the prior quarter, if you saw the benefit of four quarter loan refinance with Morgan Stanley and also lower average borrowing as we used proceeds from the home sales to pay down debt. Acquisition and integration costs reduced to $2.2 million compared to $7.6 last quarter and are expected to drop very significantly next quarter, now that the transition of our home to our internal platform has complete. G&A expenses this quarter included about $2 million of non-ordinary cost legal and professional expenses related to the AMA negotiation, proxy contest and litigation. Core NOI margin of 62.7% was 1.2% higher than last quarter as we continue to see elevated turn cost due to continued accelerated efforts to maximize the number of properties available for rent as we start the leasing season, results so far have been very encouraging. We ended the quarter with occupancy at 95.7%. Core FFO for the quarter was $0.07, a 28% increase over the last quarter. We believe we remain on track to achieve the targets for the end of 2019 shown on slide 15. Regarding our balance sheet, approximately 92% of our debt is now fixed rate or capped with weighted average maturity of 5.5 years. In April, we successfully negotiated a 70-basis-point reduction in interest rates spreads, the rental properties on both our Nomura and Credit Suisse lines from 3% to 2.3%, as well as some other improvements to the fee structures. Finally, during the quarter we sold 576 non-core homes that did not fit our rental criteria, 444 of the homes was the block sales that we previously announced. Net sales proceeds were approximately $102 million giving a $4.6 million gain of a gap carrying value. Additionally, we sold further 132 homes in the first quarter. Sales proceeds were approximately $23 million giving a $2.9 million gain of a gap carrying value. We believe these gains are further evidence of the value embedded in our portfolio. Once again on slides 19 and 20 we are providing details of investment costs and home price appreciation by key markets that we believe provide support for baseline valuation of our portfolio. I will now turn the call over to Miles.

[Miles Adams:]

Thank you, Robin, and good morning, everyone. This quarter for the operations team was very similar to the prior quarter in terms of focus areas and objectives. Our first objective was to successfully transition all of the MSR homes on to our management company platform. Next to complete the expansion of our footprint and to a similar team capable of operating 15,000 properties at best-in-class metrics. Finally, we challenge our team to improve occupancy levels. As a reminder, during the Q4 of 2018 we transition all of the approximately 4,000 homes from ASPS on to our internal platform and had a total of 7,300 homes under management at December 31, 2018. I'm pleased to report that as of the end of Q1 2019 we have completed the transition of rental homes on to our internal platform well ahead of schedule. During the first quarter of 2019 we transferred approximately 7,300 homes from MSR. After the sale of approximately 600 homes during the quarter we are currently managing over 14,000 homes. This is no small feet and is a testament to the dedication and skill of our great team. After completing the property transitions our operating footprint now spans from Miami to Minneapolis, Charlotte to Kansas City. Our portfolio is located in approximately 25 MSAs, which we've divided into seven distinct geographical regions. Within those regions we have strategically located offices and people to service our residence and homes. Our local teams are well-versed with the residence demand and jurisdictional requirements of their markets. When we begin this transition process our management company was comprised of approximately 80 people. This team has been expanded to include proximally 185 team members as of today and the team is now largely complete. We have assembled an experienced team of professionals to deliver best-in-class service and operating performance. We are in the middle of the rigorous training programs to optimize the performance of the talent that has joined our company and we're truly excited about our new team members. Our primary focused during this transition was to maintain high quality service for our existing resident, which we believe was accomplished. We also challenge ourselves returning and leasing homes to improve our portfolio occupancy level of 94.2% at December 31, 2018. As a result of our team's focused efforts our portfolio stabilized lease percentage at March 31st was 95.7%. This represents a significant improvement of 150 basis points from December 31, 2018 and sets us up very well for the rest of the year. In addition to improving occupancy we were able to maintain a stabilized blended rental growth rate of 4.3%, consistent with the prior quarter. This growth rate was comprised of renewal rent growth of 4.2% and release rent growth of 4.4%. The Q1 renewal rate of 79% represents an improvement of 800 basis points over the 71% rate of Q4 2018. The Q1 turnover rate of 6.1% represents a 50-basis-point improvement over Q4 turnover rate of 6.6%. We certainly expect lower retention rates and higher turnover during the seasonal summer months. But we are very pleased with the rates achieved this quarter and during Q4, particularly as we on-boarded over 7,000 homes and double the size of our team at the same time. Residences have many different options for they may choose to live. We are honored that they have chosen our company and continue to demonstrate their [inaudible] our service by renewing their leases with us. For Q2 and the remainder of the year our primary goal is to further improve our operating margins while keeping service levels high. Continued growth in revenue combined with the reduction in turn cost of repairs and maintenance expense is required to unlock cash flow commensurate with our expectations. I am confident our team is focused on these objectives and will achieve our goals. In summary, it was another very successful quarter. We have completed the build-out of our property management team. We completed the transition from external property management on to our platform and we improved our occupancy significantly. The property transition process we just completed provided a unique opportunity to gain experience with the steps necessary to on-board the large number of homes. Many of these requirements are the same or similar to those associated with the major acquisition of homes. This experience combined with the depth and reach of our platform uniquely positioned our company to take advantage of a wide array of market opportunities. We are focused on improving margins within our existing portfolio. However, we are eager to take on new challenges that are sure to come our way. I'll now turn the call back over to George.

[George Ellison:]

Thanks, Miles. Great job. If you turn to page six, we can hit the highlights of the new asset management agreement. As I stated, the need for simplicity, clarity and transparency were overarching goals during the construction of this deal, as well as creating a deal that was shareholder friendly. What are the features of the last contract that held back grow the RESI was it is RESI Group, the AAMC management team would disproportionately increase RESI G&A, the structure of the new contract allows for a gradual increase in the fees paid to AAMC, but only after the quarterly AFFO of $0.15 is reached. We want to ensure that the dividend was covered. After this target hit, the additional AFFO will be split 50-50, but only up to a cap. So let’s cover that again, the stated goal of $0.15 of AFFO per share will not be impacted only after this target is reached, for AAMC share we anticipated growth of RESI’s AFFO. But that sharing is capped. This important feature allows RESI’s dividend to be covered and then grow. As RESI continues to grow the fees earned by AAMC grow as well, but at a descending rate and that makes sense. G&A must decline as a ratio of real estate assets as the portfolio grows. If you look at the chart on page six, we have modeled how the G&A ratio will decline over time. The chart shows the declining fees, as well as the capped that governs them. This is parallel. So regardless of internal or external issues our competitors managed to and openly discuss this ratio and we are holding ourselves to that same high standard. Incentive fees can also earned by AAMC, but again they are capped. The control G&A and its growth over time a really which is the heart of this contract. We think we've come up with an excellent solution which will enable us to manage expense growth within industry standards as we grow. The second important feature that we felt need to be address in the contract was to had a clear simple quantifiable termination mechanism. The existing contract only allows Front Yard and AAMC to separate other than for cause in a change of control situations. There are no other options under RESI’s control. The two Board studied dozens of contracts in our marketplace and industry and found a fair, frequently used market convention that allows external managers to be terminated for a reasonable, visible, multiple of past fees. This new deal allows RESI to terminate AAMC for three times the average of three trailing years of fees. This termination is one of convenience and is available to RESI at its sole discretion. As stated, dozens of structures were reviewed and the average multiple of annual fees paid to terminate was free, just is in our view. We were asked to make termination quantifiable, available and simple. That is now done. These are just the key terms to the agreement. Obviously, the details could be reviewed in full and we file that today. But the bottomline is that there is now clear path to grow Front Yard Residential with tight expense control and a mechanism of the two companies to separate as them install, one that mirrors best industry practice. Page seven recaps our performance on several stated initiatives. We have completed the internalization of property management. We continue to drive our operating efficiency, increasing occupancy rates, strong rental growth, low turnover to name just a few metrics. We continue to proven our portfolio of existing home in non-target markets with excellent financial results. We continue to improve our earnings and maintain our goal of hitting $0.13 per share to $0.16 per share of AFFO by the end of the year and now we've delivered on a new shareholder-friendly asset management agreement. These accomplishments position us to continue our great growth story for our shareholders. Macro trends providing opportunity to grow our revenue and improve our operating margins, we continue to focus on leverage, bringing it down, if and when the time is right, but I would remind you that some of our larger competitors in the sector have leverage high when they were in their growth model and some private competitors have high leverage as well. To wrap up, financially and operation, it's clear that Front Yard Residential is turning the corner. All of the key metrics are improving and should continue to improve each quarter, NOI, occupancy, rate increases, FFO. We are continuing to push revenue growth even inside of our current portfolio and with property management internalization complete we have greater clarity into and better control over our expense. Today we are starting two-day operational deep dive here at our headquarter with all of our senior leaders to review and finalize several expense control strategies as we map out our next three years. The business is on solid ground, which continue to produce better and better results, just as we have this quarter. And now the last remaining structural impediment, the existing asset management agreement has also been addressed. We have thrilled to have this last building block in place. I would like to thank both Boards of RESI and AAMC for having the vision, courage and patience to bring resolution to the difficult and complicated negotiation for finding the right balance for shareholders. Today Front Yard stands as one of the best ways to play the largest segment of the single-family rebel market, workforce housing. We have world-class management team, deep experience in acquisition and a market footprint that give us first move advantages in our industry. I will now turn the call back to the operator to open up the Q&A.

[Operator:]

[Operator Instructions] Your first question comes from the line of Douglas Harter of Credit Suisse.

[Douglas Harter:]

George or Robin, can you talk about under the new management agreement how fees or G&A will look kind of in the short-term -- at the current size?

[Robin Lowe:]

Yes, Doug. So obviously the first thing to say is that the fees are dropped at all until RESI covers the $0.15 quarterly AFFO. So that’s the first thing. Once we get pass that level, there is 50-50 sharing until RESI – AMCC’s (sic) [AAMC] hit the cap at the current level of gross rental assets, which is $21 million. By that stage if you work through the math and we just seen this, so you need some time to work through, but that’s like $0.82 AFFO a year. So in the short-term AAMC is not going to get at all until that 50-50 quota is covered.

[Douglas Harter:]

Okay. And then, you guys mentioned that now that the internalization is mostly complete, you would expect to see some expense benefits from that, is -- can you quantify a kind of what the -- what the extra costs that you kind of incurred during the quarter and what type of benefit you would expect to receive going forward?

[George Ellison:]

Yeah. I will start and then I will hand over to Miles. So, as I mentioned in my prepared remarks, one of the things that we still thing, the accelerated turn cost as we on-boarded all those, new homes, so on-boarded very big scale 11,000 for the last two quarters, which is not an easy. We have tried to accelerate turn cost both last quarter and this quarter, so as easily I think 1% of NOI just embedded in that. And then, now that we have done that and focus on occupancy and driven that out at our entire focus now is on operational efficiency as we fully integrate the HavenBrook platform and I will let Miles talk a bit more about this, but I think, there is a lot of opportunity here to really focus on reduced cost.

[Miles Adams:]

Yeah. So over time we want to unlock another couple 100 basis points in the R&M categories and that’s going to happen primarily by utilization of our internal resources and through improve use of technology in R&M space. Those are what we think are the greatest opportunities. And then in addition to that we still have some room to grow the topline beyond where we are at, where we ended the March 31st on an average occupied basis we can certainly be up another 100 basis points or 50 basis points from where we are currently, very comfortably, both of those things would contribute very nicely to NOI margin above where we are today.

[Douglas Harter:]

Great. Thank you.

[George Ellison:]

Thanks, Doug.

[Operator:]

And your next question comes from the line of Jade Rahmani of KBW.

[Jade Rahmani:]

Thanks very much. Just looking at the NOI margin, 62.7%, I think, you have a target of 66%. What are – as you still sticking to that 66% target and what are the main drivers to get there?

[Robin Lowe:]

Yeah. As we just said in reference to Doug’s question, Jade, I think, we – as I said, we still accelerated turn cost this quarter again that was $0.5 million [ph] of those, that’s 1% right there on NOI. We should have going forward. And then as Miles alluded to, I think, we have a lot of opportunity in R&M over the next few months. So we are still shooting to 66%, we still think that’s achievable by the end of the year.

[Jade Rahmani:]

And just separately on the internalization, I mean, sorry, on the revised management agreement, did the Boards consider and contemplate potential internalization that just put the entire external structure behind the company?

[George Ellison:]

I mean, we – this was a negotiation by both Boards, it took probably six months to seven months, so pretty much everything was discussed. I think the real trust that what we're trying to deliver to shareholders was maximum flexibility and maximum optionality, and so internalizing or putting it all together right now, I don't think was necessary, but getting control of costs as the external manager went forward was critical and we have all talk about that. So I think what this does is that option can happen now. There is a lot of opaqueness and confusion around the -- around how the two work and what strategic things could happen. So now that often that you are discussion could happen, but all types of options could happen now. Everything is on the table, is very clear, very clean, very quantifiable, very simple.

[Jade Rahmani:]

Thanks very much.

[Robin Lowe:]

Thank you.

[Operator:]

[Operator Instructions] If there are no more question…

[George Ellison:]

Julie, that is…

[Operator:]

If there are questions at this time, I will now turn it back over to the speakers for any further comments.

[Alysia Cherry:]

I’d like to thank everybody for joining today and have a great day. Thank you very much.

[George Ellison:]

Thank you.

[Operator:]

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