UDR, Inc.
Q3 2014 Earnings Call Transcript

Published: 29 Oct 2014

[Operator:]

Good day, and welcome to UDR's 3Q '14 Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Chris Van Ens. Please go ahead.

[Christopher G. Van Ens:]

Thank you for joining us for UDR's Third Quarter Financial Results Conference Call. Our third quarter press release and supplemental disclosure package were distributed yesterday afternoon and posted to our website, www.udr.com. In the supplement, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G requirements. I would like to note that statements made during this call, which are not historical, may constitute forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be met. A discussion of risks and risk factors are detailed in yesterday's press release and included in our filings with the SEC. We do not undertake a duty to update any forward-looking statements. [Operator Instructions] Please note that there is another multifamily REIT call that begins at 2 p.m. Eastern so our call will be kept to 1 hour. Management will be available after the call for your questions that did not get answered on the call. I'll now turn the call over to our President and CEO, Tom Toomey.

[Thomas W. Toomey:]

Thank you, Chris, and good afternoon, everyone, and welcome to UDR's third quarter conference call. On the call with me today are Tom Herzog, Chief Financial Officer; and Jerry Davis, Chief Operating Officer, who will discuss our results, as well as senior officers Warren Troupe and Harry Alcock, who will be available during the Q&A portion of the call. First, all aspects of our business continue to perform well in the third quarter and remain in line with or ahead of the key targets outlined in our most recent 3-year plan. With 2014 largely wrapped up, we're fully focused on setting the company up for a strong 2015. In short, but without providing forward guidance at this time, we expect 2015 to look relatively similar to 2014, meaning that operating fundamentals should remain very favorable and development highly accretive. Both of these will help drive cash flow and NAV growth in 2015. Nationally, multifamily fundamentals remain strong. The vast majority of our markets continue to experience outsized demand relative to supply, while single-family housing challenges persist due to changing demographic trends, strict credit standards and low inventories. We do not expect these dynamics to change anytime soon, but we'll be monitoring the recent news that the GSEs may loosen credit standards. Against this backdrop, and in conjunction with our strong 2014 results to date, we raised our full year earnings and same-store revenue forecast in today's press release. Tom will discuss the details in his prepared remarks, while Jerry will address the success we achieved pushing rental rates during the quarter to benefit 2015. In fact, even when faced with higher supply in many of our markets than at 1 year ago, our advantageous product mix and strong submarket locations resulted in combined new and renewal lease growth of 4.8% this quarter, 30 basis points above that achieved in third quarter 2013. This acceleration is more noteworthy when considering that Jerry and team accomplished this, while maintaining high occupancies during the quarter. Moving on. The third quarter was successful for UDR in a number of fronts. First, and as previously announced, we closed on $97 million of noncore multifamily dispositions at better pricing than originally contemplated. Proceeds will continue to fund our accretive development projects. Second, we are under contract to sell all the communities in our Texas joint venture or approximately 3,400 apartment homes, of which we own 20% plus a promote and fees. We have received hard money and the sale is scheduled to close in January 2015 for approximately $400 million in total proceeds. We expect to achieve a strong return on this investment although the loss of the management fees will negatively affect our 2000 earnings by around $0.01. We will provide additional details when the transaction closes. Third, we completed $121 million of 1031 acquisitions in Seattle, a market where we were under-allocated from our NOI perspective. The addition of the newly constructed high-quality community satisfies our acquisition guidance for 2014. Fourth, we issued approximately $100 million of equity at or around consensus NAV during the quarter, which will primarily be used to fund our accretive $92 million Steele Creek participating loan investment in Denver. This use is consistent with our past commentary, that is we will consider issuing equity to fund accretive growth opportunities when our shares trade at or above NAV after fees. Fifth, we started $125 million, 381-home development during the quarter in Irvine, California and a 50-50 joint venture with MetLife. We will continue to develop with Met as we work through the remaining 6 land parcels in joint venture 1. In the fourth quarter, we will complete the development of 2 wholly owned projects for a total cost of $183 million. Jerry will speak on our pre-leasing progress, which is going quite well. Sixth, we've received a credit upgrade from Moody's to Baa1 and changed outlook from S&P to BBB+. Tom will provide additional details on these items in his prepared remarks. However, from a bigger picture perspective, these achievements continue to advance the strategic initiatives outlined in our 3-year plan and emphasize our ongoing commitment to generate long-term, high-quality cash flow growth, while also continuing to improve our portfolio and balance sheet. In conclusion, I'd like to thank all my fellow associates for all their hard work in producing another strong quarter for UDR. We look forward to the remainder of 2014 and to a great 2015. And with that, I will turn the call over to Tom.

[Thomas M. Herzog:]

Thanks, Tom. The topics I will cover today include

[Jerry A. Davis:]

Thanks, Tom, and good afternoon. In my remarks, I will cover the following topics

[Operator:]

[Operator Instructions] And the first question will come from Karin Ford with KeyBanc Capital Markets.

[Karin A. Ford:]

Just a question on the ATM usage in the quarter. You mentioned -- obviously, you used it for Steele Creek, which you consider to be an accretive use of the capital. Do you guys see additional accretive uses for ATM capital based on where you could issue stock today? And should we expect to see more ATM issuance in coming quarters?

[Thomas M. Herzog:]

Karin, this is Tom Herzog. Yes, good question. As far as accretive uses, there will be other accretive uses. I mean, the fact is, from a development perspective, we've always spoken to that being accretive, but that's funded through noncore sales. But as we think about just funding sources in general, there are really 3 different types of funding sources, as you know. There's equity, there's debt, there's sales and there are merits to each depending on market conditions. So as we look out into the future, certainly, we have to take into account market conditions at those times as to which of those funding sources makes the most sense for us and our shareholders. So we still like funding development with noncore sales. We like the match funding aspect to it. But we don't rule out the possibility that with the right market conditions, that we would consider other sources of capital as well, including equities. So we have to wait and see what it looks like as circumstances dictate in the future.

[Karin A. Ford:]

My second question is, you mentioned the sale of the Texas JV. Could you just talk about what drove the decision to make the sale at this time and what your expectations are for your remaining Texas portfolio?

[Thomas W. Toomey:]

Karin, this is Tom. With respect to that sale, what drove it, the debt maturity is coming up for prepayment. We looked at the value and the IRR returns that we saw we're achieving at this point in time. And with the partnership with Fannie Mae concluded, it would be best to expose it to the market and we had a price that was very attractive to us and to them. And so we think it's going to be a good execution and a good benefit for UDR.

[Karin A. Ford:]

Do you expect to exit those markets entirely over time?

[Thomas W. Toomey:]

No, I think we're very comfortable with our exposure in Austin and Dallas and then see those as dynamic markets. We like our submarket and product fit. And we're all very comfortable about where we're at on the investment side, but we do like those markets.

[Operator:]

And the next question will come from Haendel St. Juste with Morgan Stanley.

[Haendel Emmanuel St. Juste:]

A couple of questions on the operations, I guess, for you, Jerry. The gap between new and renewal has narrowed from about, let's see, 190 bps at 2Q to about 60 bps this quarter with a meaningful pickup on the new lease side. First, what was that gap for October? And then also, how do you think that relationship evolves over the next new weaker seasonal quarters? And perhaps can you give us some regional insight on the October numbers?

[Jerry A. Davis:]

Sure. I'll start with the gap in October. It's actually our current new lease rate growth rate in October is projected to be probably a hair under 3% and renewals will be about 5.1%, so it's about 200 basis points. This is normal seasonality, as you know. New lease rate growth tends to fluctuate with the bell curve and below in the first quarter and fourth quarter and then it peaks up in the second and third, so you would expect the gap to compress. Probably more importantly, I mean, you picked up what was it last quarter and what was -- what is it in October. But when we looked at what the gap was a year ago, because we think that's more important to look at, last year in the third quarter, the gap was 180 basis points, and this quarter, it was 60 basis points. And really, what we're trying to do, Haendel, we may have spoken about this before, is we've been focusing more on driving up new lease rates because we think that sets a new market rent for our properties. When you set those new market rents, we think it makes it easier as you go forward to achieve higher renewal growth. So it's hard to continuously have a large gap between renewals and new and it will eventually put a ceiling on what you can get on renewals. We thought this was the best strategy to have. And I think when we look at our total revenue growth and when you look at how much better new lease rate growth is doing, both in the third quarter as well as so far this quarter, we're pretty optimistic about strength as we go into the remainder of the year and especially into 2015. The part that really surprised us, we said last quarter on this call that we were willing to take a reduction in occupancy to achieve this higher new lease rate growth that's at higher markets. And what we saw was we had no drop-off in renewal -- in occupancy. Part of that was because turnover dropped the 450 basis points and it gave us the ability to continue to push new rate. Even though our closing ratios came down a bit, we didn't have to close on every one. People that were just price shopping chose to go live somewhere else and we were able to elevate that. So we think it's going to pay off in the long term. Now you had another question about...

[Thomas M. Herzog:]

Some regional insight...

[Haendel Emmanuel St. Juste:]

Some regional insight into the new versus renewal for October.

[Jerry A. Davis:]

Yes, you've seen -- again, I told you October versus 3Q is down about 140, 150 basis points in total. You've seen less of a drop in the West, where it stayed -- the total western part of the United States is at 5.3%. There were probably at about a 6%, 7%. So it did drop but it's still very strong. The southwest, which is our 2 Texas markets, are coming in closer to a 2%. The Mid-Atlantic region is the one that's suffering the most right now. It's at a negative 2%. That's made up of Washington, D.C., Baltimore and Norfolk and Richmond. All of those are negative with the exception of Richmond. Currently, in Washington, D.C., we're showing new lease rate growth that's about negative 2.7% and that compares to negative 1% in September. So you're seeing that typical seasonality of drop. Baltimore has probably turned more negative than we would have expected based on how well we did there last quarter. Last quarter, we had new lease rate growth that was positive 1.8%, and today, it's down at negative 3%. So we have been feeling the effects not only of the seasonality but of also some new supply. Then the other one that drops and I think this is predominantly seasonality, maybe a little bit new supply, but -- is Boston. Boston went from being up on new lease rate growth in the third quarter at 6.9%, and in October, it's 1.8%. While that seems alarming, when I go back and look at how I did last October in Boston, it was sub-2% also. So that's a typical seasonality. Everything else has stayed pretty much the same or has had that typical 150 basis points drop with 2 exceptions to the upside. New York City stayed stable with where it was in the third quarter at 4.5%, and our Orlando market actually picked up its pace. It was at 5.4% in 3Q and it's up to 6.3%. And then on renewals, like I said, Haendel, those stayed fairly stable year-round. So the 5.1% has stayed exactly the same in October.

[Haendel Emmanuel St. Juste:]

Okay. And you brought up occupancy, which is sort of my follow-up. You guys ended the quarter here at 96.8%, unchanged from last quarter, your highest level in, looks like, 15 years of operating data that we have in front of us here. Despite your turnover being -- your turnover is down about 250 basis points, as you noted. You're pushing new leases more aggressively as you mentioned during the quarter. So my question is, looking back, perhaps do you feel like there is some opportunity left on the table in retrospect by not pushing more? And then I guess heading into, again, 4Q, 1Q, do you expect to maintain a similarly low turnover, high occupancy levels?

[Jerry A. Davis:]

I think occupancy will probably drop a bit. We do have 1 or 2 seasonal markets like our Monterey Peninsula that will just naturally bring it down. I think renewals, did we leave money on the table? We had a strategic -- we made a strategic decision really to go after new to reset that mark that would help us on renewals later. I think you're going to see renewal growth probably strengthen a bit as the rest of this quarter goes and not drop from its 5.1%. But we are definitely more focused on taking care of our existing residents, watching probable effect of what it does to our NOI stream. But we do feel the strategy, more than anything, Haendel, sets us up for 2015. It's paid off better than I expected in 2014 but it definitely set us up to go into 2015 probably as strong or stronger than we finished last year.

[Operator:]

Next will be Nick Joseph with Citi.

[Nicholas Gregory Joseph:]

What was the difference in performance of A and B class assets across the portfolio? And then you mentioned D.C., but are there any other markets where that variance was pronounced?

[Jerry A. Davis:]

Really, Bs for the quarter, Nick, in new and -- a blend between new and renewal growth was about 110 basis points better than As. As we look at the month of October, that compressed to about 60 basis points. And again, we think that goes predominantly to the effect of new supply on A and not on B product. D.C. was probably the most pronounced. I will tell you, in our Seattle markets, we got A product both in the city of Bellevue as well as downtown Seattle. While they've done well, our suburban product that's more of a B-caliber asset in Renton as well as down south near Tacoma and some of the suburbs up north that cater to the Boeing plants have done a bit better.

[Nicholas Gregory Joseph:]

Okay. And then you talked about the Seattle acquisitions and increasing your exposure there after being underweight. Are there any other markets that you're either over- or underweight relative to your longer-term targets?

[Harry G. Alcock:]

I think -- Nick, this is Harry. I think if you look at the markets where we're allocating capital and you'll see markets like Boston in particular where we're completing a large development project, San Francisco Bay Area, again, where we're developing 399 Fremont, we tended to allocate capital to markets in which we want to grow our presence and we're selling out of the markets in which we want to reduce our presence.

[Nicholas Gregory Joseph:]

Okay. But nothing jumps out other than kind of that slow growth through development or selling on the margin, not new markets jump out as either overweight or underweight kind of where the portfolio is today?

[Harry G. Alcock:]

That's right.

[Operator:]

And our next question -- [Operator Instructions] And we'll go to Dave Bragg with Green Street Advisors.

[David Bragg:]

Tom, in your opening comments, you alluded to Fannie and Freddie's plans to expand mortgage credit. But can you share your thoughts on the potential impact to your business?

[Thomas W. Toomey:]

David, it's really early to tell what's going to come of this. As we look through the portfolio of things that come off on the surface, we have a very small 3-bedroom portfolio that would be probably potentially exposed, but I don't feel that -- I don't feel much exposure at this point to political rhetoric. We've got 4 months after the election to seat Congress. They're going to have time to sit down and look at this and think about what they really want to do. They have to answer questions about risk retention and how that will be handled. And so this is probably going to be a story for the third quarter of next year is about time they get their act together and come out with some clarity.

[David Bragg:]

Okay. And as it relates to dispositions, you -- it looks like you'll exceed your disposition plans for 2014. And now that we have a potential reacceleration in single-family housing plus more multifamily activity in the second half of this year from Fannie and Freddie, is this a ripe environment for you to go beyond the 6, I think you have -- sorry, $400 million to $600 million dispositions penciled in for 2015 and '16, given the risks on the single-family side plus a robust disposition environment, might we see you go nicely beyond that range?

[Thomas M. Herzog:]

Dave, this is Tom Herzog. Our disposition guidance, obviously, for this year came in about where we expected it with a couple of minor adjustments that we've made. As we look to '15 and '16, again, we're really looking at it, that we've got 3 different sources of capital. We have to -- as we go forward to make the optimal decisions for our company, our shareholders, we have to look at where equity prices out at, what debt looks like, what the different objectives around those are and then look to sales proceeds additionally. And with that, do we have assets that are noncore that we would like to liquidate early or recycle? Those decisions come into play. So we're not ready yet to specify how much each of those different buckets we'll include. And I don't even think that's something, when we set guidance at the beginning of the year, that we want to get too specific on. I think that there's a general capital need and it's more directional and then decisions are made throughout the year as conditions become known. So we'll certainly start the year with the type of capital need that we have as a whole and some directional guidance. But as far as specifics, that probably comes later.

[Operator:]

And we'll go on to Jana Galan with Bank of America.

[Jane Wong:]

This is Jane Wong for Jana. I was wondering if you could provide some outlook for 2015 in Washington, D.C., what you're expecting there.

[Thomas M. Herzog:]

Well, I'd say this -- and again, this is Tom Herzog and I'll turn it to Jerry for something directional. But as far as providing guidance for 2015 at this point, that's something we're going to save for our fourth quarter call. We've got great momentum going into the end of the year. And as Tom Toomey has indicated, we expect '15 as a whole to look a lot like 2014. So we're very optimistic, but not providing specific guidance. But kind of directionally, Jerry, any comments you'd make on D.C.?

[Jerry A. Davis:]

Yes. I guess, generally, I would say we would expect D.C. next year to be slightly worse than this year. I'd remind you this year we're going to have positive revenue growth of somewhere between 0.5% and 1% with meaningful decline. We think it's a submarket-by-submarket situation in Washington, D.C., and just as we've outperformed there, really, over the last several years because of our mix of A and B product with B staying about 60%. While we are affected by supply, it's not quite as much. We're optimistic that next year we'll see more job growth that will help to absorb those new units that are coming on. But I don't think you're going to see it be meaningfully different than what you saw this year.

[Jane Wong:]

Great. And then just one more quick question. Thank you for the color on the spreads to cap rates for your development yields being towards the upper end of your range, but can you talk a little bit about prevailing cap rate trends in your markets, any changes? And for the 2 starts in California, you expect the 150 to 200 basis points spread. But kind of what are the prevailing market cap rates there today that you see?

[Harry G. Alcock:]

This is Harry Alcock. I think that, in general, in the types of markets where we're developing cap rates of -- remain the same to perhaps come down slightly. The types of cap rates that we're looking at for our California starts, the Irvine property, for example, is around 4.25%. Most of them are going to be between kind of in that 4%, 4.25% cap rate type range. So these are quality properties in high-quality locations as measured by having very low cap rates.

[Operator:]

And we'll go to the next question from Michael Salinsky with RBC Capital Markets.

[Michael J. Salinsky:]

Jerry, just going back to your positive comments about leasing strengthening in October, the uplift you're getting from the leasing efforts. As we think about the earn-in going into '15, is it reasonable to expect the earn-in in 2015 to be actually higher than it was going into '14? And then Tom, is your -- I know you're not providing guidance for '14 -- I mean, for '15 rather. But as you think about the preliminary budgeting, just on the expense side, anything that stands out to you at this point?

[Jerry A. Davis:]

This is Jerry. I'll go first. We've looked at it and it's -- the earn-in to '15 is very similar to what it was last year, which leads back to what Toomey said in his initial comments, that '15 to us is looking quite a bit like '14, both -- as far as job growth, supply and all that stuff coming to hit us. But where we are in the ground right now is, again, we're doing better on new lease rate growth. We've been pushing that over the last 4 to 5 months. We're going into the year with probably higher occupancy than we went into last year. So you probably won't see next year us get as much of a pickup in occupancy, if any, but we do think we're going to see the same type of strength in pushing the rate as we saw last year.

[Thomas M. Herzog:]

Okay. Mike, Herzog here again. As far as budgeting on the expense side, we're well through the process so I have a feel for that. There's nothing dramatic coming up on the expense side that you need to be concerned about.

[Michael J. Salinsky:]

That's helpful. And just as my follow-up question. As we think about dispositions, any governor on that just related to taxable net gains just because you had the 1031s in the quarter? I know you're working through some of those noncore and warehouse assets; you've held them for quite some time. How do you -- can you talk about kind of how you manage the process of tax gains versus issuing equity as we think about funding kind of going forward?

[Thomas M. Herzog:]

Yes, good question. The 1031s in 2014, those are mainly sales out of the TRS, so that avoids any cash taxes as we're recycling some of those assets. As far as sales out of the REIT, we have to take care to watch our gain capacity and that is something that the team here is very tuned into, and it is a limiter on how much, frankly, we can sell or any REIT can sell. So that does definitely enter into our calculus.

[Operator:]

And that does conclude the question-and-answer session. I'll now turn the conference back over to Mr. Tom Toomey for any additional or closing remarks.

[Thomas W. Toomey:]

Well, again, thank all of you for your time, and as we started this conference call, we feel really good about the business. We feel great about the business plan. '14 is a good year for us. We're very focused on '15 and the execution. It looks, at this point in time, to be a very similar year to '14, and we feel very proud about that and that's driven by solid fundamentals by a team working very well together on a good plan and execution. And we know that we'll see a lot of you next week at NAREIT and we'll let you get to your next call. Thank you for your time again today.

[Operator:]

Thank you. That does conclude today's conference. We do thank you for your participation today.