Elme Communities (NYSE:ELME) Q4 2022 Earnings Call Transcript

Elme Communities (NYSE:ELME) Q4 2022 Earnings Call Transcript February 17, 2023

Operator: Welcome to the Elme Communities Fourth Quarter and Year End Earnings Conference Call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Amy Hopkins, Vice President, Investor Relations. Amy, please go ahead.

Amy Hopkins: Good morning, everyone and thank you for joining us for our fourth quarter earnings call. On the call with me today are Paul McDermott, President and Chief Executive Officer; Steve Riffee, Executive Vice President, and Chief Financial Officer; Steven Freishtat, Vice President of Finance; Grant Montgomery, Vice President and Head of Research; and Drew Hammond, Vice President, Chief Accounting Officer, and Treasurer. Today’s event is being webcast through the Investors section of our website at elmecommunities.com, and a replay will be available this afternoon. We will have a slide presentation in conjunction with our prepared remarks and those slides will be available on our webcast replay. Before we begin our prepared remarks, I would like to remind everyone that this conference call contains forward-looking statements that involve known and unknown risks and uncertainties, which may cause actual results to differ materially and we undertake no duty to update them as actual events unfold.

We refer to certain of these risks in our SEC filings. Reconciliations of the GAAP and non-GAAP financial measures discussed on this call are available in our most recent earnings press release and financial supplement, which was distributed yesterday and can be found on the Investors page of our website. And with that, I’d like to turn the call over to Paul.

Paul McDermott: Thank you, Amy. Good morning, everyone and thanks for joining us today. We ended the year with a strong fourth quarter performance and 2023 is off to a good start with solid operating fundamentals and favorable demand indicators. We are reiterating our 2023 guidance, which reflects double-digit same-store NOI and core FFO growth. Our investment grade balance sheet is in great shape with low leverage and ample liquidity and we have no debt maturities until 2025. We feel very good about our AFFO growth outlook and we are increasing our quarterly dividend by approximately 6%. The economic outlook continues to evolve and we will likely face a slowing economy this year. While we are not immune, our mid-market strategy is designed to outperform across cycles and to provide relative insulation during downturns when residents are more likely to trade down to a lower rent level instead of trading up.

Over the past 5 and 10-year periods, our target vintages have outperformed newer vintages in our respective markets. Towards the end of last year, we began to see headlines surrounding job cuts for high-wage technology positions due to the intentional cooling of the economy by the Fed. However, in the Washington Metro, the tech-heavy, informational and professional, scientific and technical sectors continue to grow, up 2.7% and 2% respectively year-over-year. As recently highlighted in the Wall Street Journal, a study of software engineering job postings at year end found that Washington region has more job openings in this field than the San Francisco Bay Area. The strength in these jobs is particularly evident in Northern Virginia, where most of our portfolio is located and where the information sector, which includes software engineering jobs, grew at a brisk rate of 5.6% in 2022.

The Washington Metro is known to have the most stable employment of all gateway markets. This stability supported very strong credit performance throughout the pandemic as we sustained 99% collection rates and we expect to continue to experience solid collection trends. Furthermore, multifamily rent growth for the Washington Metro is expected to outperform the U.S. average this year and nearly all the major gateway markets. In Atlanta, the regional economy is projected to fare well in the face of increased macroeconomic headwinds in 2023, maintaining job growth of over 1% according to Oxford Economics. Over the long-term, we continue to believe that Atlanta’s industrial mix will drive outsized job creation, wage growth and net migration, supporting sustained demand for apartments that are affordable to the largest segments of the renter market.

In terms of the potential impact from new supply in a slowing economy, our price points are well below the rent levels for new deliveries. In the Washington Metro, our monthly rents are over $600 below nearby Class A communities. In Atlanta, our monthly rents are over $500 below nearby Class A communities. Furthermore, our communities are not located in areas that are receiving high supply. Almost 88% of the new supply in the Atlanta Metro is delivering outside of Elme submarkets in 2023 and 2024. And in Washington, development is highly concentrated in the region’s core versus our suburban focus with 84% of units under construction inside the Capital Beltway. Again, in both markets, the new supply is priced above our price points for different renter cohorts.

In terms of the impact of a slowing economy on the cost of homeownership, the national cost of owning a home compared to renting a single-family starter home is the highest it’s been in over 20 years. The cost of owning a home in our markets has grown more than renting an apartment over the past few years and now stands at nearly $600 per month or 28% above our rents in Atlanta and over $1,200 per month or 43% above our rents in the Washington Metro. Even after factoring the potential for home price declines, homeownership will remain unaffordable for median income renters in our markets. To summarize, our portfolio offers downside protection and a slowing economy for the following reasons. First, our resident base is less exposed to job losses.

Second, our price points serve as a buffer during periods of supply pressure. Third, we do not have exposure to high-supply submarkets. And lastly, housing remains undersupplied in our markets, driving up the cost of homeownership, which is particularly impactful for median income households. Our rent levels are affordable for the largest and most underserved renter cohorts and our communities to benefit from sustained demand for affordable rental options over the near and longer term. We are now in the final phase of our infrastructure transformation, which includes transitioning community level operations to Elme management. The process has been seamless thus far and we will have nearly 40% of our homes under management by next week, over 50% by the end of the quarter and all communities under management by the end of the summer.

The full spectrum of operational benefits is extensive and we continue to identify opportunities to deliver operational upside once our community onboarding process is complete. We built an operating platform that is highly scalable and we continue to see the opportunity to deliver positive operating leverage by growing our portfolio and expanding it into the Sunbelt markets. We are confident in our investment strategy and our ability to create value through thoughtful capital allocation. The markets that we are targeting have industries with the best long-term growth prospects and a growing need for affordable rental options for median incomes. While deal volumes remain muted, we are actively underwriting opportunities. We will be ready to act when the time is right and will only pursue opportunities that we expect will create value for our shareholders and align with our strategy and mission.

This year, we plan to extend the rollout of Smart Home technology to all our communities. We designed our Smart Home initiative to improve our residents’ day-to-day experience at investment levels that makes sense for mid-market price points. Our initial program includes smart locks, smart thermostats, smart lights and water leak sensors. Overall, these technologies will provide ease of living for our residents, reduce our operating expenses, advance our environmental goals and enable a better digital experience in the form of self-guided tours for potential residents. I am pleased to share that we made substantial progress on our ESG initiatives during 2022. Delivering industry-leading ESG performance for value-oriented community is core to our goal of elevating the standard for value living.

To quickly summarize our achievements, we achieved our highest GRESB score to-date, achieved our greenhouse gas and water goals, aligned our reporting with GRI standards, joined the better climate initiatives, increased our multifamily sustainability certifications and expanded the number of EV chargers at our communities. As we transition our communities to Elme management, we are advancing financial inclusion by providing our residents the ability to boost their credit scores by submitting on-time rent payments to all three credit bureaus at no cost. ESG is core to our mission of delivering a superior living experience for mid-market rents and we are pleased with the progress we made in 2022 and look forward to keeping you updated on our ESG goals.

Before I turn it over to Steve Riffee to provide an update on our operating trends and to cover full year and fourth quarter performance, I’d like to say a few words of gratitude. This is Steve’s last earnings call with us ahead of his retirement on February 28. I cannot thank Steve enough for the dedication that he has shown this company over the past 8 years. His leadership and vision were instrumental to our transformation and he is leaving us with a team that is well-prepared to drive our company forward. He will be greatly missed by everyone who worked with him and we wish him the best in his retirement.

Steve Riffee: Thank you, Paul. I am grateful to you and to our team for all we were able to do together and I am looking forward to the growth ahead for our company going forward. Now starting with our operating trends, the year is off to a strong start and demand indicators continue to look good through the winter months. Year-to-date traffic and application volumes are up on a year-over-year basis, extending the trend that we experienced during the second half of last year. Effective new lease rate growth was 1.1% and the effective renewal lease rate growth was 10.1%, which blends to 5.7% for same-store move-ins that took place during the fourth quarter. Thus far this year, demand trends remained solid and lease rates have increased since December.

Effective blended lease rate growth averaged 4.5% for January move-ins comprised of renewal lease rate growth of 8.8% and new lease rate growth of 1.3%. For February move-in so far, effective blended lease rate growth increased to 5.8% for our same-store communities comprised of renewal lease rate growth of 9.1% and new lease rate growth of 3.7%. Our revenue maximization strategy prioritizes occupancy over lease rate growth during the winter months. And as such, we adjusted pricing to sustain occupancy during our lightest volume months. New lease rates are on an upward trend and we are currently signing new leases with effective rate increases of over 4% on average. Looking forward, we expect new lease rates to continue to increase to the mid single-digits in the spring and summer leasing seasons followed by a decline to the low single-digits toward next winter.

Renewal lease rates remain very strong and we are currently sending out renewal offers for April lease expirations with effective rate increases of over 7% on average. And so far, we are experiencing high renewal acceptance rates. We expect renewal rates to trend down from the current high single-digit level, eventually converging to a more normalized level in the low single-digits by the end of the year. All in all, we feel good about the lease rate growth we captured during the fourth quarter and the trends that we are seeing now heading into the spring leasing season. Lease rates tend to be weaker during the winter. And while new lease rates moderated through January, renewal rates remained very strong all through the winter. The combined new and renewals that we are quoting for March and April are providing upward trending rent levels just as we expected, heading into the spring leasing season.

These are positive winter months, adding to historically high embedded growth as we head into the spring months. Occupancy averaged 95% during the quarter for our same-store portfolio and has increased 30 basis points on a year-to-date basis. As of the second week of February, same-store occupancy was 95.6%, positioning us to continue to drive rent growth and capture more of our loss to lease. Retention was 62% during the quarter, which is a slight sequential increase as we continue to experience high renewal demand, supporting very strong renewal rate growth of approximately 9% year-to-date. Average effective monthly rent per home grew 9.7% in the fourth quarter compared to the prior year and 7.6% for the full year, reflecting the impact of the very strong lease rate growth we captured during 2022.

For our portfolio, average monthly rent grew significantly more in the second half of 2022 to provide historically high embedded growth at the end of the year. Our current rent levels in February, plus the March move-ins we signed represent rental growth of approximately 5%, which is nearly 70% of the rental rate growth that we expect for the full year. Our current loss to lease, which represents the difference between current asking rents and our in-place rents is approximately 4.4%, and we expect our loss to lease to increase into the spring, given the solid demand trends that we’re seeing today. We are where we expected to be heading into the spring and summer leasing season and a line of sight on the busiest leasing months will significantly increase over the next 2 to 3 months.

By June, we expect to have locked in 90% of our total rental rate growth for the year. We feel good about the visibility that we have today and where rent growth is tracking compared to our expectations. Moving on to renovations. We completed more than 300 full renovations during 2022 and an ROI of over 13%, excluding the rent growth that we achieved on comparable unrenovated units. We expect to be closer to our historical renovation run rate of approximately 600 units per year in 2023 and for renovation-led value creation to drive higher rent and NOI growth over the next few years. Executing value-add renovation at low-teen cash on cash returns on average remains a key part of our growth strategy. Now turning to our full year and fourth quarter financial results.

Core FFO for the fourth quarter was $0.24 per diluted share, representing year-over-year growth of over 40%, driven by strong growth in rental income and the full deployment of our commercial portfolio sale proceeds. Core FFO for 2022 was $0.88 per share, in line with the midpoint of our guidance range. Multifamily same-store revenue grew by 8.9% for the quarter and 7.3% for the full year due to growth in rental rates, lower concessions, higher occupancy, and an 11% year-over-year decrease in bad debt for the full year. Operating expenses grew 4% for the fourth quarter and 4.6% for the full year, driven by non-controllable expenses, such as real estate taxes and utilities. Multifamily same-store NOI grew 11.6% for the fourth quarter and 8.8% for the full year.

This represents the end of a strong year, even while executing our transformation, and now we have excellent momentum turning into 2023. Now it is my privilege to turn it over to Steve Freishtat, who I have great confidence in. Steve will cover financing updates and our 2023 outlook. As we announced in November, Steve is succeeding me as Chief Financial Officer following my retirement at the end of this month. Steve brings extensive knowledge of capital markets, strategic transactions, capital allocation, public company operations, and financial planning. He’s been instrumental in the execution of our multifamily transformation, and I know he is going to be an excellent CFO. He also has an excellent team that has been through all of this with us and are ready for new opportunities to create value.

Steven Freishtat: Thanks, Steve. You’re leaving me with a great team, and we are very excited for the opportunity to continue to build on everything you helped to create over the last 8 years. Now I’ll start with our balance sheet. With an annualized fourth-quarter net debt to EBITDA of 4.8x, over $650 million of availability on our line of credit, no secured debt, and no maturities until 2025, our balance sheet is in excellent shape. In keeping with our proactive approach to managing our debt maturity ladder, on January 10, we executed a new 2-year $125 million term loan with two 1-year extension options. We used the proceeds to pay down our previous $100 million term loan with no prepayment penalty and a portion of the balance on our line of credit.

Our new loan has a variable interest rate of adjusted SOFR plus 95 basis points. At a time when many banks are tightening their lending requirements, we have taken steps to ensure our financial flexibility and increase our liquidity. We feel good about our ability to successfully navigate market volatility while executing on our strategy. Now turning to our outlook for 2023. We are reiterating our 2023 core FFO guidance range of $0.96 to $1.04 per fully diluted share, which implies double-digit year-over-year growth. Same-store multifamily NOI growth is expected to range from 9% to 11%, which reflects year-over-year growth of 10% at the midpoint. Further building on the double-digit NOI growth achieved in the second half of 2022. Non-same-store multifamily NOI is expected to range from $12.75 million to $13.75 million in 2023.

While this guidance range does not reflect the impact of potential acquisitions, we had more than $650 million of availability on our line of credit as of year-end, and we are running below our targeted leverage levels. We will continue to evaluate acquisition opportunities in our target markets and will further pursue acquisitions when they create additional value for shareholders. Other same-store NOI, which consists solely of Watergate 600 is expected to range from $13 million to $13.75 million. We are slightly reducing our guidance for G&A net of core adjustments through a range of $25.75 million to $27 million. We expect G&A to decline in 2024 as we realize the full-year benefits of internalizing multifamily operations and then to remain stable as we scale our portfolio when the time is right to do so.

Our G&A guidance excludes the impact of transformation investments for our platform and our full integration, which we now expect to be between $3 million and $4 million. Interest expense is now expected to range between $29 million and $30 million, which incorporates a higher anticipated future Fed funds rate as the interest rate outlook has shifted since we announced our 2023 guidance last year as well as the impact of our new term loan. The new term loan is subject to our existing swap agreement, which fixes the interest rate on $100 million at 2.16% through July 21 of this year. We remain very confident in our NOI growth outlook and are currently within our core FFO guidance range. However, recent Fed actions have put pressure on our midpoint.

If expectations were to shift further, we will update our interest expense guidance again and possibly our core FFO guidance range. We finished 2022 with a 75% AFFO payout ratio. As Paul mentioned, we are increasing our quarterly dividend by approximately 6% to $0.18 per share, reflecting confidence in our growth in 2023 and beyond and the strength of our AFFO growth profile. We expect our core AFFO payout ratio for this year to be at or below our mid-70s target. And with that, I will now turn the call back to Paul.

Paul McDermott: Thank you, Steve. To conclude, we are where we expected to be at this point in the year. We feel good about our ability to deliver double-digit core FFO growth, which will be driven primarily by rent growth as nearly 70% of that rent growth is already locked in. We are on track to complete the transition of our portfolio to L management by this summer and to begin to see the benefits of that transition and our Smart Home initiatives in 2024. Our strategy offers growth as well as relative insulation during downturns, and we expect to benefit from sustained demand for quality, affordable rental options over the near and longer term. And now operator, I’d like to open it up for questions.

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Q&A Session

Operator: Your first question for today is coming from Michael Lewis with Truist Securities.

Michael Lewis: Great. Thank you. Steve, you’ll certainly be missed and I wish you all the best in retirement and congratulations to Steve, other Steve, on taking over the role. My first question, I was wondering if you could provide some of the components of the same-store NOI guidance, occupancy, revenue growth, or expense growth or any details you could share?

Steven Freishtat: Yes, Michael, this is Steve Freishtat and I’ll take a first crack at that. So to get to our NOI guidance, we look at our revenue growth expectation of about 8.5%. Of that is primarily driven by rental revenue growth, where we’re expecting that to be almost 7%. And as we talked about in our prepared remarks, we’ve captured approximately 5% of that already with our in-place leases and leases signed but not yet moved in. So we’re at 70%. We’re expecting that number to be 90% by June. So €“ and that leaves about an additional 2% of additional rent growth that is expected to be captured over the remainder of the year. The difference between the 7% and the 8.5% is smaller contributions from line items like other income and declines in bad debt.

On the expense side, we’re expecting expenses to go up about 7% net of reimbursements. And that’s primarily driven by three line items. The first is payroll, which we’re seeing pressure on salaries. And we’re also ramping up positions ahead of our onboarding that we’re currently going through for our communities. The second one is taxes as we’re seeing taxes reset. We’re seeing pressure on expenses from increased taxes. And then the third one is utilities. We’re seeing utilities higher in electricity and gas for 2023, but that’s mitigated somewhat by reimbursements where we see reimbursement at about 60% to 70%. So that’s really the buildup to our 9% to 11% NOI growth.

Michael Lewis: Yes. That’s great detail. Thanks. My second question, how should we think about the upside from getting properties onto your internal property management platform? I don’t know if you have €“ is there an operating margin improvement that you’re measuring or seeing that you can point to? Or how do you kind of measure and quantify the longer-term benefits from that transition?

Steven Freishtat: Yes, Michael, this is Steve again. I’ll take that one as well. So as we said, we are €“ we have onboarded as of next week, almost 40% of our communities by the end of the quarter would be at 50% and have them all on board by the end of the summer. And we think when we can get there in the mall on board that there are efficiencies that we can take advantage of. Just examples of it are centralization, better revenue management through occupancy initiatives, smart buildings and ability to produce R&M, maintenance efficiencies, and global contract strategy. So we see a lot of potential upside from being able to take advantage of opportunities of managing our own communities. But in addition to that, we’ve talked about scalability before that we’re building out a platform that is scalable.

So, when we think about being able to double the unit count of this company and keep G&A essentially the same from where it is now, but that’s even an additional opportunity and an additional driver for growth.