Mid-America Apartment Communities, Inc. (NYSE:MAA) Q4 2022 Earnings Call Transcript

Mid-America Apartment Communities, Inc. (NYSE:MAA) Q4 2022 Earnings Call Transcript February 2, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the MAA Fourth Quarter and Full Year 2022 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, the company will conduct a question-and-answer session. As a reminder, this conference call is being recorded today, February 22nd, 2022 . I will now turn the call over to Andrew Schaeffer, Senior Vice President, Treasurer and Director of Capital Markets of MAA for opening comments. Please go ahead.

Andrew Schaeffer: Thank you, Natty and good morning, everyone. This is Andrew Schaeffer, Treasurer and Director of Capital Markets for MAA. Members of the management team also participating on the call with me this morning are Eric Bolton, Tim Argo, Al Campbell, Rob DelPriore, Joe Fracchia, Tom Grimes, and Brad Hill. Before we begin with our prepared comments this morning, I want to point out that as part of this discussion, company management will be making forward-looking statements. Actual results may differ materially from our projections. We encourage you to refer to the forward-looking statements section in yesterday’s earnings release and our 34 Act filings with the SEC, which describe risk factors that may impact future results.

During this call, we will also discuss certain non-GAAP financial measures. A presentation of the most directly comparable GAAP financial measures, as well as reconciliations of the difference between non-GAAP and comparable GAAP measures can be found in our earnings release and supplemental financial deck. Our earnings release and supplement are currently available on the For Investors page of our website atwww.maac.com. A copy of our prepared comments and an audio recording of this call will also be available on our website later today. After some brief prepared comments, the management team will be available to answer questions. I will now turn the call over to Eric.

Eric Bolton: Thanks, Andrew, and good morning, everyone. MAA wrapped up calendar year 2022 with fourth quarter results for core FFO that were ahead of expectations as higher fee income along with continued growth in average rent per unit and strong occupancy more than offset pressure from higher real estate taxes. Looking ahead to the coming year, there is clearly some uncertainty surrounding the outlook for the employment markets, the pace of inflation and the broader economy. In addition, while we do know that new supply deliveries in 2023 broadly will be higher than in 2022, we continue to believe that MAA is well positioned for the coming year as the leasing market returns to more normalized conditions. Our expectations for the coming year are built on a lease-over-lease pricing environment of 3%.

This performance assumption, coupled with the earn-in from 2022’s rent growth should drive growth in effective rent per unit of around 7% over the coming year. We will, of course, see conditions vary some by market and submarket location, but we believe that our portfolio is in a uniquely solid position to weather expected moderation from the historically high rate growth of last year. This view is really supported by three key variables: first, we continue to believe that our Sunbelt footprint maintains an advantageous position for capturing demand, given the stronger and more stable employment markets in the Sunbelt states. We continue to see job growth, positive migration trends, affordable rent-to-income ratios and low resident turnover.

Secondly, MAA’s unique diversification across the Sunbelt region, including both large and high-growth secondary markets, provides exposure to a good range of employment sectors and works to help soften some of the pressures surrounding new supply levels in a number of our larger markets. And thirdly, with a rent price point average for our portfolio that appeals to our broad segment of the rental market and it is around 20% below the price point of the mostly high-end new product being delivered, we believe we will capture more stability and top-line performance as leasing conditions normalize in 2023. In the event that we do find ourselves later in the year headed towards a more severe contraction in the economy or a recession, as MAA has consistently demonstrated over the past 20 years, we expect to perform with a lower level of volatility than what generally is seen with more concentrated portfolios and/or those costs traded in large coastal markets.

The transaction market remains very quiet and we are likewise remaining patient with what opportunities we do see. I expect it will be the second half of the year before pricing data becomes more readily available. We do have plans to initiate development on four new projects in 2023 associated with sites that we already own or that are under our control. These projects will, of course, not actually start delivering units for another couple of years. In conclusion, I want to give a big thank you to our MAA associates for their tremendous service and record performance in2022. We have the company well positioned for the next cycle, as a number of new tech initiatives will positively impact performance over the coming years. Our external growth pipeline continues to expand and the balance sheet provides a good, strong foundation for supporting our current portfolio operations, as well as active pursuit of new growth opportunities.

That’s all I have in the way of prepared comments and I’ll turn the call over to Tim.

Tim Argo: Thank you, Eric, and good morning, everyone. Same-store performance for the quarter was once again strong and ahead of our expectations. While pricing performance moderated during the fourth quarter from the record growth we had achieved September year-to-date, blended lease-over-lease pricing was up 5.7%. As a result, effective rent growth or the growth on all in-place leases for the fourth quarter was 14.9%, versus the prior year and 2.0% sequentially from the prior quarter. Full year 2022 blended lease-over-lease pricing was 13.9%, helping to drive full year effective rent growth of 14.6%. Alongside the strong pricing performance, average daily occupancy remained steady at 95.6% for the fourth quarter and 95.7% for the full year 2022.

In line with normal seasonality, our January new lease rate of negative 0.3% improved from December’s new lease rate of negative 0.9% and other than 2022 represents a higher new lease rate than any year since we have been tracking the data. Combined with renewal pricing of 8.6%, January blended lease-over-lease pricing was 4.2% and average daily occupancy was 95.7%. With new lease pricing moderating as expected, renewal pricing, which lagged new lease pricing for much of 2022 is providing a catalyst for the strong January pricing and is expected to be strong for the next few months before moderating to a more typical range. We are achieving growth rates on signed renewals of around 8% to 9% for the first quarter. We do expect new supply in several of our markets remain elevated in 2023, putting some pressure on rent growth, but the various demand indicators remain strong and we expect our portfolio to continue to benefit from population household and job growth.

As Eric mentioned, should we see a more dramatic downturn in the economy from here, we expect our market’s diversification and price point will help mitigate some of the impact to performance. During the quarter, we continued our various product upgrade initiatives. This includes our interior unit redevelopment program, our installation of smart home technology and our broader amenity-based property repositioning program. For the full year 2022, we completed more than 6,500 interior unit upgrades and installed over 24,000 smart home packages. As of December 31, 2022, the total number of smart units is over 71,000, and we expect to finish out the remainder of the portfolio in 2023. For our repositioning program, leases have been fully or partially repriced at the first 11 properties in the program and the results have exceeded our expectations with yields on costs averaging approximately 17%.We have another four projects that will begin repricing this quarter and five additional projects currently under construction.

Those are all of my prepared comments. I’ll now turn the call over to Brad.

Brad Hill: Thank you, Tim, and good morning. Despite execution challenges in the transaction market, our team successfully completed our disposition plan for 2022 by closing our last two dispositions in the fourth quarter. Our total disposition proceeds for the year were approximately $325 million, representing a stabilized NOI yield of 4.3% and an investment IRR of 17.7% for assets with an average age of 25 years old. In 2023, we will continue the discipline of steadily recycling capital out of older, higher CapEx properties with the intent to redeploy the capital into newer, lower CapEx, higher rent growth properties to drive higher long-term earnings growth within our portfolio. While transaction volume continues to be muted, we believe it’s likely that the transaction market will provide more opportunities towards the back half of the year.

Currently, the number of marketed properties is down substantially from 2022, with the majority of sellers waiting until at least the spring leasing season before reevaluating their planned sale timing. In the face of this lower volume, we have seen some upward pressure on cap rates with the degree of the movement varying based on property characteristics, embedded rent growth, as well as market and submarket location. However, until closed transactions materially increase transparency around cap rates will be difficult. When marketed deal volume does increase, we expect buyer financial strength and speed of execution to be attractive key differentiators and our balance sheet strength and capacity will support our ability to transact despite a more difficult credit environment.

On our new developments, our team has done a tremendous job working through the challenges of elevated construction costs and permitting delays, leading to steady growth in our development pipeline. During 2022,we started construction on 1,253 units at a cost of $468 million, a record level of starts for MAA. During the fourth quarter, we started construction on two projects that have been in predevelopment for some time. These two projects will begin delivering units in two years and should finish construction in three years, lining up well with what we believe is likely to be a strong leasing environment. While the timing of planned construction starts can change as we work through the local approval and construction bidding processes, we expect to start four new developments during the back half of 2023.

This includes two in-house developments, one located in Orlando and one in Denver and two pre-purchased joint venture developments, one located in Charlotte and the other a Phase 2 to our West Midtown development in Atlanta. Our construction management team continues to do a tremendous job actively managing our projects and working with our contractors to keep the inflationary and supply chain pressures from causing a meaningful increase to our overall development costs or our schedules. Despite these headwinds, the team delivered three projects on time in 2022 and under budget by approximately $4.5 million. During the fourth quarter, construction wrapped up on MAA Windmill Hill, and we reached stabilization at MAA Robinson, MAA West Glenn and MAA Park Point with operating results well ahead of our pro forma expectations delivering stabilized NOI yields on average of 6.6%.

Leasing demand at our new properties remains high and the competition from other new supply has, to-date, not had a significant impact on our lease-up performance with rents being achieved well ahead of pro formas. That’s all I have in the way of prepared comments. So with that, I’ll turn the call over to Al.

Albert Campbell: Okay. Thank you, Brad, and good morning, everyone. Reported core FFO per share of $2.32 for the quarter was $0.05 above the midpoint of our guidance and contributed to core FFO for the full year of $8.50 per share, representing a 21% increase over the prior year. Same-store rental pricing and occupancy levels were in line with expectations for the quarter, while higher fee and reimbursement revenues, combined with strong lease-up and commercial revenues, to produce about two-thirds of this earnings outperformance for the quarter. This favorability was partially offset by real estate tax expenses, as final millage rates came in higher than expected during the quarter for several markets, primarily in Texas. Our real estate tax estimates were based on strong valuations supported by the very strong revenue trends over the last year, offset by expected millage rate rollbacks as counties managed overall tax needs and rollbacks occurred but were less than expected in Texas, particularly in Dallas and Austin.

Our internal guidance for €“ our initial guidance, excuse me, for ’23, which we’ll discuss more in a moment anticipate some continued pressure in this area given its backward-looking nature. Our balance sheet remains very strong, as we ended the year with historically low leverage debt-to-EBITDA RE of3.71 times with 95.5% of our debt fixed at an average interest rate of 3.4% and with $1.3 billion available capacity to support growth and manage our debt maturities late in 2023. Also at the end of January, we settled our outstanding forward equity contracts, providing an additional $204 million of capacity at an attractive cost of capital. We currently expect to fund our near-term acquisition, development and refinancing needs with short-term debt capacity allowing the financing markets to continue to stabilize before locking in long-term financing.

Finally, we did provide initial earnings guidance for 2023 with our release, which is detailed in the supplemental information package. Core FFO for the year is projected to be $8.88 to $9.28 per share or $9.08 at the midpoint, which represents a 6.8% increase over the prior year. The foundation for the projected 2023 performance is same-store revenue growth produced by historically higher rental pricing earn-in of about 5.5% combined with the more normalized blended rental pricing performance of 3% for the year, as well as a continued strong occupancy remaining between 95.6% and 96%for the year. Based on this, effective rent growth for the year is projected to be a solid 7% at the midpoint of our range, with total same-store revenues expected to grow 6.25%, slightly diluted from the other revenue items, primarily reimbursement in fee income, which grew at a more modest pace.

Same-store operating expenses are projected to grow at 6.15% at the midpoint for the year with real estate taxes and insurance producing the most significant growth pressure. Combined these two items alone are expected to grow just over 7% for 2023 with the remaining controllable operating items expected to grow around 5.5%. These expense pressures are offset by the continued strong revenue growth with NOI for the year projected to grow 6.3% at the midpoint. We’re also expecting continued external growth, both through the acquisitions and development opportunities during the year with a combined $700 million full year planned investment. This growth will be partially funded by asset sales, providing around $300 million of expected proceeds.

We expect to fund the remaining capital needs for the year from internal cash flow and short-term variable rate borrowings, as we anticipate the financing markets to continue stabilizing over the next year, eventually providing better opportunities to lock in long-term debt rates. This does produce some slight pressure on current year FFO performance given high short-term rates, but is expected to be rewarded with lower long-term financing costs when markets stabilize further. So that’s all that we have in the way of prepared comments. So Nikki, we’ll now turn the call back to you for any questions.

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Q&A Session

Operator: And we will take our first question from Nick Yulico with Scotiabank. Please go ahead.

Nick Yulico: Thanks. Good morning, everyone. So I just wanted to start with the guidance on same-store revenue. So if you’re at sort of right around 6% at the midpoint, I think you guys had an earn-in that was close to that number coming into the year. So, you have occupancy being roughly flat in the guidance. So just trying to understand kind of what might be the offset as to €“ and you are assuming some market rent growth, as well. So just trying to understand kind of the buildup there and if there is anything we’re missing as to why the revenue growth guidance wouldn’t be a little bit higher based on the earnings you’ve cited?

Albert Campbell: Yes. Nick, I’ll give you the components €“ this is Al. I’ll give you the components of how we built it, and maybe Tim can give a little color, if he would like, on some of the components. But really it’s built on the earn-in. You talked about based on where pricing was when we think about earnings is pricing at the end the year if it were to carry-forward that same level, not up or down, what would it be built into our portfolio. That’s about5.5%, that’s the way we think about it. And on top of that, you get about half of the current year expected blended pricing. And as we talked about, we’re expecting about 3%. So you add those two numbers together, you get right at the 7% effective rent growth guidance that we put out.

Now that is, as we mentioned in the comments, a little bit moderated from other income items. About 10% of our revenue stream is from reimbursements and fees those things and they’re expected to grow more modestly than that. So that’s what gets to 6.25%, but in terms of the earn-in and the components, that’s really what it is.

Nick Yulico: Okay. Thanks. That’s helpful. And then just the second question is just to get a feel for what type of economic scenario is baked into guidance whether this is a softer landing with modest job losses, any commentary from you guys on the economic outlook would be helpful? Thanks.

Eric Bolton: Well, Nick, this is Eric. I mean broadly, as Al mentioned, I mean, we do expect that the overall rent growth for the market next year will be something around 3%, which I think is going to be fueled by what we expect to be a continued relatively stable employment backdrop to what we’re seeing today. We’re not seeing any real evidence, significant evidence building in any of our markets at this point relating to employment weakness or people losing jobs. We’re not having any kind of issues surrounding collections. Migration trends continue to be very positive. And so, as we think about the outlook for ’23, I mean, we’re €“ it’s definitely moderated from what it was 2022, but we’re not seeing any concerns at the moment that a severe contraction or any sort of a worse €“ a materially worse decline in the employment markets were to occur now.

If that does happen is, as I alluded to in my comments, we’ve been through recessions in the past, and we think that if we find ourselves in a more severe economic contraction, where broadly the employment markets start to really pull back, we think that that’s where the sort of defensive characteristics that we’ve built into our strategy really start to pay a dividend for us and that’s where our secondary markets come into play on lower price point of our product comes into play and the broad diversification to employment sectors that we have across the large number of markets that we’re in, all provide some level of cushion, if you will, if we find ourselves in a more severe downturn. So right now, we’re not calling for that, but we think that it should have happen, we would probably weather that pressure better than a lot of others.