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

Mid-America Apartment Communities, Inc. (NYSE:MAA) Q4 2023 Earnings Call Transcript February 8, 2024

Mid-America Apartment Communities, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Please go ahead.

Andrew Schaeffer: Thank you, Carrie and good morning, everyone. This is Andrew Schaeffer, Treasurer and Director of Capital Markets for MAA. Members of the management team participating on the call this morning with prepared comments are Eric Bolton, Brad Hill, Tim Argo and Clay Holder. Al Campbell, Rob DelPriore, and Joe Fracchia are also participating and available for questions as well. 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 34x 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 differences between non-GAAP and comparable GAAP measures can be found in our earnings release and supplemental financial data. Our earnings release and supplements are currently available on the — for Investors page of our website at www.maac.com. A copy of our prepared comments and 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. Core FFO results for the fourth quarter were ahead of our expectations. Higher non-same-store NOI performance and lower interest expense drove the outperformance. As expected during the fourth quarter, a combination of higher new supply and a seasonal slowdown in leasing traffic increasingly weighed on new resident lease pricing during the quarter. Encouragingly, we did see some of this pressure moderate in January with blended pricing improving 130 basis points from the fourth quarter performance led by improvement in new lease pricing. Stable employment conditions, continued positive migration trends, a higher propensity of new households to rent apartments and continued low resident turnover are all combining to support steady demand for apartment housing.

We continue to believe that late this year, new lease pricing performance will improve and we will begin to capture recovery in that component of our revenue performance. In addition, with the pressure surrounding higher new supply deliveries likely to moderate later this year, we continue to believe the conditions are coming together for overall pricing recovery to begin late this year and into 2025. As you may have seen last week, MAA crossed a significant milestone marking the 30-year anniversary since our IPO. Over the past 30 years, MAA has delivered an annual compounded investment return to shareholders of 12.6%, with about half of that return comprised of the cash dividends paid. Through numerous new supply cycles and various stresses associated with the broader economy, MAA has never suspended or reduced our quarterly dividend over the past 30 years, which, of course, is a key component of delivering superior long-term as returns to REIT shareholders.

Today, I’m more positive about our outlook than I was this time last year. Today, as compared to a year ago, we have more clarity about the outlook for interest rates with downward movement likely later in the year. More REITs associated with material economic slowdown or recession are dissipating. Inflation pressures on operating expenses are declining. The demand for apartment housing and absorption remained steady. And with clearly declining permits and new construction start, we have increasing visibility that competing new supply is poised to moderate. With a 30-year track record of focus on high growth markets, successfully working through several economic cycles, an experienced team and proven operating platform, a strong balance sheet and long-term shareholder performance among the top tier of all REITs, we’re confident about our ability to execute on the growing opportunities in the coming year and beyond.

Before turning the call over to Brad, I do want to take a moment to say a big thank you to Al Campbell, who will be officially retiring effective March 31st. Al has been with our team for the past 26 years and has served as our Chief Financial Officer for the past 14 years. Al has been instrumental in the growth of our company, transitioning us to the investment grade debt capital markets and has built a strong finance, accounting, tax internal audit platform for MAA. Al leads our company and finance operation in strong hands with Clay and his team. Overall, grateful for Al’s service and tremendous accomplishments. So thank you, Al, for all you’ve done for MAA. And with that, I’ll now turn the call over to Brad.

Brad Hill: Thank you, Eric, and good morning, everyone. As mentioned in our earnings release, we successfully closed on 2 compelling acquisitions during the fourth quarter at pricing 15% below current replacement costs. Both properties fit the profile of the type of properties we expect to continue to emerge throughout 2024. Properties in their initial lease up, with sellers focused on certainty of execution with the need to transact prior to a definitive deadline. Our relationships with the sellers and our ability to move quickly and execute on the transactions utilizing the available capacity on our line of credit without a financing contingency were key components of MAA being chosen as the buyer for these properties. MAA Central Avenue a 323-unit mid-rise property in the Midtown area of Phoenix and MAA Optimist Park a 352-unit mid-rise property in the Optimist Park area of Charlotte are expected to deliver initial stabilized NOI yields of 5.5% and 5.9%, respectively.

We expect both properties to achieve further yield and margin expansion as a result of adopting MAA’s more sophisticated revenue management, marketing and lead generation practices as well as our technology platform. Additionally, we expect to achieve operational synergies by combining certain functions with other area MAA properties as part of our new property potting initiative. Due to continued interest rate volatility and tight credit conditions, transaction volume remains tepid, down 50% year-over-year and 16% from the third quarter space. We continue to believe that transaction volumes will pick up later in 2024, providing visibility into cap rates and market values. For deals we tracked in the fourth quarter, we saw cap rates move up by roughly 35 basis points from third quarter.

Our transaction team is very active in evaluating additional acquisition opportunities across our footprint with our balance sheet in great position to be able to take advantage of more compelling opportunities as they continue to materialize later this year. Our forecast for the year includes $400 million of new acquisitions, likely in lease up and therefore, dilutive until stabilization is reached. Despite pressure from elevated new supply, our two stabilized new developments as well as our development projects currently leasing continue to deliver good performance, producing higher NOIs and earnings than forecasted in our original pro-formas, creating additional long-term value. New lease rates are facing more pressure at the moment, but these properties have captured asking rents on average approximately 20% above our original expectations.

Our four developments that are currently leasing are estimated to produce an average stabilized NOI yield of 6.5%. We continue to advance predevelopment work on several projects, but due to permitting and approval delays, as well as an expectation that construction costs are likely to come down. We have pushed the three projects that we plan to start in 2023 into 2024. We now expect to start between 3 to 4 projects this year, with 2 starts in the first half of the year and 2 starts late in the year. Encouragingly, we have seen some recent success in getting our construction costs down on new projects that we’re currently repricing. As we have seen a meaningful decline in construction starts in our region, we’re hopeful to see continued decline in construction costs as we progress through the year.

Our team has done a tremendous job building out our future development pipeline. And today, we own or control 13 well-located sites, representing a growth opportunity of nearly 3,700 units. We have optionality on when we start these projects, allowing us to remain patient and disciplined. Any project we start this year, we’ll deliver first units in 2026, aligning with the likely stronger leasing environment supported by significantly lower supply. Our development team continues to evaluate land sites as well as additional prepurchase development opportunities. In this constrained liquidity environment, it’s possible we could add additional development opportunities to our future pipeline. The team has our portfolio in good position. Our broad diversification provides support during times of higher supply with a number of our mid-tier markets outperforming.

As we ramp up activities in 2024, we’re excited about the coming year. Beyond the new external growth opportunities just covered and as Tim will outline further, we continue to see solid demand and steady absorption of the new supply delivering across our markets and remain convinced that pricing trends will begin to improve late this year and into 2025. In addition, we continue to make progress on several new initiatives aimed at further enhancing our leasing platform to further position us to outperform local market leasing metrics during the supply cycle. Before I turn the call over to Tim to all of our associates at the properties and our corporate and regional offices. I want to say thank you for coming to work every day, focused on improving our business, serving our residents and exceeding the expectations of those that depend on us.

With that, I’ll turn the call over to Tim.

Tim Argo : Thank you, Brad, and good morning, everyone. Same-store NOI growth for the quarter was right in line with our expectations with slightly lower operating expenses offsetting slightly lower blended lease over lease pricing growth. Expanding on Eric’s earlier comment on new lease pricing, developers looking to gain occupancy ahead of the holiday season and the end of the year did put further pressure on new lease pricing, particularly in November and December. However, because traffic tends to decline in the fourth quarter, again, particularly in November and December, we intentionally repriced only 16% of our leases in the fourth quarter and only about 9% in November and December. This resulted in blended lease-over-lease pricing of minus 1.6% for the quarter comprised of new lease rates declining 7% and renewal rates increasing 4.8%.

Average physical occupancy was 95.5% and collections remained strong, with delinquency representing less than 0.5% of bill grants. These key components drove the resulting revenue growth of 2.1%. From a market perspective in the fourth quarter many of our mid-tier metros performed well. Being invested in a broad number of markets, submarkets, asset types and price points is a key part of our strategy to capture growth throughout the cycle. Savannah, Richmond, Charleston and Greenville are examples of markets that led the portfolio and lease-over-lease pricing performance. The Washington, D.C. metro area, Houston and to a lesser extent, Dallas/Fort Worth for larger metros that held up well. Austin and Jacksonville are 2 markets that continue to be more negatively impacted by the level of supply being delivered into those markets.

Touching on some other highlights during the quarter. We continued our various product upgrade and redevelopment initiatives in the fourth quarter. For the quarter, we completed nearly 1,400 interior unit upgrades, bringing our full year total to just under 6,900 units. We completed over 21,000 smart home upgrades in 2023 and now have over 93,000 units with this technology and we expect to complete the remaining few properties in 2024. For our repositioning program, we have 5 active projects that are in the repricing phase with expected yields in the 8% range. We have targeted an additional 6 projects began in 2024, with a plan to complete construction and begin repricing in 2025. Now looking forward to 2024, we’re encouraged by the relative pricing trends we are seeing thus far.

As noted by Eric, blended pricing in January, it was 130 basis points better than the fourth quarter. This is comprised of new lease pricing of negative 6.2%, an 80 basis point improvement for the fourth quarter and notably a 150 basis point improvement from December and renewal pricing of 5.1%, an improvement of 30 basis points from the fourth quarter, while maintaining stable occupancy of 95.4%. Similarly, renewal increases achieved thus far in February and March average around 5%. As noted, new supply being delivered continues to be a headwind in many of our markets. While we do expect this new supply will continue to pressure pricing for much of 2024, we believe we have likely already seen the maximum impact to new lease pricing and that the outlook is better for late 2024 and into 2025.

It varies by market, but on average, new construction starts in our portfolio footprint peaked in the second quarter of 2022. Based on typical delivery time lines, this suggests peak deliveries likely in the middle of this year with some positive impact of pricing power soon thereafter. While increasing supply is impactful, strength of demand is more indicative of the pricing power in a particular market. Job growth is expected to moderate some in 2024 as compared to 2023, but growth is still expected to be strongest in the Sunbelt markets. Job growth combined with continued in-migration accelerates the key demand factor of household formation. Separately, the cost gap between owning and renting gapped out considerably in the back half of 2023, even before considering the impact of higher mortgage rates.

Move out to buy a home dropped 20% in the fourth quarter on a year-over-year basis, and we expect a continued low number of move-outs due to home buying to contribute to low turnover overall in 2024. That’s all I have in the way of prepared comments. Now I’ll turn the call over to Clay.

Clay Holder: Thank you, Tim, and good morning, everyone. Reported core FFO for the quarter of $2.32 per share was $0.03 per share above the midpoint of our quarterly guidance and contributed core FFO for the full year of $9.17 per share, representing an approximate 8% increase over the prior year. The outperformance for the quarter was primarily driven by favorable interest and the performance of our recent acquisitions and lease-up during the quarter. Overall, same-store operating performance for the quarter was essentially in line with expectations. Same-store revenues were slightly below our expectations for the quarter as effective rent growth was impacted by lower lease pricing that Tim mentioned. Same-store operating expenses were slightly favorable to our fourth quarter guidance primarily from lower-than-expected personnel costs and property taxes.

During the quarter, we invested a total of $20.7 million of capital through our redevelopment, repositioning and smart brand installation programs, producing solid returns and adding to the quality of our portfolio. We also funded $48 million of development costs during the quarter toward the completion of the current $647 million pipeline, leaving nearly $256 million remaining to be funded on this pipeline over the next 2 years. As Brad mentioned, we also expect to start to 3 to 4 projects over the course of 2024, which would keep our development pipeline at a level consistent with where we ended 2023, in which our balance sheet remains well positioned to support. We ended the year with nearly $792 million in combined cash and borrowing capacity under our revolving credit facility, providing significant opportunity to fund potential investment opportunities.

Our leverage remains low with debt to EBITDA at 3.6x. And at year-end, our outstanding debt was approximately 90% fixed with an average of 6.8 years at an effective rate of 3.6%. Shortly after year-end, we issued $350 million of 10-year public bonds at an effective rate of 5.1%, using the proceeds to pay down our outstanding commercial paper. Finally, we did provide initial earnings guidance for 2024 with our release, which is detailed in the supplemental information package. Core FFO for the year is projected to be $8.68 to $9.08 or $8.88 at the midpoint. The projected 2024 same-store revenue growth midpoint of 0.9% results from rental pricing earned in of 0.5% combined with blended rental pricing expectation of 1% for the year. We expect blended rental pricing as to be comprised of lower new lease processing impacted by elevated supply levels and renewal pricing in line with historical levels.

Effective rent growth for the year is projected to be approximately 0.9% at the midpoint of our range. We expect occupancy to average between 95.4% and 96% for the year and other revenue items, primarily reimbursement and fee income to grow in line with effective rent. Same-store operating expenses are projected to grow at a midpoint of 4.85% for the year, with real estate taxes and insurance producing most of the growth pressure. Combined, these 2 items are expected to grow almost 6% for 2024 with the remaining controllable operating items expected to grow just over 4%. These expense projections combined with the revenue growth of 0.9% results in a projected decline in same-store NOI of 1.3% at the midpoint. We have a recently completed development community in lease-up, along with an additional 3 development communities actively leasing.

As these 4 communities are not fully leased up and stabilized and given the interest carry associated with these projects, we anticipate our development pipeline being diluted to core FFO by about $0.05 in 2024 and turning accretive to core FFO on later stabilization. We are expecting continued external growth in 2024, both through acquisitions and development opportunities. We anticipate a range of $350 million to $450 million in acquisitions, all likely to be in lease-up and not yet stabilized and a range of $250 million to $350 million in development investments for the year. This growth will be partially funded by asset sales, which we expect dispositions of approximately $100 million, with the remainder to be funded by debt financing and internal cash flow.

This external growth is expected to be slightly dilutive to core FFO in 2024 and then again, turning to accretive to core FFO after stabilizing. We project total overhead expenses, a combination of property management expenses and G&A expenses to be $132.5 million at the midpoint, a 4.9% increase over 2023 results. We expect to refinance $400 million of bonds maturing in June 2024. These bonds currently have a rate of 4% and we forecast to refinance north of 5%. This expected refinance, coupled with the recently completed refinancing activities mentioned previously, results of $0.04 of dilution to core FFO as compared to prior year. That is all that we have in the way of prepared comments. So Carrie, we will now turn the call back to you for questions.

Operator: [Operator Instructions] We will take our first question from the line of Josh Dennerlein with Bank of America.

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Q&A Session

Joshua Dennerlein : I appreciate all the color you provided on guidance. My first question would just be on the same-store revenue growth outlook. Can you provide us any more details on what would get you to the high and low end of guidance? And I guess, I’m really curious about what you would assume for the blended rate growth at the higher low end.

Tim Argo: This is Tim. So I think as far as the high end of the low end, I think we feel pretty comfortable with the renewal rates and they’ve been steady for the last few months. What we’re seeing, as I noted, the next few months as being in that 5% range. I think that the new lease rates are what could certainly determine whether we get more to the high and low end, which is going to be a function of the demand side. We expect to see steady job growth, steady demand and migration, all those factors. So that’s a little bit better. I think it obviously pushes new lease rates higher and then the opposite is true. But if you think about our full year guide, it’s built on new lease rates for the year, and this will be seasonal, starting a little bit lower in Q1, accelerating to Q2 and Q3 and then declining a little late Q4, but somewhere in the negative 3%, 3.25% range on new lease for the year and expectations of the 4.5% to 5% range on renewals, which blends out to the 1% blended is what we’re assuming for the full year.

Joshua Dennerlein : I appreciate that. And then there’s a drag that you’re assuming on the $400 million of acquisitions, is there a way to quantify that?

Clay Holder: Yes, I think you can think — Josh, you think through what we’re projecting new rates to come in in this next year, and kind of the timing of those acquisitions from the standpoint of just the timing of it, we’re assuming that those start in second quarter and then play out over the remainder of the year and we think about it maybe in the range, call it, 4 acquisitions at roughly $100 million each. And I think they’ll look similar to what these other 2 acquisitions that we just completed in 2023 as far as how they will lease up and how they’ll — the drag that we’ll see on earnings over 2024.

Brad Hill : Josh, this is Brad. Just to add to that. Our assumption on the acquisitions is that obviously, as Clay mentioned, they’re very similar to the ones we purchased last year. They’re in lease-up. We’re assuming about a 4.5% NOI yield contribution at the time of closing, given that those are in lease up and given the comments that Clay made about where our current commercial paper is and where our cost of debt is you can kind of do the math on what the dilution there is.

Operator: We’ll take our next question from the line of Austin Wurschmidt with KeyBanc.

Austin Wurschmidt: Great. Eric, you remain confident that new lease pricing is going to improve this year, but it really sounds like peak deliveries don’t hit until around midyear. And we’ve really yet to see, I guess, leasing volume pick up, so with kind of that expectation of the improvement in new lease rates for the year, do you think that lease rates get better in the back half of this year versus last year on sort of a lease weighted basis? I know things deteriorate late in the year, but more interested in sort of that period of July through October.

Eric Bolton : Well, I’ll answer your question, and Tim you can jump in here. But probably speaking, yes, we do think that as you get into the summer leasing season, we’ve always traditionally seen leasing traffic pick up. And as commented in our prepared comments, I mean, we just see no evidence of demand really deteriorating. And we do think that normal seasonal patterns will continue to play out. So as we think about supply delivery, and we see it is pretty elevated at this point. And I mean does it go up another 10%? I don’t think so. I think that kind of we’re in the sort of the peak of the storm from a supply perspective. I feel like right now and a weak demand quarter. And we think that supply now stays high, certainly in Q1 and Q2 and probably even early Q3, it’s hard to peg it by month, but we do think that there is a lot of reasons to believe that supply starts to peter out or starts to moderate a little bit as you get into — particularly into Q4.

So we do think that the pressure surrounding supply that will persist will be met with even stronger leasing traffic and demand patterns as we get into the summer as a function of a normal seasonal patterns and therefore, it does lead us to believe that new lease pricing performs better in Q2 and Q3. And as Tim alluded to, we expect — again, it’s a function of normal seasonal patterns that begins to moderate a little bit in Q4. And the other thing that I would just point out, of course, is that we began to see early effects of supply pressure really in 2023 and particularly in the latter part of 2023, so in some ways, you could also suggest that the prior year comparisons in terms of new lease-over-lease performance starts to get a little bit easier, if you will in the back half of 2024.

So collectively, that sort of leads us to the consensus of where we think things are headed. I mean, Tim, what would you add to that?

Tim Argo: Yes. I’ll add on to what Eric was saying. If you go back to last year, I mean, our new lease pricing went slightly negative starting in July, and we got to progressively got more so throughout the year. So there is a comp component that plays into this as well. So I do think to answer one of your questions, Austin is that new lease pricing does look better at the end of 2024 as compared to the end of 2023 with those comps, with supply getting a little bit better. Now, I think the improvement won’t be as clear to see because it is a lower demand time of the year when you get into November and December, but I think the trends will be positive and really start to play out in 2025.

Austin Wurschmidt: When do you guys think new lease rate growth could turn positive? And then just my second question is, I’m just curious how — what underlying assumptions in same-store revenue guidance changed the most relative to what you published in November of last year.

Tim Argo: I think likely new lease pricing probably doesn’t go positive until 2025. I think it will get close to flat, probably in the middle of this year and the highest demand part of the year. But even in a normal year or a good year, we typically see new lease pricing is negative in the back part of the year. So I think likely, it’s early 2025 as we see the flat pressure start to moderate more, so I think that’s probably the most likely scenario for new lease pricing. As far as what changed, I mean, it was really, really to earn in, which is based on what we saw in November and December, as I mentioned in my comments, it is pricing really moderated quite a bit, particularly in November and December, which the way we calculate our earn in is just basically saying all right, all the leases that were in place at the end of December 31, if they all price the year for the rest of the year, what would our range growth be in that — so the earnings more in the 0.5 range, a little bit lower than that range we talked about at NAREIT, but really driven by the new lease pricing in November and December and the pressure we saw from the developers and looking for occupancy and that sort of thing.

Operator: And we’ll take our next question from the line of John Kim with BMO Capital.

John Kim : I wanted to follow-up on that comment you just made on the earn in that basically half of what you expected in November. I realize the blended rates probably seen in lower than expected. But you also mentioned, Tim, in your prepared remarks that the leasing volume was very light fourth quarter is only 16% of leases overall. I’m just trying to understand that impact of the fourth quarter leases and why earn in come down so much in September month?

Tim Argo: Yes. I mean it’s basic on that. I mean I think the other — the other component that played into is we did — we saw turnover for the year down, but November and December, we had a little bit higher weighting on new lease pricing as compared to renewals. So more new leases in November and December than renewals obviously, with the new lease pricing was a bigger impact on the blended. Now we’ve seen that shift more so to what we think will happen throughout the course of 2024, which is we’re waiting. We think turnover remained down and be weighted a little more towards renewals. So while we have seen new lease pricing improve in January, the blend had improved even more as we’ve seen more what we think will be the lower turnover component.

So it’s really just that. Like I said, we’re — that’s comparing at the lowest part of it what was the main part of the year, we do expect blended to be positive in 2024. So I think that’s calculating loss lease earning whatever you want to call it the end of the summer, certainly the most pessimistic time to look at it, but it was not pricing that drove it.

John Kim : But when you calculate earn in, do you just take the blended lease change for your entire portfolio and just not weighted by number of transactions, such as [inaudible] basically?

Tim Argo: No. We just said when we talked about earn-in, we’re just saying, okay, if our total rents were $2 billion at the end of December. And — or if we take just December, whatever that number was for rent and applied that all the way through 2024, what is the full year growth over 2023. And so where that ends up, can affect that number here now.

John Kim : Okay. My second question is on acquisition yields, which your last 2 were at 55 and 59. How do you see that move towards this year when you see more acquisition activity occur? And your recent bond rate is done at 5.1%. How does that change your view on initial yields that are acceptable to you?

Brad Hill : John, this is Brad. I’ll start off with that. Well, certainly, we were fortunate with the 2 acquisitions that we executed in the fourth quarter. And we felt like we got really good pricing on those for the reasons I mentioned really in my comments, but we haven’t seen a lot of activity in that area. And so even in the first quarter here in January, we’ve seen a little bit of an uptick in terms of the deals coming out. We were at NMHC last week and certainly think that volume picks up a little bit as we go through the year. But we haven’t seen a lot of opportunities coming that way. Now we do think as we continue to get further into the year that pressure given where interest costs are for the developers, given the supply pressures that they’re likely to feel that the urgency from some of these developers to execute on transactions will continue to increase, and we’re certainly hopeful that yields additional opportunities.