CSR - NYSE

Welcome to the Centerspace Q1 2024 Earnings Call. My name is Carla, and I'll be coordinating your call today. [Operator Instructions] We'll now hand you over to your host, Josh Klaetsch to begin. Josh, please go ahead.

Good morning. Centerspace's Form 10-Q for the quarter ended March 31, 2024, was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted to our website at centerspacehomes.com and filed on Form 8-K. It's important to note that today's remarks will include statements about our business outlook and other forward-looking statements that are based on management's current views and assumptions. These statements are subject to risks and uncertainties discussed in our filings under the section titled Risk Factors, and in our other filings with the SEC. We cannot guarantee that any forward-looking statements will materialize, and you're cautioned not to place undue reliance on these forward-looking statements. Please refer to our earnings release for reconciliations of any non-GAAP information, which may be discussed on today's call. I'll now turn it over to Centerspace's President and CEO, Anne Olson, for the company's prepared remarks.

Good morning, everyone, and thank you for joining Centerspace's first quarter earnings call. With me this morning is Bhairav Patel, our Chief Financial Officer; and Grant Campbell, our Senior Vice President of Capital Markets. Before taking your questions, we'll briefly cover our first quarter results and trends, our transaction activity and our outlook for the remainder of 2024. I'm happy to report core FFO per share of $1.23 for the first quarter, driven by stable fundamentals across our markets paired with disciplined expense management and a little help from a mild winter that reduced our utilities and associated expenses. While Bhairav will discuss our quarter results in detail, I'd like to take a minute to discuss our current leasing trends. In our same-store portfolio, market rent has increased year-over-year for the first quarter. And while a moderate amount of 2.5%, this is in line with our expectations and year-to-date, we're pleased to see that translate into positive lease-over-lease growth. For new leases, our trade-outs were flat for the quarter, and renewals priced debt increases averaging 3.4%, for blended rate increases of 1.5%. The new lease trade-outs increased each month in the quarter. This bodes well for us as we begin the leasing season. Occupancy remains a focus, and today, we're slightly above 95%. Our marketing strategy aimed at the highest intent lease has led to converting more leases in this quarter than the same period last year. As we look at April, pricing is trending positively with indications of new lease trade-outs of approximately 3.5% and renewal increases of 3.3%. We feel good about our resident retention rates, which are above 50%. Our results in Q1 and the trends we see give us confidence to bring up the low end of our guidance, raising our outlook for 2024 at the midpoint to reflect estimated annual core FFO growth year-over-year of 1%, with this growth coming in addition to the deleveraging and portfolio upgrades we achieved last year. Our confidence in this portfolio is bolstered by low bad debt of just 26 basis points in Q1 as well as continued stability in our regional economy. On the whole, our portfolio is not experiencing the high supply dynamics of Sunbelt in some coastal markets, and our supply profile remains relatively muted. Denver and Minneapolis are our markets with the highest levels of supply and we're seeing tapering of homes under construction and projected deliveries into next year. With respect to Minneapolis, our largest market concentration, it ranked eighth in the nation for most apartment absorption over the last 12 months, and according to RentCafe was the #1 search market for the fourth month in a row. Turning to transaction activity. All is quiet on the acquisition front. We believe some recent larger transactions could help narrow the bid-ask spread on valuations and loosen up the market for acquisition activity. During the first quarter, we closed the previously disclosed sales of 2 communities in Minneapolis for gross proceeds of $19 million. These proceeds were used to pay down the line of credit debt that was associated with our Q4 2023 acquisition in Fort Collins. Completing our capitalization of that transaction, advancing our capital recycling initiatives and facilitating the purchase of $4.9 million worth of our common stock early in the quarter, we're committed to growing our business, and while the overall economic environment has limited our access to capital, we do believe we can effectively recycle portions of our current portfolio for the right opportunities. We'll be well-positioned when those opportunities arise. I'm extremely grateful for all our teams dedication to deliver value to our shareholders. Our strong culture is evident in our recent diversity, equity and inclusion report, highlighting our advancement of and commitment to providing a great home for our team to achieve the best results. This report is available on our website. Now I'll turn it over to Bhairav to discuss our overall financial results and outlook for the remainder of 2024.

Thanks, Anne, and good morning, everyone. We're pleased to report another quarter of strong earnings growth with core FFO of $1.23 per diluted share, driven by a 7.5% year-over-year increase in same-store NOI. Revenues from same-store communities increased 3.5% compared to the same period in 2023 with the increase attributable to 3.9% growth in average monthly revenue per occupied home, which was partially driven by higher RUBS income, as the rollout was fully implemented at the end of last year. The higher per home revenue was slightly offset by a 30 basis point year-over-year decrease in weighted average occupancy to 94.6%. However, occupancy has picked up nicely in April, as Anne noted in her remarks, and with market rents trending in line with expectations, we're well positioned as we enter leasing season. Property operating expenses were down by 2.2% year-over-year. The decrease was driven by lower utilities costs and successful real estate tax appeals offset by increases in compensation, administrative and marketing costs and higher insurance premiums. While successful tax appeals are not uncommon, we recognize approximately $700,000 or $0.04 per diluted share from one such appeal spanning more full years. However, it did not materially impact our full year projections as the anticipated refund was incorporated in our prior projections and corresponding guidance ranges we shared last quarter. Turning to guidance. We updated our 2024 expectations in last night's press release. For 2024, we now expect core FFO of $4.74 to $4.92 per diluted share, an increase of $0.03 at the midpoint from prior expectations. This number assumes same-store NOI growth of 2.5% to 4%, driven by same-store revenue growth of 3% to 4.5% and same-store total expense growth of 4% to 5.5%. A warmer than usual winter and favorable changes in natural gas pricing led to better-than-expected results in utilities during the first quarter helping us reduce year-over-year controllable expenses and in turn, decreased our expectations for controllable expense growth. On the noncontrollable expense side, favorable results, particularly in real estate taxes related to both the previously mentioned rebate and other tax adjustments as well as lower nonreimbursable losses are leading us to decreased full year expectations. Importantly, I'd like to highlight the relation between utility expenses and RUBS revenues, and remind everyone that the lower utilities costs drive lower expectations for RUBS revenues, which led to the decrease in the high end of our revenue guidance. Moving on to other components of guidance. G&A and property management costs and interest expense are expected to be slightly higher than previously projected. Our guidance for capital expenditures, including value-add spend is unchanged from last quarter. On the capital front, our balance sheet remains flexible. We've a well-laddered debt maturity schedule that features a weighted average cost of 3.6% and weighted average time to maturity of 6 years and we had approximately $230 million of liquidity at quarter end via cash and line of credit capacity. Our capital repositioning activities last year drove leverage down half a churn over the course of the year, leading to Q1 net debt to EBITDA of 7.1x. As noted in our February call, this balance sheet strength allowed us to opportunistically buy back shares with Centerspace repurchasing 88,000 shares at an average price of $53.62 during Q1. We've already funded $8.8 million of the $15.1 million we committed to a development project in the Minneapolis area, with the remaining funding expected to occur over the next several months. This, along with the sale of 2 assets in the Minneapolis metro area for roughly $19 million has been incorporated in our guidance. Our guidance assumes no additional investment activity for the rest of 2024. To conclude, we're proud of the results we achieved in the quarter, and I commend our Centerspace team on providing us with an excellent start to the year. We look forward to building upon these results in the rest of 2024. And with that, I'll turn the line back to the operator for your questions.

[Operator Instructions] Our first question comes from Brad Heffern from RBC.

Can you walk through how things look on the ground in your smaller markets? I think we all have a pretty good handle on Minneapolis and Denver, but it would be great to get a quick perspective on Rochester, St. Cloud, Omaha, North Dakota, et cetera.

Yes. Brad, great question. As you know, our smaller markets do make up a pretty significant portion of our NOI. And we've seen real strength out of those markets, particularly across North Dakota on a year-over-year basis. Those markets, the hallmarks are really lack of supply there. And so we -- and continued demand. So we've been able to see good rental increases, good renewal increases and really steady occupancy across those markets. a lot of very low unemployments in those markets. So we've really good, strong jobs and regional economies supporting that demand in Omaha, Rapid City, Billings. Across North Dakota, we've seen a lot of strength.

Okay. Got it. And then you mentioned that April pricing, new lease had a pretty significant inflection there, is kind of the mid-3s where you would expect it to shake out for the bulk of leasing season? Or do you expect to see sort of more of a sequential gain there as we get deeper into it?

Yes, we're right on where we expected right now, and we do expect some acceleration into the leasing season, but we may see the renewals stay right around where they're or a little bit flat for a few more months, but we do expect that new lease pricing is going to continue to accelerate.

Our next question comes from John Kim from BMO Capital Markets.

I had the opposite question to Brad's first question. What's going on in Minneapolis? You mentioned it's in one of the top net absorption markets. It's one of the most searched markets 4 months in a row. What's driving the -- what's driving demand right now?

Yes. I think similar to some of our smaller markets, Minneapolis has very low unemployment. And continued rise in costs of housing from single-family homes, particularly single-family homes and then coupled with high interest rates. So one of the reasons Minneapolis or any market gets supply is because there was demand. I think Minneapolis had quite a bit of pent-up demand, a lot of years of lack of supply. I'll let Grant touch on the supply and demand dynamics just a little bit. But I -- here, what we're seeing on the ground is continued interest and good traffic and rising occupancy rates coupled with strong renewals and now new lease pricing that's positive. So Grant, do you want to just give a couple of comments on the supply?

Certainly. John, from a supply perspective, in Minneapolis, the pipeline certainly has tapered over recent quarters. Currently, we're at about 3.7% of existing stock under construction that is down from 6% at midyear 2023. So that tapering has been realized, peak supply in our opinion has been realized in Minneapolis, and we've moved past it. Next 12-month forecasted deliveries in this market are 6,700 apartment homes. And if you look at the 5-year annual average between 2019 and 2023, our next 12-month figure is about 2/3 of that annual run rate that has been realized historically.

Okay. And Anne, you mentioned in your prepared remarks, I think, April new and renewal leases were -- the growth rates were right on top of each other. Historically, you've had 120 basis points spread renewals higher. Was there anything in April that -- whether it's concessions or something else building occupancy that led to that renewal rate not being higher the new lease growth rate?

Yes, yes. Part of it is building occupancy. We're back up above 95% as we -- as of April 15, and I think aiming towards the 96% as we head into leasing season. So that is holding the renewal rates a little bit flatter. Also, these renewals that priced in April or that were affected in April, those really priced in January. And so at that time, we did have really low -- slightly negative new lease rates. So some of the deceleration is just timing-wise, from when they price to when they're actually effective for April. But yes, also, we're building occupancy with a really strong focus on that.

And how do you see renewals for the remainder over the quarter or the year?

Yes. I think right now, renewals are pricing around 3.3% and that's out into July. And so I think for the quarter, they're going to come in right around 3%, 3.5% -- between 3% and 3.5% for the quarter is our estimate right now.

Our next question comes from Rob Stevenson from Janney.

Anne, just to follow up on John's question. At what point do you expect new lease growth to have the inflection go back below renewals? Because it's -- you guys are one of maybe 1, maybe 2 companies that are seeing that strong and new lease growth. Just curious as to when that -- if that stays relatively consistent throughout the year or whether or not that sort of falls back at some point here?

Rob, this is Bhairav. I'll take that one. So with respect to new lease pricing, typically, we see that higher than renewals in the second quarter and the third quarter, just given how our market rent acts as we go through the season. So towards the end of the third quarter into fourth quarter is when you'll see that kind of trend slip.

Okay. And then the midpoint of the same-store revenue guidance, I think is 3.75% now versus the 3.5% you did in the first quarter. What is it over the remainder of the year? Is it just conservatism that doesn't see revenue growth accelerate from here, given the seasonally beneficial moves usually in second and third quarter?

Yes. I mean, so from our perspective, the first quarter was about a couple of things, right? It was utilities costs, which has an impact on RUBS revenues. But with respect to actual rental revenue, it's been trending exactly the way we had expected. So heading into the second quarter and the third quarter, our projections haven't really materially changed. We do price 60% of our leases in the second quarter and third quarter. So if the trend continues, we do expect to be in the same ballpark that we had expected 2 months ago. What's driving the lower revenue is really RUBS income because the lower utilities cost is reducing rental revenue. So -- but overall, I think I mentioned on the last call, that our blended rate estimate for the year was about 3%. That is still what we're expecting. What you've seen is rental revenue trend exactly the way we had thought it would. It's -- in the first quarter, it was about 1.6%, in April, it's about 3%. We'd expect to see it increase a little bit as we enter Q2 and Q3. So again, not materially different from a revenue perspective. On the expense side, there's a couple of things that are driving the change. And we mentioned real estate taxes, that's a onetime thing in the first quarter. And again, utilities costs, which, again, is related to the mild winter. So as we think about the rest of the year, our projections are materially different from what we had said last time, and revenue is trending exactly the way we had thought, including occupancy, which is trending in the right direction.

Okay. And then I got the other question.

Go ahead.

No, no, go ahead, Anne.

I was just going to say, the corresponding offset to that revenue is actually greater on the expense savings side. So overall, even though we're being -- feels conservative on the revenue, that decline and what we're projecting for total revenue, I mean, it's actually going to drop to the bottom line in a positive manner in NOI.

Okay. That's helpful. And then can you talk a little bit about the pricing environment for the types of assets and the markets and submarkets that you're looking to potentially sell? Where was the sort of cap rate fall out on that $19 million of dispositions? And you guys -- I know it's not in guidance, but are you guys thinking about marketing more assets for sale and seeing if you can get your price hit this year, how are you thinking about sort of culling the portfolio over the remainder of '24?

Yes. This is Anne. And then I'm going to ask Grant to comment specifically on pricing. But as we look at '24, we certainly do have assets that we believe could be good candidates for capital recycling. We need some pickup in transaction volume in the markets that we'd like to acquire. So if we found a great opportunity or if there was some good transactions that we thought we'd have a good use of proceeds, we do have some assets in mind like our historical capital recycling, those are in markets, where we think have lower growth. They're older assets with high CapEx and/or low growth potential, lower rents overall. So we do feel like we've a pipeline that we could use for capital recycling. We just need some acquisition activity and the right opportunity in order to implement that. With respect to the Minneapolis assets that we sold in pricing, I'll let Grant answer it.

Yes. The Minneapolis sale, those older vintage communities, cap rate there was low 6s. Regarding your question on current pricing landscape, one, there continues to be a bid-ask spread that exists in a lot of cases today on individual asset conversations that we're having. Along with that, there is the continued disconnect between public market valuations and private market valuations based on the recent transaction data points that do exist. In Denver, current price talk today is 5% to 5.5%. We did see an incremental uptick approximately 1 month ago in valuation conviction in the private market, where buyers and sellers were increasingly finding common ground at, call it, 5% to 5.25% for well-located communities. That was then followed by the recent run-up in the 10-year treasury, which has again brought real-time volatility to asset pricing and is leading to what I'll call the latest installments of price discovery.

Okay. And I guess the question that I ask or raise is, what is the financing environment? I mean you've got Fannie and Freddie and you've got some other stuff available, the 2 apartments that aren't available to other guys. But are you seeing the financing market flow reasonably? Is it still tight? Is it choppy with whether or not guys are using bank financing? And if they pulled back in your markets, how would you characterize the financing environment for somebody buying a $19 million worth of assets or the sort of BB- stuff?

Rob, this is Bhairav. So from a financing perspective, we've kind of seen spreads hold steady. I mean, I think the volatility is really driven by the treasury market or the treasury rates. So from a financing perspective, we haven't really seen a big change in terms of being able to finance some of these assets. Overall, I think despite the volatility, the spreads have held -- the banks are still willing to lend. The term loan environment is a little bit challenged. The pricing from a private placement perspective for someone like us is a little bit challenged in terms of spreads, but from a treasury or from an agency perspective, I think the financing is still available on assets that are cash flowing.

Our next question comes from Connor Mitchell from Piper Sandler.

Anne and Bhairav, you guys kind of answered this a little bit, but maybe going back to the RUBS and how that's affecting you guys. Just maybe ask a different way. How much of the lighter winter benefited cost savings or lower revenue for you guys versus savings for the residents that you've implemented, the RUBS?

Connor, so from a full year perspective, maybe the -- if you look at our revenue guide, we kind of reduced it at the midpoint. Most of that reduction is driven by RUBS revenue that is expected to be lower as the expense was lower as well. So I'd say about -- at the beginning of the year, we expect about 50 basis points of year-over-year increase driven by RUBS, now it's about 30 basis points. So that's really driving the reduction in rental revenue projections or overall revenue projections.

Okay. That's helpful. And then maybe considering the acquisition market and the transaction market, that's been discussed a couple of times. You guys mentioned that it's a tough market right now. Is that primarily due to the spreads you've been discussing? Or are there -- is there more competition from like some cash buyers or other competition or another component that's causing this tough market at the moment?

Yes. Connor, this is Grant. I'd say from a competition perspective, we're seeing high net worth and private capital types as the most aggressive buyer profile right now. Some of those groups are -- they're obviously fully aware of what the cap rate is on the buy side, and they're taking a view that -- their long-term hold they acknowledge there may be a period of time of negative leverage. They're willing to accept that. They may be an all-cash buyer. We've certainly seen that in many instances, where groups are saying, we'll buy this all cash, and we'll "figure out financing later". So I'd say that competition for us, the same amount of people are doing all the same things. So touring assets, underwriting deals, having conversations. When it comes to who's actually getting most constructive, it's high net worth and private capital types.

Okay. That's helpful. And then you guys mentioned that you're kind of -- you're seeing this tough acquisition market. So maybe in the meantime, can you just share your thoughts on how you view utilizing that capital for stock buybacks or other purposes currently versus maybe waiting for the market to find some better spreads and you can go after some acquisition opportunities?

That's a great question. And one that is top of mind for us. I think when we think about potentially selling or having either free cash flow or other proceeds from sales, our priorities right now are keeping the balance sheet flexible. And so -- and also maintaining a very low floating rate debt, which we've currently, executing on our value-add program this year. I think we'll spend around $20 million on value add this year, which -- that's a good return for us and also keeps the products competitive as we hopefully move into a more competitive environment and watch a little -- the supply moderate. And then after that, I think we're more mindful of the balance sheet and I think more focused on deleveraging the company than executing additional stock buybacks at this time.

[Operator Instructions] Our next question comes from Michael Gorman from BTIG.

Anne, I'm sorry if I missed this, but in your discussions about kind of the quarter-to-date trends for the second quarter, are there any particular differences in the geography in terms of the improvement in the new leasing trends across your portfolio?

No, I think we're seeing improvement across the board. I mean, we've seen some outperformance in some of the smaller markets. I mentioned North Dakota. We've seen some good performance in Rochester year-over-year. In St. Cloud, we've seen good performance. But overall, the market as a whole has moved in a way that's better for us and seeing stronger new lease rates across the board.

Okay. That's helpful. And then maybe just one last question on the acquisition side of things. Understanding the bid-ask spread, obviously, given all the market volatility, is there any kind of disconnect in terms of underwriting, in terms of buyer and seller expectations for the trends in NOI at the property level, just given some of the impact that we've seen across markets in terms of supply or in terms of pricing pressure?

Yes. I'd say in this environment, it's very hard to underwrite large outsized rent growth that maybe certain groups were underwriting here over prior years. So I think the dispersion of underwritten rent growth, if we stick with that variable, that dispersion was wider a couple of years ago than it is today. I think people that are being thoughtful if they were underwriting heavier growth, they've dialed that back. Groups that were fair to conservative a couple of years ago, continue to be fair to conservative. So that dispersion has tightened from a rent growth perspective. And I think at the end of the day, it's which group is willing to accept some of the variables that we've touched on here earlier, perhaps negative leverage, perhaps cap rate that doesn't maybe feel great to them today, but they believe in the long-term story of the submarket.

Our next question comes from Buck Horne from Raymond James.

Just quick question for Grant. Because the deep dive on Minneapolis was a really helpful discussion there about the supply pipeline there. I was wondering if you could do the same for Denver. Just kind of discussing where we're at in terms of the supply pipeline if we're kind of getting close to peak deliveries? And also just any additional color in terms of trends between the suburban assets versus downtown Denver?

Yes, Buck. From a supply perspective, Denver is our market with the highest levels of supply, currently 9% of existing stock is under construction, which represents about 25,000 apartment homes. These figures similar to Minneapolis, have also tapered since last quarter. Minneapolis has seen a longer period of tapering, but the data is telling us and telling others that the tapering is -- could be beginning in Denver. Next 12-month deliveries in Denver are forecasted at 11,000 apartment homes. That is consistent with 2022 and 2023 delivery levels in that market. So we really try and bifurcate what's in the pipeline, will that all get completed versus what is actually going to deliver and delivery forecast tell us that we're not going to see any outsized deliveries. It's going to be on par with what the market has produced here over the recent past.

Awesome. And any differences between kind of the suburban assets versus downtown Denver?

Yes. I think certain pockets of downtown or the urban environment are feeling maybe more concessionary pressures, you've had more construction activity when you think of just the size of geography in that downtown area. Suburban Denver certainly has had new construction. There are highly desirable micro markets, where people have been building and will continue to desire to build. But the spread of that over a larger geography is leading to, in our opinion, on a relative basis, less concessionary pressure in the suburban environment.

We currently have no further questions. I'll hand back over to Anne Olson for final remarks.

Thanks, everyone, for joining us this morning, and we look forward to seeing many of you at the upcoming BTIG, BMO and Janney real estate conferences. And if we don't catch you there, we'll see you at NAREIT in June.