Q1 2022 Washington Real Estate Investment Trust Earnings Call
Welcome to the Washington Real estate investment Trust first quarter earnings Conference call.
A reminder, today's call is being recorded.
At this time I would like to turn the call over to Amy Hopkins, Vice President of Investor Relations.
Please go ahead.
Good morning, everyone and thank you for joining us on our first quarter earnings call on the call with me today, Ophthalmic Chairman, President and Chief Executive Officer, Steve Murphy Executive Vice President and Chief Financial Officer Drew Hammond, Vice President Chief Accounting Officer, and Treasurer, and Grant Vice President and head of research before we begin I would like to you.
Mind, 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 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 is distributed yesterday and can be found on the Investor Relations page of our website I'd now like to turn the call over to our President and Chief Executive Officer, Paul Mcdermott.
Thank you Amy.
Morning, everyone and thanks for joining us today.
Our first quarter results reflect the beginning of the earnings momentum, we expect to generate over the coming years as we capture the strong rent growth embedded in our portfolio and continue to expand our footprint in the southeast.
On today's call I will provide an update on our geographic expansion, which is progressing well and is delivering results that exceed our initial expectation.
I will then discuss first quarter operating highlights and our historic multifamily market conditions, and the Washington Metro and Atlanta.
I'll also touch on the latest progress on our operating model and technology transformation, which is focused on resident satisfaction and driving better performance and operating leverage as we scale the company.
Steve will discuss our first quarter results and performance highlights our 2022 guidance and the earnings momentum that we're building, which will carry over into the years ahead.
I'll start with our expansion into the southeast.
In March we entered into binding agreements to acquire two garden style communities and Cobb County, Georgia for $178 million.
Which completes the full deployment of the net proceeds of our commercial asset sales at a combined cap rate of 4.25%.
Following the completion of these acquisitions, our Atlanta portfolio will include over 1800 apartment homes, which represents over 20% of our total apartment portfolio.
The Cobb County communities align with our class b value add strategy.
<unk> offering price points that range from 80% to 95% of their sub market averages and the opportunity to renovate a portion of the homes.
Following these acquisitions, our total renovation pipeline will grow to 3000 homes.
The communities also offer the opportunity for immediate operational improvements as we onboard them to our daily pricing revenue management system.
Cobb County, Georgia is known for its pro business environment superior quality of life and low real estate taxes, making it a sought after location for both businesses and residents.
Workforces the highest educated in Georgia and supports a variety of key sectors in the economy, including aerospace and advanced equipment manufacturing.
Science healthcare services.
And software development professional and business services travel and tourism and wholesale trade the.
The areas and into the second largest university in Georgia, Kennesaw state as well as multiple fortune 500 companies and major employers.
We expect to generate strong NOI growth on our Cobb County communities over the next few years with above market growth driven by value add renovation thereafter.
Beyond our two latest acquisitions, we have a pipeline of opportunities that will contribute strong NOI growth.
Recently, we have seen an increase in opportunities that fit our strategy and offer the potential to gain scale quickly.
As interest rates rise and more portfolio deals and other opportunities come to the market. We anticipate the field will continue to become more level for all cash buyers relative to higher levered buyers.
Thus far we have executed on our geographic expansion by targeting specific assets, but we are also evaluating portfolios and other opportunities, which would allow us to swiftly scale our portfolio in line with our strategic direction.
Fortunately, we are seeing more and more opportunities for continued growth as we build the track record and the interest rate environment shifts. We will continue to remain disciplined with our underwriting and we will pursue opportunities that align with our strategy and provide stronger NOI growth and more value for our shareholder.
Yes.
Nearly 80% of our same store portfolio is located in northern Virginia with a rapidly expanding consumer technology sector continues to drive job and income growth.
Year over year effective rents in northern Virginia continue to accelerate rising nearly 14% on average during the first quarter. According to real page.
New lease trade outs for the Washington region, which continue to have positive momentum were up 10% for the first quarter up one 7% from the last quarter.
And Atlanta.
Year over year effective rents group grew by over 20% in Q1 as reported by real page and we remain at near record levels.
Occupancy driven by continued solid demand in the Atlanta region remains very tight at nearly 97% for the first quarter.
In order to invest in Atlanta without directly competing with new supply, we are targeting submarkets, where mid market renters form the deepest part of the demand curve.
These renters are benefiting from economic and wage growth, but remain underserved by new supply.
Similar to our investment strategy in the Washington Metro Our geographic expansion strategy provides the opportunity to deliver a high quality living experience, while also growing rents without competing with new supply.
Furthermore, as the housing shortage continues the cost of ownership in our markets has skyrocketed with home prices up by 29% in the Washington Metro and 57% in Atlanta compared to three years ago.
Our value add oriented price points are positioned to benefit from favorable supply and demand fundamentals over the long term.
In addition to these favorable market dynamics that are driving strong fundamental trends, we continue to execute value add renovations, which is a key part of our growth strategy.
We are currently completing renovations at nearly half of our same store communities and we expect the pace of renovations to pick up significantly in 2022 compared to 2021.
As we continue to acquire communities with renovation potential we expect renovation led value creation to have an increasing impact on our growth trajectory alongside our geographic expansion.
Before I turn it over to Steve I'd like to update you on the progress of our operational infrastructure transformation, which is focused on raising the bar for customer service at value oriented communities.
We are executing a major overhaul of our operating model technology platform human resource infrastructure and brand strategy ahead of internalizing property level residential operations later this year.
This transformation includes it includes three phases in total and we are currently in phase II.
Since our last update.
We have designed our near term and future state human capital models and have filled several key management level positions and are continuing to recruit for corporate positions that will support our internalized model.
We are redefining our culture building out our training program and developing compensation and incentive packages to align all team members with our resident centric mission and long term vision and ultimately support our business strategy and growth.
We are implementing our core technology platform and are planning for testing and cutover of third party data into our new core operating system.
We are also creating a resident focused brand strategy with plans to launch our new name brand and website later this year.
A significant component of our marketing will be focused on customer experience and technology enablement.
Phase III, which starts in the second half of 2022 with expected completion in mid 2023 incorporates the onboarding of our property level operations to our internal systems.
We expect the vast majority of the work that needs to be done to prepare for the on boarding process to be completed by September and for most of the costs related to the broader infrastructure transformation to be absorbed this year in line with the guidance range, we have provided.
By the end of 2022, we expect to have the G&A expense base, which will not be substantially different from the level that it's at today to support a doubling of our unit count.
Going forward, we expect to realize significant benefits as we scale the business and optimize our expense base.
Now I'd like to turn the call over to Steve to discuss our performance and trends.
<unk> of our value creation opportunities, our first quarter results and our near term outlook as we execute our transformation.
Thank you Paul and good morning, everyone.
I'll start with an update on our operating trends and will then cover our first quarter results and 2022 outlook.
The year is off to a very strong start occupancy and retention remained very strong and are supporting low double digit effective lease rate growth across our portfolio on average.
For same store move ins that took place during the first quarter effective new lease rate growth was 10% and effective renewal lease rate growth was nine 2%, which blends to nine 5%.
For Atlanta move ins that took place during the first quarter effective new lease rate growth was 16% and effective renewal lease rate growth was 12, 5%.
Both outperforming our underwriting as we are taking over new assets.
New and renewal lease rate growth continues to trend upward renewal lease rates have outperformed our expectations. So far this year driven by strong demand and very high retention.
For at least the signs thus far in April we achieved blended lease rate growth of 25% in Atlanta, and 11, 5% in the Washington Metro on an effective basis.
We expect blended lease rate growth to remain very strong through the spring and summer months.
As we head into the spring and summer leasing season, our portfolio is positioned with the best growth prospects in recent history.
Occupancy remained strong with a forward trend that will allow us to continue to increase rents.
Same store average occupancy was 95, 8% during the quarter up 150 basis points compared to the year ago period.
Total same store occupancy increased to 96% post quarter end.
Our loss to lease stands at 16% for our non same store portfolio and 9% for our same store portfolio, which blends to a total loss to lease of 10%.
We expect to capture our loss to lease over the next 12 months to 16 months.
Place rents grow as the portfolio turns.
We expect the top end of our loss to lease to grow as well driven by projected significant market rent growth for our markets and submarkets.
Average effective market rent growth is expected to be approximately 9% for the Washington Metro area and 18% for Atlanta in 2022, According to real page data.
Retention remained very strong at 71% during the first quarter, even as we grew our renewal rates, which makes us confident that we can continue to capture both the market rent growth that has already occurred and which will work its way into our rent roll as activity picks up into the spring as.
As well as the additional market rent growth that will occur over the course of the year.
As Paul mentioned these positive trends will be further accelerated by increasing renovation led value creation.
During the quarter, we achieved an average cash on cash return of 13% on renovated units.
We expect the pace of renovations to increase as the year progresses.
We have a pipeline of approximately 3000 units, including our two latest acquisitions, which are expected to close next week and we are targeting $8 million renovation investment in 2022, which represents a substantial increase compared to $3 million in 2021.
Our programs were starting back up after you put them on hold during the pandemic.
Now turning to our financial performance net loss for the first quarter of 2022 was approximately $7 7 million or <unk> <unk> per diluted share compared to a net loss of $1 1 billion or two cents per diluted share in the prior year.
Core <unk> was <unk> 20 per diluted share, reflecting a year over year decline in 2014.
Due to the impact of our commercial asset sales.
Multifamily same store NOI grew seven 9%.
Compared to the prior year, driven by higher base rent occupancy and moving to fee income compared to the prior year period.
Our same store NOI growth nearly doubled in the first quarter compared to the fourth quarter as the rapid rebound in core multifamily operating trends that began last summer is now having a more pronounced impact on our financial performance.
Average effective monthly rent per home for the quarter increased three 1% compared to the prior year period, which also represented a substantial improvement compared to the 50 basis point year over year growth achieved in the fourth quarter.
Looking forward, we expect these positive trends to accelerate.
63% of our leases expire between April and September .
As we execute leases during this timeframe and capture the balance of post infection rate increases also capturing additional market rent growth. During the year. We expect same store NOI to grow at a higher rate during the second half of the year.
Other NOI, which represents Watergate 600 declined one 7% in the first quarter compared to the prior year, primarily due to the impact of annual expense recoveries watergate's performing well, despite the challenging market environment for office properties or.
Our 2022 guidance range for Watergate 600 implies a three 4% annual growth rate at the midpoint.
Occupancy ticked up slightly since year end to 91, 4% at this one remaining office asset.
And with riverfront views at monument views.
High quality institutional tenants and a weighted average lease term of approximately eight years, we continue to see opportunity to.
Create value by owning and leasing Watergate 600.
Now turning to our outlook for the balance of the year. We are reiterating our full year core <unk> per share guidance range of 87 to <unk> 93 per share.
We expect same store multifamily NOI growth of between 7% and three quarters percent to nine and three quarters percent with higher growth occurring in the second half of the year.
NOI growth for same store and drove combined is expected to be between 11, five and 13, 5%.
<unk> was fully invested in both years and represents true year over year growth for the same capital investment.
Non same store multifamily NOI, which include stroke, the Oxford Assembly Eagle's landing Carlyle of Sandy Springs into two Cobb County, Georgia communities is expected to range between 22, and a half and $23 5 million of which drove represents approximately $7 billion.
Same store other NOI, which consists of Watergate 600 is expected to contribute between 13 million and 13 and three quarters a million dollars of NOI.
We expect to close the $178 million acquisition of two properties and Cobb County, Georgia in the very near term and our <unk> guidance range incorporates approximately $100 million of additional acquisitions beyond that.
When fully invested we expect our leverage to be in the mid five times range on an annualized basis.
G&A net of core adjustments for severance costs is expected to range between $25, five and $26 $5 million excluding the.
The impact of the transformation investments for our future platform and our pool immigration.
Interest expense is now expected to range between 25 and $26 million.
Which incorporates the potential impact of higher interest rates on our line of credit balance.
During the second half of the year.
We expect our core <unk> payout ratio for the year to be in the mid Sevens and as we continue to invest in multifamily assets, which are less capital intensive than the commercial assets we sold.
We are establishing an <unk> growth profile that should provide us with additional flexibility to grow the dividend.
And finally, we continue to expect transformation costs to range between 11% to $13 million.
As we previously outlined these costs are related to our strategic transformation, including core system implementation branding and human capital initiatives operating platform design and retention of termination benefits.
By the end of 2022, we expect to have the infrastructure in place to manage all of our communities in house and we will.
And we'll be positioned to achieve expense efficiencies and to deliver operating leverage as we scale the business.
Furthermore, as Paul mentioned, we believe that our current G&A expense level can support doubling our unit count.
As we complete Onboarding the remaining communities to our systems and platform in 2023, we expect we will incur minimal transformation costs in 2023.
Considering our outlook as we move further into 2022, we are building momentum that will carryover into the years ahead.
2021 was our year of transformation, where we shifted our portfolio from commercial to multifamily two.
<unk> 2022 is our year of building earnings to a higher run rate level.
We see a lot of momentum building as the year progresses.
There are several growth drivers that represent substantial momentum above our fourth quarter of 2021 baseline, but are worth highlighting the first is acquisitions with $230 million of cash on hand at the end of last year. Most of the acquisitions that we've completed or expect to complete this year will provide income directly to the bottom line because we're not incurring a new car.
The capital to pay for them.
Second our loss to lease of approximately 10% is expected to be substantially capture throughout 2022 in early 2023.
Third the outside market rent growth, which is projected to occur this year will drive the top end of our loss to lease higher.
Our in place leasing pool turns.
Sure.
<unk> will provide meaningful growth experiencing a full year of stabilized occupancy coupled with initial lease up concessions burning off.
Finally.
Our renovation program is expected to fully ramp backup and accelerate growth with $8 million of spend in 2022 forecasted at low to mid teens cash return.
Our first quarter results are only the beginning of reflecting these impacts and as NOI ramps up throughout the year, we will be establishing significantly higher earnings run rate growth from a strong trajectory thereafter.
And with that I will now turn the call back to Paul.
Thank you Steve to conclude we are pleased with our strong start to the year and the solid fundamentals that we're seeing across our portfolio with signal outside its growth this year and into 2023, our Atlanta acquisitions continue to outperform our initial expectations.
And lease rate momentum at our Washington Metro apartment communities is the strongest we've seen in over 20 years.
Over the coming year, we are focused on growing and geographically expanding our portfolio capturing significant market rent growth as our portfolio churns.
Executing value add renovations.
<unk>, our new resident focus brand and culture and weaving ESG into every aspect of our business as we execute our internal infrastructure transformation ahead of internalizing property level operations.
And with that I will open the call up to answer questions.
Ladies and gentlemen, the floor is now open for questions. If you have any questions or comments. Please press star one on your phone at this time.
We ask that while posing your question. Please pickup your handset is listening on speaker phone to provide optimum sound quality.
Please hold while we poll for questions.
Your first question for today is coming from Blaine Heck. Please announce your affiliation then pose your question.
Great. Thanks, Blaine Heck from Wells Fargo here Paul.
Paul can you talk about what youre seeing in terms of pricing in each of your key markets have you seen any backup in cap rate to 90 segments of the market given the rising rate environment.
Pricing remained really competitive kind of throughout the beginning of this year.
I think Blaine.
Question.
I would answer that a couple of ways.
We have not seen any material movement in cap rates.
I know that we've had over.
Over the last 12 months, we've had cap rate compression in DC I think.
First quarter to first quarter year over year, I think it's been about 40 basis points in Atlanta, I think the cap rate compression has been about 45 basis points, but what we have seen with a rising interest rate environment is really kind of on the on the seller side.
We're definitely getting.
More.
Feedback from.
Selling brokers about a preference for cash buyers.
We're seeing more portfolio deals come to the market Blaine as I think people are trying to minimize execution risk for the second half of the year.
I would say our deal team is getting calls more on a pre marketing basis, where brokers are.
Going to their sellers, saying hey.
I've got three years to five cash buyers do you want me to do a quick pre market and see if we can select from here rather than doing a full protracted marketing process.
And the sellers are saying, yes, and they are following that up at least some of the larger portfolios that we've looked at that they are trying to.
Stay away from fully Levered buyers and don't want to really take on any type of appraisal risk in the process, but it's clear to us blame that.
Certainty of execution has really.
Jumped up the chart.
And I think youre going to see a bit of a headache thinning of the herd.
As the year progresses.
Okay that makes a lot of sense.
And then just sticking with the potential impacts from rising rates and inflation as well do you think the renters and class b properties or any more sensitive to rising rates and rising prices in it.
It doesn't seem like you've seen any pushback on rent increases.
That might be attributable to that squeeze on your tenants purchasing power, but do you think theres any tipping point.
On that subject in the future.
Blayne this is Steve.
Steve and then maybe granted for a little color too.
So far all of our indicators are.
Getting record retention.
Getting the strongest tradeoffs that we've had historically.
We're really not experiencing bad debt in any significant way in fact year over year, our forecast for bad debts down 20%.
All the early indicators are that.
We're not really seeing any credit issues in our portfolio.
Grant always researches as part of our capital allocation process.
Who are the employers are the cohorts that we're allocating capital to.
We attribute a lot of that to just.
Who our tenants and residents are granted I know if you want to add anything sure happy to sort of add to that so blayne.
We are seeing.
In terms of our rent to income ratio. It is over the last 12 months its remaining stable.
Where we've seen historically.
And as Steve said.
We track income.
Ratios, but we also look at more high frequency data.
We've touched on like collections and retention because we do believe they do give you an immediate look at any changes that are occurring.
We are seeing strong income growth.
In Atlanta for example is up six 6% and we do look at the industries that we have exposure to.
I think I mentioned this in the past, but some of the ones that were exposed to most such as trade transportation utilities.
<unk> services are actually outperforming some of the headline numbers that you may see around the market. So thus far.
We are not seeing anything showing up in our portfolio performance even in the sort of early indicators that Steve mentioned.
Great. Thanks, guys.
Just one more for me.
Paul can you give us an update on any conversations or potential interest you've had regarding the sale of Watergate have you seen any kind of positive signs in the investment sales market that might suggest it's getting closer to that optimal time to sell that property or vice versa.
Well, a couple of things Blayne, and let's let's start with leasing.
The the top.
Leasing in the market in DC right now is probably a short term two to three year.
Spec suite.
<unk> turnkey ready to go and is that as a backdrop, we still have a couple of those left at Watergate that we would like to complete.
And I think we've only really had about 90 days to establish a fact pattern and I still think there is ample room for recovery here and I don't want this.
As you know, we put a lot of blood sweat and tears into that asset renovating it.
And getting it still has eight years of wall left on it.
We just don't want to.
Have that asset position does any type of distress sales. So we're still letting the market recover it is not a.
Super long term hold for us as we've said on other calls so I think we'll know it when we see it blayne, but.
We will keep you apprised as we move forward.
Very helpful. Thanks, Paul.
Thanks Blaine.
Your next question for today is coming from Anthony Pallone. Please announce your affiliation and pose your question.
Thanks, J P Morgan.
I guess my first question is.
Paul I think you mentioned your G&A is effectively at a level that could support twice.
Twice as many.
Units as you have and so I guess I'm just trying to think through what the governor is in terms of really getting to that higher unit count and whether it's.
Just the need for maybe more equity or more capital or is just the pipeline is what it is and youll get the deals done as they happen.
Hey, Tony Steve I'll start it and Paul can probably rounded out a little bit.
I think we've.
We've said this all along and we've executed a lot of transactions over $5 billion of trades and repositioning This company and we said and I think we limit that we.
We work both sides of the equation at the same time, so we look for the opportunities to scale and then we match the right capital to do it I think we are solving for two things at the same time, one has to profitably scale the company and the others to geographically diversify it.
I think there's multiple levers that we look at and evaluate cooling sometimes equity to do it will help with both.
Sometimes we're looking at opportunities with portfolios, where our structure, including units will help you tie up and scale faster.
We keep a low leverage and complete pretty vanilla balance sheet, which gives us.
And we have our maximum liquidity. So it gives us leverage and that is a potential and then there is the.
Our research is always looking at what's the right inflection point to recycle out of some assets into higher growth profile assets or assets, where we wouldn't want to continue to reinvest capital into an asset because we see a greater in higher value I think we will continue to play all elements of the playbook.
I think.
What we've done so far is kind of one at a time and we certainly have used our transformation capital, but I think we've seen some portfolio opportunities where there might be some value.
And what we can provide structurally above just normal equity prices and we're looking at that as an option too so the whole playbooks open.
Clearly the world's volatile.
What might be the right way to go today might be different a couple of months. So we keep evaluating all options.
Tony the only other thing I would add to that is that.
We consistently get calls.
From outsiders incur in terms of.
Private and.
Want to do ventures that.
We're looking to see something I can tell you that.
Since we've made this switch and signaled our expansion into the southeast markets. We've never seen more portfolio deals than we're seeing right now so I think our ability to scale. If you had asked me. This time last year, where I felt like it was really more of a one off environment, where probably underwriting five.
Or six portfolios right now and that has been a bit of a shift.
From 2022 from 2021.
Okay. So I mean.
Is it fair to say then this $100 million that you outlined for mid year to kind of round out the initial repositioning thats one thing but.
There is a chance that we could see like a portfolio or something that.
But you're only guide we're only guiding youre exactly right I think we're only guiding what's visible in what we don't need additional capital for but we are exploring all of those creative options.
It's our goal to both scale the company profitably and to geographically diversify it.
Okay, and then just other item the renovations what are you spending.
Per per unit on those these days and you mentioned $8 million in 2022, just curiously and 3000 units just curious like what the governor is.
Doing either more or less of that.
I'll start off and then Steve if you want to jump in.
Right now.
The DC metro market on renovations.
Like some something Tony like the assembly, where probably 13 to 15000.
A door and then.
Then.
Carlyle that we bought down in the Atlanta market.
That's probably 10 to 12, a door and we're looking at.
Steve highlighted we're looking at low to mid teens.
For those.
It's also.
It's also.
The.
Also based on availability, Tony I mean.
We try to meet as you know you've known us for a long time, we're trying to maintain that affordability gap and when we do that when we do those renovations. It's based on availability, we had pretty high retention in the first quarter here. So we're not actually getting access to the.
The same amount of units that we normally would but as that fluctuates you asked one of the governors was high retention and then also are we going to get paid for it while maintaining that affordability gaps so we try to.
<unk> all of that in our calculus as we evaluate renovation opportunity.
Okay, great. Thank you.
There are no further questions in queue I would like to turn the floor over to Paul for any closing comments.
Thank you again I would like to thank everybody for their time today, and we look forward to seeing many of you in the near future. Thank you.
Okay.
Thank you ladies and gentlemen, this does conclude todays event you may disconnect. Your phone lines at this time and have a wonderful day. Thank you for your participation.