Q4 2022 Centerspace Earnings Call
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Okay.
Hello, everyone and welcome to the sudden toothpaste fourth quarter 2022 earnings call. My name is Daisy and I'll be coordinating your quote today.
You'd like to register a question. Please press star one on your telephone keypad.
I would now like to hand, the credit you Hi, J Mccray, Mitch VP of finance to begin Jai. Please go ahead.
<unk> Form 10-K for the year ended December 31, 2022 was filed with the FCC yesterday. After the market closed. Additionally, our earnings release and supplemental disclosure package have been posted to our website at center space homes Dot Com and filed on form 8-K.
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 filing under the section titled risk factors and in our other filings with the SEC, we cannot guarantee that any forward looking.
Shipments 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 Mark Decker for the company's prepared remarks. Thanks, Joe Good morning, everyone and thank you for joining US with me this morning.
As Anne Olson, our Chief operating Officer, and Barack Patel, our Chief Financial Officer.
2022 was an ambitious year for center space.
It had several large forces at work multiple large integrations of communities people and systems from late in 'twenty, one meaningful labor pressures given that all of our communities are in highly employed markets.
Inflation and the reset of the cost of capital.
And yes, we did continue to grow the quality of our portfolio and we were able to grow core <unk> per share by 11%.
I'm confident we're on the right track as I listened to the many earnings calls and speak to private peers.
We're in good company as it relates to strong fundamentals and expense challenges, though we are different in terms of our Midwest and mountain west market exposure.
Provided us with leading consistency in revenues and NOI growth since 2018.
Get more excited when I consider that we've been able to find accretive ways to grow and our internal growth opportunity remains since we really are just a five year old owner operator.
I'm sure and we'll have some depth to the operating commentary so I'll stop there, but before I move on I want to say, thank you to our teams and operations and support who continue to show incredible dedication to our residents and each other.
Moving to capital allocation and balance sheet, we had a quiet first half we pursued a large strategic portfolio that would have been funded with stock in units that didn't break our way.
Got a little more active in the second half of the year and we deployed capital to continue to improve our portfolio.
Purchasing a newly built property in Denver lira for $95 million.
And we also took advantage of the dislocation in public markets to buy back some of our own shares at a significant discount to intrinsic value.
In all we deployed about $125 million.
Our plan was to fund those investments with the equity from sales of some of our least efficient and most capital intensive communities.
As well as long term fixed rate debt and that is what we expect will happen in the coming months as we have 500 homes under contract today, and we have rate locked in $90 million mortgage for 12 years at just over 5%.
We delayed our financing plan to let the market settle and in so doing took more variable rate exposure.
This proved to be the right long term thing to do but did cost us in the short term and Thats reflected in our results for Q4 and to some extent our 2023 guidance, where you can see that interest expense is eating and strong operating results.
Asset sales May also hamper our core <unk> per share growth. However, in our analysis, our cash flow and quality of earnings has improved and that's a trade off we like and well continue to seek them.
I'm pleased to say that we expect in the next 60 days to have long term financing in place and have our line nearly back to zero.
So when it's all said and done we'll have a robust and scalable operational system with numerous chances to improve resident and team experienced while gaining efficiencies.
Portfolio of communities with better long term pricing power and ability to grow and distribute cash flow.
And abundant liquidity with an untapped line low blended rates long maturities and a formidable unsecured asset base.
Looking forward and considering our overall outlook, we believe that our portfolio provides a strong value proposition to our residents.
That our residents are economically strong and our portfolio of communities are amongst some of the least exposed to new supply in the public markets.
We're excited about the opportunities to continue to improve the company in 2023 and beyond.
And with that and would you. Please provide a quick operations update.
Thank you Mark and good morning, I'm happy to say that 2022 was a great year and like Mark I'm extremely grateful for our team and their hard work. We ended the year with 9% growth in our same store net operating income compared to 2021 revenue was the highlight for the year with our same store growing at nine 3% in the fourth quarter compared to the same period.
In 2021, and 10% for the full year during the fourth quarter, our same store new lease rates increased one 8% on average over the prior leases and same store renewals achieved average increases of seven 2%.
Blended basis. This is fourth quarter rental rate growth of four 2%.
During 2022 overall, our same store portfolio achieved an average new lease increase of 8% while renewals increased eight 4%.
Renewals remain strong given the significant growth in rates, we saw earlier in the year and we are experiencing a return to normal seasonality and new lease pricing.
In January our new leases saw positive increases at one 4%, while our renewal rents increased six 5% over the prior lease.
Our traffic has returned to pre Covid trends and is currently up year over year.
We feel good about the demand in our markets the financial health of our residents are strong and we increased weighted average occupancy of 40 basis points during the fourth quarter to 94, 9%, while maintaining collections of 99, 8%.
Expenses came on quickly in the second half of the year and while we are experiencing our fair share of inflationary effects on labor and materials utility increases contributed 26% of our overall same store expense increase in 2022 over 2021.
On a controllable expense basis, it was 32% of the total increase year over year.
We are projecting utility expenses will remain relatively flat in 2023 and as we look forward. We believe that the bulk of the inflationary increases were realized in the second half of 2022, and thus our expense growth will moderate.
Of note, we had an increase in addiction and similar activity in Q3, and Q4 with 10% of our explorations attributable to evictions in Q4. These drive expenses related to legal and administrative fees and often correlate to higher turn costs, we believe that activity, which was driven by the midyear lifting of the rental assistance programs in Minnesota will.
For this year as we start 2023, we're focused on systems and processes that will gain efficiencies and contain expense growth now I will turn it over to Brian to discuss our overall financial results and 2023 outlook.
Thanks, Anne and good morning, everyone last night, we reported core <unk> for the quarter ending December 31, 2020 to $1 17 per diluted share, bringing our full year core <unk> to $4 43 per diluted share, which represents an increase of 11% over the prior year.
The key driver of the increase was strong growth in same store net operating income as Ed mentioned, although we felt expense pressure across the board during the second half of the year same store revenues established a strong foundation to sustained operating momentum as the impact of inflation and higher energy prices on expenses begins to moderate.
I will discuss that in further detail when I cover our financial outlook for 2023.
Turning to our financial position, we continue to take steps to further strengthen our balance sheet and broadened our capital options. During the fourth quarter, we repurchased 427000 shares at an average purchase price of $67 25 per share, which we believe to be a significant discount to the value of our portfolio Ali.
Also during the fourth quarter, we closed on an unsecured $100 million term loan facility with an initial term of one year with a one year extension option the loan bears interest at Sulphur plus a spread of 120 to 175 basis points based on our leverage ratio. The current spread on the loan is 130 basis points, which is roughly in line with the <unk>.
Current spread on our unsecured line of credit.
The term loan augmented capacity and provided balance sheet flexibility during a period of extreme volatility and uncertainty in the capital markets as we embarked on a plan to prune the portfolio as Mark discussed in his remarks.
As of December 31, 2022, we had total debt of $1 billion with a weighted average maturity of five eight years and a weighted average interest rate of 362%.
Now I will discuss our financial outlook for 2023, which is presented on page S 17 of the supplemental at.
At the midpoint, we expect same store NOI growth to be 8% in 2023, driven by continued topline growth coupled with a moderation in expense growth.
The key components of revenue growth our earn in of approximately 4% at year end projected blended rate growth of four 5%.
Driven in part by value AD spend and the expansion of what we collect and rubs across our portfolio.
We expect total expenses to grow by five 5% at the midpoint compared to 11, 6%. During 2022 as we anticipate key drivers of higher growth in 2022, such as utilities and R&M to remain relatively flat in 2023.
Almost two thirds of the increase in expense is driven by higher real estate taxes and insurance costs as assessed values and premiums continue to rise.
We expect core <unk> for 2023 at the midpoint to be roughly flat compared to 2022 at $4 42 per share as the impact of higher interest expenses and the planned dispositions is expected to offset strong operating results.
Approximately 21% of our total debt as of December 31, 2022 was variable rate debt that short term rates projected to be significantly higher in 2023.
However, we expect to refinance approximately $90 million of our current floating rate debt with fixed rate secured debt at a coupon of 5.0% to 4% and the maturity of 12 years as we were able to rate lock during a brief window of time, when the 10 year yield dipped slightly below three 6%.
We used to have locked in those savings as treasury yields have since risen by approximately 35 basis points.
Lastly, as Mark mentioned in his remarks, our guidance assumes disposition proceeds of approximately $155 million to $165 million from the planned sale of 11 assets or approximately 19 100 units.
Do you expect to close nine assets for approximately $140 million by the end of the first quarter with a balanced plan to be completed by the end of the third quarter.
The proceeds from the dispositions will be used to pay down outstanding balances on the term loan and the line of credit.
Pro forma for the refinancing and asset sales a weighted average interest rate as of year end would've been three 5% a weighted average maturity would have increased by over a year and a 5% to seven five years and our variable rate exposure will decline by approximately 1% of the total debt balance post the paydown.
Additionally, our leverage will decline by about one one times and our capacity will be fully restored further strengthening our balance sheet too.
To conclude I would like to thank our entire team that center space, where their contribution in making 2022, one of the strongest years in the history of the company.
While there are challenges ahead, we are extremely confident in our team's ability to execute our operating strategy and propel center space to newer heights.
And with that I will turn it over to the operator to open it up for questions.
Thank you.
As a reminder, if anyone would like to register a question. Please press star followed by one on your telephone keypad.
If you would like to withdraw your question. Please press star followed by Chi Wen.
When preparing to ask your questions. Please ensure you Amit should likely.
So thats star one on your trying to think you put too much store question.
Our first question today comes from Brad Heffern from RBC capital markets. Please go ahead. Your line is open.
Yes, Thank you and good morning, everyone on the dispositions can you walk through exactly where those assets are the cap rate.
You expect and what the dilutive impact was on the guidance.
Sure. Good morning, Brian This is mark I'll start with that.
The assets are two are in Nebraska.
One in Lincoln one in Omaha.
Five are in.
Sure.
Saint cloud.
And.
I think it's three three in Minneapolis, greater twin cities area.
I think it's four in San club.
So that was the first so that's where are they what was the dilutive impact.
<unk>, probably eight to 10.
And what was the other part of the question sorry.
Just the cap rate cap rate yet.
Low sixes.
On a trailing basis.
Probably higher than that on a forward basis.
But on an <unk> contribution below the line.
I think it's actually going to be a net net accretive or or or slick.
Okay got it and then on the utility front can you give an update on the progress that you're making and having the residents be responsible for their own utilities and I guess is that contributing at all to your expectation that utility expenses will be flat year over year.
Yes, good morning, Brad.
So first with respect to how we're going on rolling out the gas and heat utilities under the reps. We started that project in May and June and so it takes about a year a little bit over a year to get through all the lease roll.
So we are a little less than halfway because we had some of the lower lease expiration months on that.
That contributes to some of our revenue growth because that comes back to us on the revenue line. The expectation that the utility is will remain relatively flat is really based on our hard look into utility costs, and where we think projected are going and a comparison to the fact that last year. They increased so much. So we really expect the increases to moderate.
And then that brings the year over year number down down significantly, but the expense line, we do isn't impacted by the by the recovery of that hits in revenue.
Okay got it and are you seeing.
This sensitivity around that I know you sort of expected that as you make people responsible for their own utilities that they will become more rate sensitive and they would potentially be an offset I guess are you seeing.
A full offset to that are you still sort of recapturing.
Some uplift from it.
Yes, we've had very little pushback in fact, I'd check with the team pretty regularly to make sure that that isn't happening when you have renters looking at their full chunk rent theyre taking into account the utilities.
So we haven't had much pushback on it at all and in fact.
Still feel really good about where our overall rental rate growth is both from a new lease and renewal given where we are right now in the.
<unk>.
Okay. Thank you.
Thanks, Brad.
Thank you. Our next question today comes from John Kim from BMO Capital markets. John Your line is open. Please go ahead.
Thank you and good morning.
Your same store revenue guidance is noticeably higher than most of your peers.
I guess you have a few weeks of additional data.
Given the timing of when we report, but I wanted to focus on the four 5% blended lease growth rate.
What's in your assumption.
Can you break that down between market muscle growth and renewal rate growth that you expect.
Sure John This is Greg.
With respect to the blended rate growth I would say about three to three 5% is projected market rent growth the.
The remainder comes from projected value AD spend in 2023, plus some of the value AD spend we've put into the portfolio in the second half of.
2022, which will enable us to capture some of the premium as we go through the lease role.
Okay, you had a significant delta I think between renewal and new lease I think in January .
That Ed had mentioned do you think thats going to continue.
Throughout the year.
I do I think that it's going to take a while to burn that off our new lease rates are still <unk>.
Significantly higher than our renewal rates.
And we had several months last year, where our new lease rates were really growing and it just takes it takes time.
To catch up there we have seen we are I think going to see that moderate down they just lag those new lease rates by a couple of months. So we should see that come down a little bit as the year continues but then be bolstered up as we as we see new lease rates accelerated up to that what we're projecting three five to four 5%.
In the prime leasing season.
Have you disclosed your bad debt in 2022.
Can you.
Say, what that is and also what you're expecting as far as bad debt and 23 as well as your occupancy assumptions for the year.
Yeah.
Yes, so for bad debt in 2023.
Our projections.
And corporate about.
40 basis points of bad debt with respect to 2022, we were right about that Mark I think we had about 30 basis points of bad debt for 2022 with respect to occupancy we expect to stay around 95% as we go through 2023, obviously theres going to be some.
Volatility as we go through peak leasing season, but overall, we expect to maintain occupancy around 95% Mark.
Okay last question for me.
Do you feel about your dividend levels. These days on.
On our numbers your payout ratio is above 90% consensus is below that.
Given the cost of debt and maybe some.
Attractive use of proceeds are you are you satisfied with your dividend level, where it is today.
Or is there a possibility that you could reassess it.
So, presumably you're including all capital like value add capital to get to that number that's a very high payout number.
How do you get to that number Jonathan.
Yes.
Revenue enhancing capex, we typically to do that.
Got it.
Yes so.
I mean, obviously the revenue enhancing capital is discretionary in our view so.
We would peg our payout closer to something in the high <unk>.
And.
It's been our goal to continue to.
Work that payout ratio down.
To kind of that.
Minimum in the 60% 65% level.
So while also continuing to grow at a little bit I mean, I don't think were getting well compensated for it on one hand on the other hand.
Part of our structure and what we're all about is getting cash flow and increasing levels to our shareholders. So.
It's a board call I'm on the board in my mind. The dividend is at no risk I think we have 50 assets that have.
<unk>.
About 20% leverage on them, if you looked at sort of our unencumbered base versus our unsecured debt. So we've got lots of financial.
Security in my view and that.
That's how I look at it I think the board has a pretty similar point of view.
Okay I appreciate it thank you.
Thanks, John .
Thank you.
Our next question comes from Alexander Goldfarb from Piper Sandler Alexander. Please go ahead. Your line is open.
Hey, good.
Good morning, good morning out there.
So first question in response to the.
The dilution from the asset sales Mark I think you mentioned, 8% to 10%.
Or is that inclusive of the debt pay down or is that just on the asset side. So obviously with the debt paydown the dilutive impact is much less.
Yes. So this is rob.
That number is inclusive of the impact of the debt Paydown.
With respect to 2023, we had some growth from a <unk> perspective program for those assets. So when you kind of consider that and then netted down with the impact of the pay down that's the number that mark was referencing.
Okay. So the eight to 10 centers inclusive of the associated debt Paydown.
That's correct.
Okay then.
Next question is and you mentioned on the rubs.
Yes that you started basically middle of last year. It takes about a year to fully implement.
Is this the entire portfolio or.
Are there assets in the portfolio that you are unable to implement rubs in which case you will still have youll still be exposed.
Utilities in those assets.
No. This is the entire portfolio.
Okay. So there'll be no assets that are that will be sort of free floating if you will.
There may be a few kind of one off unique situations, but we don't have any there is no.
Geography that we operate in where there's regulation that would limit our ability to do it so to the extent, we can and it makes sense we're doing it.
Okay and then just final question you guys put out a NAREIT <unk> put out core SSO, but in looking at your core <unk>.
It seems to be a lot of recurring items that seem to be just part of running the business. So just sort of curious why not merge just to NAREIT <unk>, especially as these don't seem like one off items they seem to happen every year.
I mean fair fair comment, we'll take it under consideration.
Yeah.
Alex.
Okay.
Thank you Mark.
Thanks, Alex.
Thank you.
Next question is from Rob Stevenson from Janney. Please go ahead. Your line is open.
Good morning, guys, Mark what's the acquisition pipeline looking like today lots of talk in the sector about merchant developer stress coming and positioning to step in as a capital source.
Seeing any of that yet or are you guys seeing any attractive acquisition opportunities to redeploy capital into how would you characterize that today.
Yes.
Good morning, Rob I.
I would say we are seeing opportunities.
I do think thematic Lee there will be merchant developers, who.
Give up the ghost by the end of the year and I think end up taking profits, but less profit than they probably were expecting.
So we're in discussions on some of those we have a few okay.
<unk> unit type discussions going which we always have.
But I would say that volume Hasnt has yet to really come I think I read there were something like $40 billion done in the fourth quarter, which would be a pretty good quarter for most quarters, but it's certainly down over the last couple of years of activity.
The talk at NIH.
It has been commented on in some of the other calls was.
People were.
Kind of looking to the back half of the year.
From the buy side and there is definitely still a disconnect in.
When the treasuries are moving around like they are that certainly.
Throws cold water on folks I think to some extent.
So we don't go out there to be.
I'd say, we expect there to be activity I would think it comes more towards the second half of the year.
With our stock in the mid <unk> and debt at today, probably mid fives for secured debt and unsecured debt probably six in a quarter.
We're probably not a very vibrant participant.
It has some sort of structure to it.
Okay, and then how would you gauge your aggressiveness today on starting new.
Revenue enhancing capex projects today, given what youre seeing in the markets and your outlook for <unk>.
This year next year internally are you.
Is it more or less the same as what you would have been sitting here a year ago is it a little bit more cautious how would you characterize that in terms of the.
The dollar amount that you're willing to.
Green light at this point.
And those hurdle rates.
A year ago was a lot more fun and Robert with free money or the end of free money, but yes.
Yes, no I think our view of.
This hasn't changed a whole lot which is.
This is capital we really have to put in.
And get returns over the next couple of years and and we do it if we think it enhances the product for the resident I mean, it is the case if you look at our.
Rents there in the dollar $50 a foot range dollars 60, a foot range on a portfolio basis for renewal rents.
And there is still a pretty good gap between.
Where those rents are and where new product is and people like nice stuff. So.
When there continues to be a business case.
We're going to continue to make those investments I would say we are certainly putting more pressure on the business case.
Because the the sort of startup costs, if you will or funding costs are much higher so it doesn't.
<unk>.
I would just say it gives us a little bit more disciplined but that implies we werent as upon before and I don't think that's true.
Okay, and then last one for me you guys talked about.
The utilities and the natural gas could you guys hedge.
Hedging any of that at this point.
How big is the dollar value sort of tied to natural gas.
I mean, yes from a hedging standpoint, no I think and mentioned.
We are with the rubs program being rolled out we would be able to capture most of that back through the revenue line items. So that's going to dramatically reduce our exposure.
The fluctuation in prices from a utility standpoint.
I believe overall that accounts for about.
40% of the total utilities expense the gas prices, but again with the rollout.
Exposure on a net basis would be a lot lower going forward once that's fully implemented.
Okay. So once this is fully out there is not going to be that much of a delta between if youre talking about natural gas prices that average out to six something per million Btu is like last year or the two to $3 that you saw from basically 2015 to 2020.
That's correct, because I would say about providing.
Providing for collections and and just common area of deductions.
Approximately cover.
<unk> hundred 85% of the.
Exposure.
Okay.
Same in terms of water and other utility costs or is that de minimis compared to natural gas.
Yes in terms of water and sewer recapture back a lot of that so overall, that's already factored into the numbers. So the exposure was on the gas side.
Okay. Thanks, guys appreciate the time.
Okay.
Thanks, Rob.
Thank you before we take our next question I'd, just like to remind everyone. If you would like to register a question. Please press star followed by one on your telephone keypad.
Our next question is from Wes Golladay from Baird. Please go ahead. Your line is open.
Hey, good morning, everyone I just have a quick one for the casualty losses that just the general placeholder for the guide or is that a known event at this point.
I mean are.
Are you talking about the 2023 guide that's just like it is.
This $1 million net $1 million.
Impact.
Yes.
An estimate at this point in time.
Okay. Thanks, everyone.
Thanks Wes.
Yeah.
Thank you we have no further questions. So I'd like to hand back to the team for any closing remarks.
Thanks, very much J J well. Thanks, everyone. We appreciate your continued interest and we look forward to seeing you next quarter.
Thank you everyone for joining today's call you may now disconnect your lines and have a lovely day.
Yeah.
Yes.
Okay.