Q2 2023 Elme Communities Earnings Call
Welcome to the Elm Community's second quarter 2023 earnings conference call.
As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Amy Hopkins, Vice President Investor Relations. Amy, please go ahead. Good morning, and thank you for joining our second quarter earnings call. Today's event is being webcast with a slide presentation that is available on the investor...
known and unknown risks and uncertainties which may cause actual results to differ materially, and we undertake no duty to update them as actual events unfold. We refer to certain of these risks in our SEC silence. 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 was distributed yesterday and can be found on the investors page of our website.
and core FFO per share growth of 14.3% year over year.
I am very pleased to share that we have officially completed the transition of community-level operations to elm management.
We kicked off this strategy in 2021, and I want to thank all of the team members that contributed to countless hours to designing and implementing our new operating model. I would also like to welcome our newest community team members and thank them for all the hard work and dedication to customer service.
that they've shown throughout this transition. We launched our new platform with minimal disruption to our existing residents and very high community team retention.
We are thrilled to have this transition behind us and we look forward to turning our full attention to our operating initiatives.
On that note, we welcome the new Chief Operating Officer to our Executive Team in July .
Tiffany Butcher brings extensive experience in multifamily operations that aligns well with our goals for our operating platform. I expect her leadership to enhance our ability to drive NOI growth and look forward to her participation of future earnings calls.
Before I turn to our operating trends, I'd like to address our multifamily NOI guidance reduction.
We had expected to see a more pronounced seasonal upswing into the spring and summer leashing seasons than we experienced in our markets. Additionally, our rebranding and transition activities had a greater impact on our ability to generate leads and push rents during the summer months than we had anticipated.
These two impacts resulted in lower than expected new lease rate growth achieved during the second quarter and lower assumed new lease rate growth in the third quarter compared to our original expectations.
As communities have transitioned, we have been closely monitoring community level performance and have seen a rebound in our ability to drive rent growth as communities have restabilized under Elm Management.
Additionally, our renewal rates and occupancy trends remain in line with our expectations.
Therefore, we feel good about our outlook for high single-digit same-store, multi-family, and OI growth this year, which represents strong performance for our core business during a period when we were executing significant changes to our internal systems.
With the execution risk related to the onboarding process now behind us, we are shifting our focus to realizing the full benefits of our new multifamily platform.
Turning to operating trends, we generated effective blended lease rate growth of 3.7% during the quarter for our same store portfolio comprised of renewal lease rate growth of 6.4% and new lease rate growth of 0.4%.
Renewal rates remain very strong throughout the summer months and we signed renewal offers for July and August lease expirations of 5% on average.
in line with our expectations for continued moderation and renewal rates over the course of the year.
Our focus on occupancy continues to deliver good results and we have driven occupancy gains across our entire portfolio since the end of last year.
Game store occupancy averaged 95.6% during the quarter, up 10 basis points compared to the prior quarter. Ending occupancy was 95.9%, up 30 basis points year over year.
Retention remains strong at 63% during the quarter, up 200 basis points compared to the prior year, and above our historical average in the mid-50% range due to lower move-outs to own, and our focus on maintaining strong retention throughout the portfolio transition.
to elm management. Our geographic expansion strategy has yielded solid results thus far and our Atlanta communities are contributing very good growth.
Revenue for our SAME store Atlanta portfolio increased 15% year to date compared to prior year period and NOI grew 24%.
Occupancy for our entire Atlanta portfolio averaged 94.2% during the second quarter, 120 basis points above the market average due to our focus on driving occupancy.
SAME store multifamily revenue increased 9.6% in the second quarter compared to the prior year, comprised of approximately 9.5% growth from our DC metro portfolio and over 12% growth from our Atlanta portfolio.
Our current rent levels translate to rental growth of approximately 5.6% year over year, which represents 90% of the rental rate growth we need to achieve the midpoint of our guidance.
Burning the renovations, our price points provide the opportunity to offer like-new interiors at several hundred dollars below the monthly cost of Class A apartments, which allows us to generate cash-on-cash renovation premiums in the mid-teens.
We have completed over 141 renovations year to date at an average ROI of approximately 14%.
This return does not include the market rent growth that we achieved.
By executing renovations on turn, we have the flexibility to increase or pull back the pace of renovations as revenue maximization opportunities shift.
Given the very strong renewal rates we are seeing, we are strategically keeping turnover low and have therefore slowed down the pace of renovations as less homes have become available to renovate.
While our total pipeline and value creation opportunity has not changed, we now expect to complete 300 to 350 renovations this year.
With a 2900 unit pipeline, we have more than enough runway to drive renovation-led value creation over the next several years.
The rent-to-income ratio for new leases signed in the second quarter was in the mid-20s, consistent with our historical average, and the average income for those leases increased nearly 9% year-over-year as we continue to see that income growth is keeping up.
with the pace of rent growth in our markets.
For the first time since early 2021, the affordability outlook is improving nationwide.
middle-class wages grew faster than the rate of inflation in May and June .
Despite improving affordability, the cost of owning a home or living in recently built apartment communities remains unaffordable for mid-market renters in our markets.
Near our communities, recent deliveries are priced $440 to $680 or 28 to 32% more than our rents.
The cost of owning a home is even higher differential compared to our mid-market rent levels.
In addition to the relative insulation provided by our price points,
Most of our communities are not located in the path of new supply next year.
While at the market level, annual supply will peak for Washington, D.C. and Atlanta in 3 Q2 024, over 40% of ELMS communities are located in submarkets where supply is expected to peak this year.
for the deepest sections of the runner market. With that, I'd like to turn the call over to Steve Freistadt, our CFO , to discuss our transition to L management and balance sheet and guidance updates. Thanks, Paul. I'll start by reiterating how pleased we are to have achieved our goal of having the full transition of community operations behind us by the end of July . Our focus on making this transition as seamless as possible to our residents supported very strong resident retention.
and renewal rate growth throughout the onboarding process. Thanks to the extensive amount of planning and relationship building done by our teams, 93% of our community level staff chose to transition to ELM, which provided continuity for our residents during the transition.
With the transition behind us, our teams now have significantly more capacity to focus on driving operational improvements and leveraging our new technology to increase our profitability.
These operational upside initiatives include
smart home packages that will drive higher rents and reduce operating expenses, reducing vacant days by implementing revised scheduling, policy, and process adjustments to manage our occupancy levels more effectively, fee income opportunities, cash management, and expense initiatives. For more information, visit www.fema.gov
and centralizing resident accounts management, which represents phase one of our multi-year centralization initiative.
We estimate the additional FFO that we expect to generate from these initiatives above what we would have otherwise generated from 2023 through 2025 to be between $4.25 and $4.75 million.
Furthermore, we have the opportunity to drive additional upside by centralizing renewal negotiations, leasing, and maintenance, and we look forward to providing more detail as we continue to make progress on our centralization plan.
Moving on to our balance sheet, we are well positioned with limited exposure to interest rates and no debt maturities until 2025, with options to extend our 2025 term loan maturity another two years.
Our annualized second quarter net debt to EBITDA was 4.8 times, and we have over $680 million of availability on our line of credit as of quarter end.
We are running below our targeted leverage levels with about $100 to $150 million of investment capacity.
We will continue to evaluate acquisition opportunities in our target markets as owners come to terms with the reality of an ongoing, higher interest rate environment and will pursue further acquisitions when they create additional value for shareholders.
Now, turning to our outlook for the balance of the year. We lowered the top end of our core FFO guidance range to 96 cents, $1 for a fully diluted crucit tha Turn around nostalgiaous
As Paul mentioned, the reduction in our same-store and non-same-store multifamily NOI growth guidance ranges are the result of lower than expected new lease rate growth expectations for the year.
We have seen a sequential improvement in new lease rates in July and are seeing a favorable trend in August .
Given our year-to-date growth achieved and the trends we are seeing heading into the fall, we feel good about our ability to achieve high single-digit, same-store NOI growth for the year.
We lowered our guidance for G&A by $750,000 at the midpoint, interest expense by $500,000 at the midpoint, and reiterated our guidance for Watergate 600.
Watergate is approximately 88% occupied. We have no remaining lease expirations this year and limited lease roll over the next few years.
We continue to expect our core AFFO payout ratio for this year to be at or below our mid-70s target, and we are managing to an AFFO growth profile that should provide us with additional flexibility to grow the dividend over time.
And with that, I will now turn the call back to Paul.
Thank you, Steve.
and the execution risk related to transitioning our systems is behind us. We have been doing all our pricing and asset management in-house since 2017, but for the first time, we have the team and technology in place to take our platform to the next level. Ninety-three percent of our community teams transitioned from our third-party managers to Elm. Our regional managers have over 20 years of experience in our markets.
and we have a new COO with an extensive background in residential asset management. Given where we are today and the opportunities set ahead of us, we believe our value proposition is compelling, and we expect to earn a lower implied cap rate as we deliver the operational upside.
embedded in our platform. And now operator, I'd like to open it up for questions.
Thank you very much. At this time we are opening the floor for questions. If you would like to ask a question, please press star one on your phone keypad now. A confirmation tone will indicate your line is in the queue. You may press star two if you would like to remove your question from the queue.
For any participants using speaker equipment, it may be necessary to pick up your handset before you press the star keys. Please pause a moment whilst we poll for questions.
Thank you. Your first question is coming from Jamie Feldman from Wells Fargo. Jamie, your line is live. Great. Thank you and good morning. I guess I know you gave some color on the guidance cut, but maybe if we could dig a little deeper.
Can you just talk us through your initial guidance, your first guidance revision, and then this one, just in terms of what the process was to get the information and what you learned, what the process was that made you cut it again, just so we have some clarity on is this the last time this will happen?
Yeah, Jamie, this is Steve, and I'll kind of, you know, going back to the beginning of the year, the initial guidance you spoke about. And, you know, we came out with an initial guidance back in September , reiterated in February , you know, and saw, you know, more of a, you know, compared to where we are now.
more demand in the spring leasing season allowing us to drive rental growth on new lease rates than we did. When we got to April , we didn't see that early spring leasing season kind of kick in that would get us to the top end of our guidance.
And so to be transparent, we adjusted our guidance in April to reflect that. Now that we're sitting here on August 1st, we've seen the demand trends for how we've been able to do lease rates and be able to push new lease rates. We've felt it appropriate to adjust it according to what we're seeing in the market, according to what we're seeing in our
July and August , which, as we said, in our scripted marks, is trending better, but still not compared, not up to what we had seen or what we were needed in order to hit our initial guidance. So this updated guidance, revised guidance kind of reflects what we're seeing in the market, what we're seeing through August , and even the...
guidance, we mentioned also in prepared marks that 90% of our rental rate growth is locked in at the end of June . I mentioned being able to see lease rates now through August and September . The onboarding process is now complete and behind us, so the risks related to that are
We've put that behind us and the impact on leasing. We'll see a little bit of that in Q3 with the most recent onboarding, but should have that behind us here very quickly.
On the expense side, that's been pretty constant for us that we see, you know, expenses pretty stable, you know, at this point in time for the year. So we feel pretty good about where we are in our ability to meet this revised guidance.
Okay, and just to confirm, how much of the change is due to kind of bad information?
because pre-internalization and how much of it is purely fundamentals. It sounds like it's mostly fundamentals from your answer. I just want to confirm that. Yeah, I mean, we've looked into it. It's hard to quantify which of it is kind of the market growth versus the friction from one boarding. So, it both happened at the same time during the spring leasing season.
And our revised guidance reflects the more modest expectations for new lease rates kind of trending throughout the rest of the year.
Okay, and then what are your assumptions on rank growth in the third quarter and fourth quarter?
Yeah, so looking at, you know, as far as our renewals and new lease rate growth, when we talk about renewals, it's really the renewals have stayed in line with how we saw them coming into the year, that high single digits at the beginning of the year, by the middle of the year mid single digits, and really turning down to the lower single digits towards the end of the year.
the newly-strived growth has been, you know, around 1 1 and a half percent. But we've got it then kind of coming down towards the end of the year and finishing the year just above flat.
And do you think supply has an impact on that moderation?
This is Grant. So we definitely think that supply is having an effect on overall market performance, but as we've messaged for a while, we've remained really disciplined in deploying our capital and really looking to stay below 95% of market median rents on the capital we have put out.
And we do think that's blunting the most direct impacts of new supply. But we have seen that the share of product that's in lease upward that is delivered since 2021, is not a good thing.
That's below that 95% threshold has increased this year from around 3% to around 12%. But even so, when you look at the submarkets immediately surrounding our properties, there's still a significant gap. So for Washington, that gap is around 450 or 24% versus Class A product.
and in Atlanta that's around 470 or 30 percent. So we really don't see a lot of cross shopping on our product within our Class B resident base.
Okay, and then just one more for me. You know, you cut your G&A guidance. And, you know, how does that impact your ability to grow the platform? I think in the past you said you can expand by 80% without adding more G&A. Is that lower that number?
No, Jamie, I think that our movement and guidance this quarter for G&A is more impactful to just 2023 and not really on showing that. What we've said before about the ability to nearly double the unit counts of the company and keep G&A materially still the same still applies here, that we're still focused on growing the company. This project is based on experience, Brooks and
And this guidance adjustment hasn't changed that. Okay, so can I assume from your answer that it ramps back up in 24 if it's just a 23 G&A cut? We are not giving 24 guidance right now, but like I said the impact that we just adjusted for this quarter for G&A is related primarily just to 20.
All right, thank you.
Thank you very much. Our next question is coming from Alan Peterson from Green Street.
Alan, your line is live.
Hey guys, thanks for the time. Steve, within the NOI guidance change, I appreciate the comments on expenses. Is the 6 to 6.5% expense range that you shared last quarter, is that still intact or is there any idiosyncratic headwinds or tailwinds to expense growth this year that you're not expecting to repeat? Thanks for choosing, I'm Steve and I'll see you next time.
No, Alan, I think the 6 to 6 and a half stole plies, that's where we are. We're forecasting expenses to finish out the end of the year. Maybe there's some slight movements within some of those line items, but overall, that 6 to 6 and a half stole plies.
Understood. And then maybe as you guys are setting out renewals today, appreciate the comments on 5% renewals in July and August . Can you give us a sense where renewals are being sent out within September and October renewal negotiations? Yeah, we're still sending them out at 5 to 6%. And we are seeing...
we're really still seeing renewables trending in line with what we expected as the year progressed and still seeing it you know turning down to the the low single digits by the end of the year.
Understood. And then as you guys round out the summer leasing season here, are you guys offering concessions across any of your properties on any specific floor plans or any specific communities?
But, you know, year to date, we're seeing concessions on about 11% of leases. When you look across all new leases, that concession is less than half a week. I appreciate that. And last one from me, maybe for Paul. I know that there's an asset right now that's being marketed to media outlets, reported it on the office market on I Street, being marketed at a low double-digit nominal cap rate. I understand that Watergate 660 has a better waltz and better occupancy today, but did we see a scenario where Watergate 660 could be marketed if it were to be today at a double-digit nominal cap rate?
in terms of asset quality, location, the amount of catbacks that we've put back into our building, and as you highlighted a different wall structure. And also I would add a different credit profile with ours probably being superior to that. That is a bank-led note auction.
which should say a lot about, you know, those cap rates we continue to see. And quite frankly, the only fact pattern we do have here in Washington, D.C. has really been driven by bank auctions and note auctions at significant discounts.
I don't think there is a comparison between the Watergate and the asset on I Street that you're referencing. Obviously, we'll have to wait and see, number one, if that asset even clears the market, and number two, we will take that information and probably interpolate a cap rate.
Beyond that, it's really just speculation at this point, Alan. I appreciate that, Paul. I appreciate the time, guys. Thanks.
at this point, Alan. I appreciate that, Paul. I appreciate the time, guys. Thanks. Thanks.
Thank you very much. Your next question is coming from Tony Paloni from JP Morgan. Tony, your line is live.
Hey guys, you have Nahum on the line for Tony this morning. I guess firstly congratulations to Tiffany on joining the Elm team as COO. Just curious if you could speak to any near-term focuses you guys will have on the operations front.
Sure, I'd be more than happy to speak to that. You know, I think a lot of the things that we were focusing on and will be focused on going forward were outlined in our prepared remarks and in our slides, but we're obviously focused on finishing the year strong from an operation standpoint from both rent and occupancy and that we're very excited.
ways to bring down our average state uh... often see through changes to our policies and procedures and how we're addressing move out to think will uh... be a very strong uh... help us move into uh... twenty twenty four uh... we're also focusing on our smart home technology uh... rolling that out of which you know obviously will help drive revenue and also uh... help on the
We're also testing Managed Wi-Fi at one of our communities, which is a feet-income opportunity. So there's lots of operational outside that we're working on right now, and we're very excited about to just party that, you know, 4.25 to 4.75 million that Steve talked about in his remarks.
Got it. Thank you. I guess one more just for me, maybe on the transaction market. You guys have been.
I guess like guidance has been for acquisitions to be paused for the rest of the year, but I'm kind of curious
With what you guys are seeing in terms of cap rates in the market, maybe if you could break it down just from like the Washington D. C. area and then Atlanta.
Shunam, this is Paul. Not a lot of movement. We haven't seen a tremendous amount of movement since our remarks in the first quarter. I would say, however, that of the brokers and even some of the operators we've screened both in DC.
and in Atlanta, we believe that we're going to see more product in September and towards the end of the year. Two of the brokers had commented that their BOV activity had doubled over the last 30 days. I think just in terms of cap rates.
Kind of the Class A value add, we've seen trade in the low fours and you know, others, other Class As kind of in that four and a half to four seventy five range. Class B, I would go twenty five to fifty bps on top of that.
The going in yields have been fairly consistent, but we're seeing the higher cap rate trends or lower growth, you know, kind of those outside markets. But again, that's going to vary sub market by sub market and by vintage.
When we look at the folks, because Nam, as we've said, we have stayed in the game. We track every deal that's out there. Our observation would be that the sellers, probably 80% of those sellers are institutional. We're seeing more and more closed-end fund activity.
or folks trying to fund another part of their business, in particular, you know, funding a redemption queue. On the buy side, we've seen kind of 80% of that be private and with financing contingencies and...
I'd say of that private, you know, that's really made up of high net worth, private syndicators, family offices, 1031s. And the sweet spot we would observe in the marketplace right now just appears to be that 40 to 60 million dollar deal, maybe even as high as 75.
And those are candidly commanding kind of a scarcity premium right now. But it looks like kind of a line in the sand is $100 million or over. I mean, we would we would also observe that that kind of 100 million to 120 million or over a million dollar ocean hungry, can be looked at and it's just the basic questionominqueat and
All cash really seems to be where the opportunity is. And that's really because, number one, no financing contingency, offering certainty of execution being a cash buyer. And those large syndicators really cannot syndicate that big an equity component quick enough.
The lender market we've definitely seen getting a little bit more aggressive. Lenders are really scrubbing current cash flows as we would expect them to and adjusting for taxes and insurance. Fannie and Freddie are really not beating the market right now. I mean they're really emphasizing.
mission-driven aspects of higher quality and affordable components. And we've seen the debt funds really step up, three-year deals in that seven to the seven and a quarter range. But a lot of the deals with the private folks were seeing people either buying down rate or trying to get more proceeds, pushing for that higher LTV. But interestingly, those...
7 to 18% IRRs we're quickly seeing turn into 12 to 13s.
Thank you very much. Your next question is coming from Michael Gorman from BTIG. Michael, your line is live. Roll intro music.
Yeah, thanks. Good morning. Maybe we could just kind of synthesize a few different things here. Paul, it sounds like you're starting to see some movement on the transaction side, which is obviously a potential positive as we get into the back half of the year. As you think about that, especially some of the potentially larger transactions where maybe you have a competitive advantage.
Obviously there's some capacity on the balance sheet side, but as you think about the cost of equity versus the potential proceeds from a sale of Watergate, even in a challenged market, how do you balance that out if you found a transaction where you needed some more equity funding? How do you think about the current value of the stock versus selling out of the Watergate?
Well, let me start off with just entering that entering cap rate. And then Steve can maybe talk about, you know, what we would look at in terms of funding sources or potentially other sources of equity. I think the first thing to say is like...
We don't just look at what the going-in cap rate is. We're investing for the long term, and our strategy has always been targeting the deepest and most underserved renter cohorts and submarkets where we have high exposure to industries that'll benefit from job and productivity growth.
And we've seen cap rates, Michael, just in the last several months where you might be going into a mid-five, upper-five, but you're quickly above a six in the first nine to 12 months.
And even as I think as we talked about with some of our investors at Nayreet, we're not kind of running the company on a quarter by quarter basis, but if we see a value creation opportunity and there's some low hanging fruit, I mean just as recent as last month, you know, we...
looked at an asset that did not have a daily pricing model where we knew we could actually move the cap rate above, you know, over a six, you know, in the first nine months. Those are assets that we fear we feel bear, you know, go through the underwriting process.
and see if there's an opportunity to accelerate that. But we are trying to create long-term value for our shareholders here. And just in our observations when I talked about the transaction market because we do have that capacity and it appears that those deals over $100 million, several different
The herd is really thinned out both from, you know, buyers and lenders that, you know, it's an opportunity that we think we would like to capitalize on, but we have to find the right transaction that fits the box. And Steve, maybe you could talk about, you know, sources and…
Yeah, I'll talk about the balance sheet and kind of where we get sources from Mike. So as you mentioned, the first is our balance sheet. We're running below our target of leverage level. So we can, of course, draw on that $680 million dollar ability on our line. So we can certainly go there. You mentioned the equity markets. Obviously, the capital markets have been disrupted for a while.
having fun of us to be able to take, you know, be able to bring down the implied cap rate and be able to get, you know, equity to, you know, right now it doesn't pencil out, but maybe to, in the future, get something where it might pencil out. You mentioned Watergate, but we also have, you know, other assets, you know, in the D.C. area.
where maybe some of our multifamily assets are lower growth or maybe have a capex need that we could look to recycle out of.
And that could be a source of capital as well as we look to go into higher growth assets in the Sunbelt. You know, we've always said that we use the right capital for each opportunity, and that's not going to change going forward. As we find opportunities, you know, that Paul, you know, discussed, you know, we'll look to each of these sources and pick the one that makes sense.
Okay, thank you.
Thank you very much. We appear to have reached the end of our Q&A session. I'd now like to turn the floor back over to the management for any closing comments.
Thank you. Again, I would like to thank everyone for your time and interest today, and we look forward to speaking with many of you over the next several weeks.
Please enjoy the rest of your summer. Thank you.
Thank you very much. This does conclude today's call.