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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good afternoon. Thank you for attending. My name is Matt, and I will be your moderator for today's call. At this time, I would like to welcome everyone to the Air Communities Second Quarter 2022 Earnings Conference Call [Operator Instructions].
I would now like to pass the conference over to our host, Lisa Cohn, President and General Counsel of AIR Communities.
Thank you, Matt, and good day. My name is Lisa Cohn, and I am President and General Counsel of AIR Communities. During this conference call, the forward-looking statements we make are based on management's judgment, including projections related to 2022 expectations. These statements are subject to certain risks and uncertainties, a description of which can be found in our SEC filings. Actual results may differ materially from what may be discussed today. We will also discuss certain non-GAAP financial measures such as funds from operations. These are defined and are reconciled to the most comparable GAAP measures in the supplemental information that is part of the full earnings release published on AIR's Web site. Prepared remarks today come from Terry Considine, our CEO; Keith Kimmel, President of Property Operations; John McGrath, our Co-CIO and Chairman of our Investment Committee; and Paul Beldin, our Chief Financial Officer. Other members of management are also present, all of us will be available during the question-and-answer session, which will follow our prepared remarks.
We'll now turn the call to Terry Considine. Terry?
Thank you, Lisa, and thanks to all of you for your interest at AIR. In the past few months, AIR has largely completed its separation from the old Aimco 18 months ahead of schedule. At AIR’s IPO, 12% of AIR NAV was entangled with Aimco, now it is less than 30 basis points. The acceleration of the Aimco note and the cancellation of the Aimco master lease of four properties created noise in the quarter, making modeling more difficult, but they are important milestones in simplifying AIR'S business, which is growing steadily. AIR was designed to be the most efficient and effective way to invest in public ownership of multifamily real estate. With the separation from old Aimco now behind us, we can see more clearly what AIR will be. We can see the strength of the AIR operating platform, what Keith calls the AIR Edge. For example, challenged by inflation, peers increased second quarter operating expenses year-over-year by almost 5%. AIR costs were essentially flat. Our emphasis on customer selection and satisfaction results in stable communities with good neighbors and peer leading margins, coupled with low G&A, AIR enjoys the highest conversion of rent to free cash flow. Rent growth matters a lot. What matters more is how much of that revenue gets through to distribution to our investment for shareholders.
We can also now see the safety of the AIR business model. Thanks to Paul, AIR has low financial leverage with limited refunding and repricing risk. But the business model also has none of the supply chain risks and ongoing cash requirements of unfinished developments, and no need to replace the runoff of maturing loans, as is the case with lending programs. The safety of the AIR business and its laser focus on ownership of stabilized properties allows AIR to invest at a time when so many others are on the sidelines. The power of the AIR Edge makes the properties we buy worth more wins and because added to the AIR platform. Our paired trade discipline makes clear that acquisitions are accretive and leverage neutral. And after reinvestment of more than $1 billion, our excellent portfolio is now even better. Average monthly rents approached $2,600, [third] among the apartment REITs. But more important to shareholders, the properties purchased have expected returns 50% greater than the properties we sold to fund their purchase. And when considering investments, we regularly compare our proposed purchase to the buyback of AIR shares. And in the second quarter, we purchased about 3 million shares for $125 million.
Economists debate whether we're in a recession. When we look inside the business of AIR, we see no sign of recession, none, not now. But you and I both know that a recession will come someday and maybe soon. AIR customers have good incomes and high credit scores. Our buildings are in good repair. Our teams are well paid and stable. Our balance sheet is not exposed to higher interest rates or near term maturities, we have no buildings to finish, we have no lease-ups to complete. So, for us, a recession will be an opportunity to grow by accretive investment. The key always is people. You've heard from Lisa and you'll hear shortly from three others of our best. In the second quarter, Keith and his ops team delivered outstanding results. We're raising same store guidance based on expectations for this year. The momentum earning of leases made this year and lost to lease releases to be made next year, plus their remarkable ability to manage costs through productivity suggest that next year will also be a very good year. John will report on sources and accretive uses and the faster growth we see in our portfolio of properties newly added to the AIR platform. Paul will report on our balance sheet and why tax characteristics make the dividend on Aimco shares especially attractive to individuals, C corps, foreign investors and all who are interested to reduce income taxation.
Patti Shwayder has been called away by family duties of a happy nature, so Lisa will be her backup, ready to report on our recently published targets based on the UN sustainability goals and our commitment to measurement and public reporting of our ESG undertaking. Lisa may also express our gratification that AIR teammates high engagement exceeds the Kingsley Index, rising when others are falling, and perhaps one reason for another Kingsley report, this one that AIR’s ranked first among public apartment companies and second among all apartment companies for customer satisfaction. Finally, I thank my teammates for your help, hard work and friendship. And I thank my colleagues on the AIR Board, you're remarkable, engaged and committed to making AIR excel.
With that, I'd like to turn the call to Keith Kimmel to discuss our operating results. Keith?
Thanks, Terry. The second quarter was outstanding with over 80% of our leasing volume now complete for the year, I'd like to share a number of takeaways. First, rate performance is historically strong with leading indicators pointing towards elevated lease-to-lease performance in the second half of 2022 and into 2023. In the second quarter signed new lease rates were up 18.4%. Renewals were up 10.6%, leading to a blended average increase of 14.1%. In July, rates strengthened further with new leases up 20.4% and the blended average up 16%.
Looking forward, our loss to lease remains above 10% and indicates transacted rates will remain strong for the balance of 2022 and into next year. Second, demand is robust and occupancy is tracking on plan. Average daily occupancy in the second quarter was 96.8%, up 160 basis points from last year. By design, we saw sequential declines in average daily occupancy associated with higher move-out volumes during the summer leasing season, a trend which peaked in July and will reverse in August. Our forward indicators of occupancy signal an acceleration as we move out of peak just like we saw in 2021. Third, AIR is the most efficient multifamily operator. Our approach starts first with resident selection and world class customer service, which led to a record low trailing 12 month turnover of 38.4%. It is amplified by our decade plus of exceptional expense discipline and productivity gains. In the second quarter, expenses were up 10 basis points year-over-year with controllable expenses up 2.7% due to timing of increased maintenance of communities, offset by lower taxes and insurance.
I have three thoughts on expenses as we navigate inflation. We focus first on avoidance of cost, using process design, investment or technology to remove the cost altogether. We next work to increase productivity by hiring the most talented team possible and creating jobs in which they can maximize their skills through the elimination of administrative work, red tape and repetitive tasks. Last and most importantly, we do the right thing, solving not to managing expenses, but maximizing long term margin growth. We recently invested in additional compensation for our team members to recognize their importance to our success. All that said, for the full year, controllable expenses will be on plan, roughly flat to last year. Our efficiencies are realized in net operating margin, which for the second quarter was 73.6%, up 310 basis points from one year ago. Fourth, the AIR Edge, when applied to newly acquired communities, is a tremendous engine for growth. Our five 2021 acquisitions are expected to have revenue growth 600 basis points above our stabilized portfolio in the fourth quarter, the first time period we have a year-over-year comparison. The AIR Edge transforms the entire operation, strengthening the customer relationship, sharpening the team's approach, implementing our technology platform for efficiency and improving the physical community.
As a result, we see improved resident satisfaction and increased value for both current and future residents. This leads directly to pricing power, with weighted average lease to lease increases up 26% in the second quarter that further increased to 28% in July. Our 2022 acquisitions, Coconut Point in Estero, Florida, Watermark in Miami, Willer Towers in Chevy Chase, Maryland and now, the district at Flagler and Fort Lauderdale are off and running with the implementation of the AIR Edge well underway. And finally, the business activity happening today is not only securing a blockbuster 2022 but earning into strong performance in 2023. Eventually, the tailwinds that AIR and the industry are experiencing will subside. With the signals we see indicate that time has not yet come. My thanks to all the AIR team members, your dedication to serving our residents and your drive to continuously improve our business have made this quarter a great success.
With that, I'll now turn the call over to John McGrath, the Chairman of our Investment Committee. John?
Thank you, Keith. Since the separation with Aimco, the AIR portfolio has been materially enhanced in terms of quality, risk and capital allocation. Our portfolio strategy is focused on profitable growth and reducing both systemic and idiosyncratic risk. Our transactions have supported this strategy. Over the past 18 months, we completed $3.1 billion of transactions, $1.7 billion of equity sources, $1.4 billion of which was used to acquire nine properties located in South Florida and Washington, D.C. And we currently have another $500 million of sources and $200 million of uses under contract. Our sales supported the deleveraging efforts, which Karl reported on in the past, improved the quality of the portfolio as measured by criteria such as rents, age and physical condition and reduced concentration risk and regulatory exposure. Through acquisitions, we invested in high quality properties, which will benefit from the AIR Edge, and we reallocated capital to some markets that exhibit high growth due to durable demand factors and constraints on competitive supply.
These acquisitions are expected to be highly accretive with IRR spreads 350 basis points or more over our cost of capital. While we measure by IRR, we test by reality, take the class of 2021 acquisitions, for example. We purchased the properties last year at NOI cap rates in the mid-3s and we now expect yields to be in the 5s later this year. In effect, our portfolio is bifurcated into a fast growing same store portfolio and an even higher growth AIR Edge portfolio. Today, the AIR Edge represents about 11% of the portfolio. Over time, we expect the allocation to increase to approximately 30%, provided we can find opportunities which produce an attractive spread over our cost of capital and are within leverage policy. This shift in mix will yield higher quality earnings, will help insulate us from macroeconomic pressures and will enable greater output generation.
Before reporting on our second quarter transactions activity, allow me to offer a few thoughts. Macroeconomic factors are top of mind. Recession and inflation fears and interest rate volatility have sidelined many buyers. Having lived through the recession of 2001, 2008, '09 and 2020, AIR's seasoned investment professionals have the real world experience to navigate choppy waters, which may lie ahead. Despite market uncertainty, we see the opportunity to make profitable trades, and we remain focused on the continued systematic enhancement of our portfolio through disciplined accretive growth funded by paired trades. Paired trades allow us to be relatively agnostic to changing market conditions by locking in our cost of equity capital. As market conditions fluctuate, we adjust our target return thresholds accordingly. Simply put, AIR is in the spread business.
It is important to note that we are firmly committed to disciplined capital allocation, and we have no fixed goal for further acquisitions. While we do expect future transactions to be highly accretive, we will only transact when we can earn an attractive spread over our cost of capital, be within our leverage policies and are able to deploy the AIR Edge. Now for our recent transactions activity. During the quarter, we raised equity capital through a sale of fortuitous timing and pricing of four of our lower ranked properties located in California and Virginia for approximately $203 million. On top of these sales, we have another $500 million under contract with nonrefundable deposits.
Turning to external growth. We invested $467 million to acquire three properties located in the Washington, D.C. metro area and in South Florida. And as previously announced, we entered into an agreement with Aimco for the cancellation of its master lease of four properties for $200 million. Additionally, earlier this week, we acquired one property located in South Florida for $173 million. In accordance with our investment policies, these acquisitions are expected to earn IRR spreads of at least 200 basis points over our cost of capital, are leverage neutral and will be enhanced through the AIR Edge.
With that, I'll turn the call over to Paul Beldin, our Chief Financial Officer. Paul?
Thank you, John. Today, I will discuss our strong and flexible balance sheet, second quarter results, our expectations for the balance of the year and conclude with a brief comment on our dividend. We made significant improvements to the balance sheet during the quarter, the details of which can be found in our earnings release. I'd like to focus my remarks on three key points. First, our deleveraging effort is complete. While we target a leverage-to-EBITDA ratio of 5.5:1, we expect that the actual ratio will vary from quarter-to-quarter based on the timing of transactions.
As part of our paired trade discipline, we seek to keep our sources and uses in balance, rarely does the timing of the transactions align such that our sources and uses are in perfect balance at quarter end. For example, today, we are slightly out of balance due to the $125 million of second quarter share repurchases and the July acquisition of the district at Flagler. This imbalance will increase when we close on our agreement to cancel the four Aimco leases. We expect that the imbalance will be completely eliminated before year end by the closing of the $550 million sale of properties, $500 million of which are under contract today. As such, our expectation of year-end leverage to EBITDA at 5.5:1 is unchanged. Second, our balance sheet is insulated from interest rate volatility and any potential economic slowdown. 98% of our leverage is fixed, with rates and maturities fixed for about the next seven years. In fact, only $205 million or about 7% of our leverage is subject to repricing in the next 30 months. Third, we have abundant liquidity with $840 million available on our revolving credit facility, $84 million of cash and properties unencumbered by debt with an estimated value of almost $8 billion.
Now turning to second quarter results and our expectations for the balance of 2022. Second quarter FFO was $0.66 per share, $0.01 above the midpoint of guidance, pro forma the timing of the Aimco note repayment. We anticipated that the Aimco note will be fully repaid in the second quarter. Instead, approximately 30% of the payment was deferred into July, the effect was to shift $0.03 of the prepayment penalty from June to July. The aggregate prepayment penalty was approximately $0.035 below our expectations, a result of short term treasuries increasing significantly more than forecast. This was offset in our second quarter results by the sale of a small residual cost basis investment in Aimco entity holding the note payable to AIR. With the payment of the Aimco note, it was no longer necessary for AIR to maintain this ownership position.
Looking forward, we are narrowing our expectations for our full year FFO to be between $2.38 and $2.44 per share, maintaining the $2.41 midpoint. Primarily, our expectations for run rate FFO, which is pro forma FFO, excluding the earnings effect of the Aimco note and the gain on sale of the cost basis investment, is also unchanged at $2.19. Relative to one quarter ago, we now expect $0.03 of incremental FFO from stronger NOI growth in our same-store and acquisition portfolios, offset by $0.02 of lower contribution from the cancellation of the four Aimco leases and $0.01 of other items. As Terry commented in his remarks, first 18 months of AIR's existence has been a period of transition during which the vision and promise of the AIR business model was implemented. With deleveraging complete and entanglements between AIR and Aimco greatly reduced, simplicity of the AIR business model is clear. Best-in-class property operations, delivering strong operating results from our same-store portfolio and even faster growth from our acquisitions as they benefit from being added to the AIR operating platform and low G&A results in predictable, high quality income and faster earnings growth.
Lastly, the AIR Board of Directors declared a quarterly cash dividend of $0.45 per share. We believe the tax characteristics of our dividend makes our stock, compared to our peers, more attractive to taxable investors, such as foreign investors, taxable individuals and corporations. For example, in 2021, two thirds of AIR's dividend was a tax-free return of capital, while the remaining one third was taxable at capital gain rates. In the same year, approximately 60% of peer dividends were taxed at ordinary income rates with the remaining 40% taxed to capital gains. With that, we will now open the call for questions. Please limit your questions to two per time in the queue. Matt, I'll turn it over to you for the first question.
[Operator Instructions] The first question is from the line of Nicholas Joseph with Citi.
It's Michael Bilerman here with Nick. If you step back, obviously, you've articulated a lot of the go forward positives for the AIR company as well as portfolio, your stock is at the lowest multiple on [23] the FFO or FFO any, which way you measure it. Where do you think the company should trade relative to peers? Do you think there are any impediments left to achieving that and if it doesn't close, what do you and the Board plan to do about it?
I think that I'm not going to compete with you in giving advice to people about which stocks to buy. But what I would say is that what we have set out to do and I think have accomplished is a business model which deserves a very favorable risk premium, a very low risk because we don't have the travails of development today. We don't have lease-ups and supply chain issues and so forth. We don't have the issues implicit in a loan business where you have a runoff. We have a business of owning stabilized properties and operating them better. And the key to that is revenue and expense. And if you look at the last many years, Keith and his team have excelled at doing just that. So that's what we're going to try to focus on. And I think that what we'll see is above average growth and I think that the market will reward it.
But I guess if you stand back, you talked all about the things that you've been able to accomplish recently. To be fair, Terry, a number of these shouldn't have been an issue for when AIR was created. And I was surprised that you mentioned that this was an IPO because this was a spin. It did not have a shareholder vote, even though shareholders wanted to have their input. And so a lot of what you call entanglements, the loans, the fact that you were too highly leveraged coming out of the box, the fact that you didn't have an ATM and had to go issue direct equity at a big discount, and while the balance sheet sits today, let's not forget, it wasn't and that was a risk that the company took. And so I'm not undermining it's now we have to go forward, which is effectively my question, right? We sit here today, you've now done all these things and you've cleaned it up. I need a little bit more from you in terms of the stocks at a big discount, reflective of the fact that you purchased stock in the quarter at 43, good execution. Balance sheet fixed. You talked about the AIR Edge and the operating platforms and everything that Keith is doing. So it doesn't appear to be that there's any impediments left. And so I guess, how do you sort of see value of the company? You had, historically, we've known each other decades. You used to put out NAV. You have a very good sense of value. You compare yourself to peers and everything else in that presentation. So can you give a little bit more detail about how you sort of see value? And if the stock doesn't achieve that, what are you going to do about it?
Michael, I thank you for your prepared remarks. And what I would say is that you're entitled to your opinion, but the market has answered the question. If you look at -- whether the spin was a good idea or not. If you look at the TSRs for the seven large apartment REITs, the two Sunbelt REITs have done the best, but the AIR AID combo has outperformed handsomely the remainder. So thanks very much and please call another time if you want to continue.
The next question is from the line of Rich Anderson with SMBC.
So Keith, to your question -- or your comment about earning probably predictable, can you give or triangulate what you're seeing in numbers, and what assumptions might be in that in terms of where you think rents sort of peak out this year if they haven't already and sort of hazard an estimation about what we're -- what we have in front of us as a starting point for 2023?
Rich, thanks for the question. What I'd say about sort of where we are at in the season is that July has come in with new lease pricing that hit the high watermark for the year at better than 20%. What we see as we look forward between now and the balance of the year is some number that is similar to that or maybe in the high teens. So we think that we continue to maintain strong pricing as we go -- work our way through the balance of the year. What ultimately that will translate into is something that we'll be an earn-in and call it, the mid to high 4s when we get to 2023. And then I would couple that with what we believe to be a loss to lease of about 10% in January. So it gives you a couple of data points to know that we think that we're going to have a strong 2023, and we have more strength as we finish up the balance of this year.
So you started mid-4s and then you have this loss to lease, which could go up or down depending on the market, but the starting point’s 4 with some upside essentially is what you're saying.
I think that's a good way to think about it, Rich.
Second question is, you talk a lot about AIR Edge, and I appreciate the the terminology and all that. But I think all of your peers have their own version of AIR Edge, and that's what makes you kind of separate from the pack. So -- relative to the private market of ownership of multifamily. So with that in mind, now that you've cleared a lot of the entanglements, why would, A, AIR grow more than your peers assuming you all kind of operate at a similar level of sophistication? What's the bull case for outperformance keeping in mind that you have some tough competitors in the public world?
Rich, we have very tough competitors, and they'll get better, and we will, too. What we have today is really two important advantages. With the highest margins, we retain more money out of every bit of increasing rent. And so it's one thing to say rents up 10%, but the question is how much of that gets to NOI? The second thing, with an advantage also in G&A, more of that gets through to where it can be either distributed to or invested for the benefit of shareholders.
The next question is from the line of [Barry Liu] with Mizuho.
I'm on the line for Haendel St. Juste. I was wondering if you could talk through the expense. Impressively, your expenses stayed flat year-over-year and you decreased your guidance. So I was hoping you could break out the lines, particularly for repair and maintenance and how we should think about property taxes for the back half this year going to go forward?
Barry, this is Paul Beldin. It's so nice to meet you, and thank you for filling in for Haendel, but we miss him. So please wish Haendel well. In response to our expense expectations we did -- for our expense expectations, we did both narrow our range for expected growth and reduced the total growth at the midpoint by 25 basis points. And that is a function of continued excellent work from Keith and his team on managing controllable operating expenses. And I'll let Keith kind of fill in some of the details there. But also, it reflects the fact that we're now halfway through the year and we have greater visibility into the items that are outside of that bucket, most notably real estate tax expenses where we've had a good year-to-date where we're actually negative 2% on a year-to-date basis. And we expect that for the full year, real estate tax growth will be quite moderate, maybe in the 1% to 2% range.
Barry, just some color around it is that really where we focus is the avoidance of cost through greater retention. And that comes from the customer selection process on the front end and then having exceptional team members who are highly effective and highly efficient who provide exceptional customer service. When we match those things with the business needs and our highly qualified team, we get this high-tech, high-touch combination. And so through that we get, as you point out, lower repairs and maintenance costs. We also find our way to have lower marketing costs and seasonal staffing opportunities that we take advantage of. So those are some of the inputs.
And so actually, on turnover. So I noticed some really low turnover numbers as well. Some of your peers are trying to churn turn over to push rents higher and taking a couple of points of occupancy hit on that. Is that kind of a strategy you're thinking about or not as much?
Barry, we don't think about it as individual single inputs. We think about it as total contribution. So it's the combination of, one, having low turnover, but having high rents on both new and renewal rates and ultimately, avoidance of cost to find its way all the way down to margin and the cash that comes through. So we don't just focus on a single data point but we really look for the total optimization of return.
The next question is from the line of Chandni Luthra with Goldman Sachs.
You guys talked about these paired trades that you've been doing. Any sense of what's going on in the transaction market, how much have values come down? And has anything changed in that spread that should typically maintain, if you could give any color around that would be great?
I'll first start by saying when we think about cap rates, first, comparing them to an imprecise science. But with that said, we've seen the cap rates across the board have expanded about zero to 25 basis points on core assets and about 25 to 50 basis points on noncore assets. Valuations, we're seeing about 5% to 7% down. However, I should note that demand does remain strong and the prices continue to hold for our best -- our best assets in the best locations. As far as the bid-ask spread, what I'd say on that is, if I use, for an example, the [dispositions] we have in the market, including the $500 million we have under contract today, we're not seeing a big bid-ask spread. What we're seeing really that the spreads have tightened compared to maybe where they were a few months ago. And we're only seeing on our own deal, a small spread of maybe a couple of percent.
And if I could please get a quick follow-up on bad debt. What are your expectations for the back half of this year?
So for bad debt, as we've looked out to the balance of the year, and there's been a lot of discussion of this in other calls, is around what can you expect around government systems payments, particularly for our portfolio in the state of California? And so as we look at our second quarter bad debt, our bad debt expense, on a net basis, was about 20 basis points of revenue, which is in line with our typical long term results. But important to note within that is the benefit of having about $3 million of government assistance payments. So if you look at bad debt as we do before those payments, that was about 1.9% of revenues. And as we are projecting to the balance of the year, we're not assuming that our bad debt experience is going to get any better in order to make our guidance. We hope that it will improve. We're working hard with local jurisdictions to accelerate the eviction process. But we don't necessarily anticipate within our guided numbers to do much better than what we saw on a gross basis in the second quarter.
There are currently no further questions registered [Operator Instructions].
Well, thank you all on the call. Thank you, Matt, for managing this call. If you have questions, please call Paul or Matt O'Grady or me, Terry Considine. And enjoy the summer. Be well.
That concludes the AIR Communities Second Quarter 2022 Earnings Conference Call. Thank you for your participation. You may now disconnect your lines.