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Good day, ladies and gentlemen, and welcome to the Q2 2018 Independence Realty Trust Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference call is being recorded.
I would now like to introduce your host for today’s conference, IRT’s Investor Relations Representative, Lauren Tarola. Ms. Tarola, you may begin.
Thank you. Good morning, everyone. Thank you for joining us to review Independence Realty Trust’s second quarter 2018 financial results. On the call with me today are Scott Schaeffer, our CEO; Jim Sebra, our Chief Financial Officer; and Farrell Ender, President of IRT. Today’s call is being webcast on our website at www.irtliving.com. There will be a replay of the call available via webcast on our Investor Relations website and telephonically beginning at approximately 12:00 pm Eastern today.
Before I turn the call over to Scott, I would like to remind everyone that there maybe forward-looking statements made in this call. These forward-looking statements reflect IRT’s current views with respect to future events and financial performance. Actual results could differ substantially and materially from what IRT has projected. Such statements are made in good faith pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Please refer to IRT’s press release, supplemental information and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations.
Participants may discuss non-GAAP financial measures during this call. A copy of IRT’s press release and supplemental information containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to IRT’s most recent current report on the Form 8-K available at IRT’s website under Investor Relations. IRT’s other SEC filings are also available through this link. IRT does not undertake to update forward-looking statements in this call or with respect to matters described herein, except as maybe required by law.
With that, it is my pleasure to turn the call over to Scott Schaeffer.
Thank you, Lauren, and thank you all for joining us this morning. The second quarter delivered positive results that were in line with our expectations and confirmed our confidence and excitement about our ability to generate outsized returns from our value-add program.
Starting with a high level overview of our financial performance and operating results. IRT reported core FFO per share of $0.19, in line with the second quarter of 2017, and adjusted EBITDA of $24 million, up 21% year-over-year.
Same-store NOI for the quarter, which increased 1.7% year-over-year, reflects a temporary disruption in occupancy in the four same-store communities undergoing larger scale value-add renovations. Excluding these four value-add communities, same-store NOI growth was 2.3% for the second quarter. By year-end there will be a total of seven same-store communities undergoing value-add renovations representing half of all of the communities earmarked for phase 1 and phase 2 of these value-add programs.
The additional three same-store communities will begin renovations in the third quarter. Phase 1, which spans five properties and 1566 units, is fully underway and will be completed early next year. While this process has a temporary impact on occupancy we expect to see occupancy rebound and rents increase meaningfully as completed units are leased. Phase 1 is just the beginning. We believe there is a tremendous opportunity to take a long-term view on our value-add strategy, one that will increase rental rates, reduce operating costs and ultimately generate strong returns on investment, which will increase value for our shareholders.
We recently began construction on phase 2 of the program, which consists of nine communities with 2752 units. Renovated units across both of these phases are currently being leased faster than they are being completed. As of today we have a backlog of approximately 100 pre-leased units. In total, our renovated units are generating average rent premiums of $186 per month, which translates into a 21% return on investment. All in, over the next year and a half phase 1 and phase 2 value-add projects are expected to generate approximately $8 million to $9 million of incremental annual NOI, which we believe represents over $1 of net asset value accretion.
We believe the portfolio contains additional value-add opportunities in future years, which will unlock more NOI growth and ultimately more NAV accretion. When coupled with organic rent growth, these value-add initiatives are expected to drive increased cash flow that will strengthen our dividend pay-out ratio and enable us to achieve our leverage target.
Our core investment strategy has been and will continue to be owning the right assets in the best non-gateway markets. As discussed on previous calls we have now finalized the capital recycling plan and have commenced the sales process on five communities. These dispositions will allow us to accelerate our efforts to exit markets that are not core to our portfolio and recycle the proceeds into expanding IRT’s portfolio across key scalable markets.
Now I'll turn the call over to Farrell for an in-depth discussion of our markets, the capital recycling initiative, and then to Jim to review the financial results. Farrell?
Thanks, Scott. In the second quarter, we continued to grow our value-add initiative, while driving organic NOI growth in communities not in our redevelopment pipeline. We saw sustained outperformance across several of our core markets this quarter, including Atlanta, Dallas and Orlando. These markets saw 4.6%, 5.8% and 4% revenue growth respectively from our same-store communities.
Atlanta continues to be an attractive market, where we are benefiting from consistent outsized job and population growth. In Dallas, we are benefiting from continued housing demand, specifically a surge in commercial construction and a thriving job market are leading to strengthening multi-family fundamentals, most notably rent growth.
Lastly, our community in Orlando, Millenia, provided strong rent growth and consistent high occupancy for the past several quarters, even as the sub-market has experienced new supply.
The community will be tested later this year as a new multifamily development will be delivered adjacent to our property in the fourth quarter. We will monitor the situation closely and anticipate some impact caused by the lease-up, which we have factored into our forecast. We also saw consistent and strong performance in two of four Midwest markets. Columbus and Indianapolis had year-over-year same-store revenue growth of 3.2% and 3.6% respectively. These are two markets that we have targeted for growth and have expanded our exposure.
Over the last year we have purchased 1075 units across four communities in Columbus and increased our exposure to 7.7% or our total portfolio NOI. In Indianapolis, we acquired two communities totaling 488 units bringing our total exposure in this market to 5.6%. The sustained outperformance we have seen in these markets is further proof that our strategy of owning and operating in non-gateway markets is yielding desired results.
We see opportunity to grow scale in our core markets and plan to capitalize on this through our capital recycling initiative that I will expand more on in a moment. We experienced a softer quarter in communities like Charlotte and Louisville for different reasons. Same-store revenue declined in these markets by 2.8% and 2.4% respectively. The South Boulevard sub-market where our community is located in Charlotte has and will continue to see new construction due to its desirable location and proximity to the light rail line, which provides access to uptown Charlotte in 10 minutes.
While we continue to see some near-term softness we believe that once supply abates, over the long-term this location will provide substantially higher returns as compared to the overall Charlotte market. The performance of our Louisville communities is primarily attributed to disruption from our value-add initiatives. We are confident that as these properties continue through our value-add program and stabilize we will be able to deliver rent growth that originally attracted us to this market, which continues to experience favorable job growth trends.
While some of our markets like Louisville experienced a near term impact from the value-add initiative, we believe the table has been set for long-term growth through these projects. We are encouraged by the demand of our renovated units as evidenced by our availability to pre-lease units prior to the renovations being completed. We believe this reinforces the locations we have chosen and the product we are updating.
The opportunity these products have exposed are tremendous. Our thesis that the short-term pain will yield long-term growth is validated by these returns. We have the right personnel and in-house expertise in place to capitalize on current and future projects. In our first 500 units leased we have driven rents by 21%.
Turning to our capital recycling initiative. Our team has identified five communities in markets where we no longer see growth opportunities in the long-term in order to gain scale in markets where we see more favorable long-term fundamentals. We are expecting the value of these five assets to be between $170 million and $190 million with a blended economic [capital] of 5.6% at the midpoint, which we detailed in our press release and supplement.
As we sell these assets we will have the opportunity to recycle into markets that demonstrate healthy fundamentals and where we had or can achieve scale. Additionally, based on the infrastructure we have built we will look to honor the acquisition opportunities with assets where we believe there is a value-add component and can replicate the redevelopment playbook that we are currently executing across the portfolio. To this end, we have shown our ability to identify communities with upside.
We have demonstrated this in a nine-property portfolio acquisition that we finalized in the first quarter. In this portfolio total revenue increased 6.8% as compared to Q2 of 2017 with effective rent growth of 4.5%. Expenses were reduced by 3.8% generating significant NOI growth of 18.9%. As part of the capital recycling, we are targeting markets in which we see favorable trends, including but not limited to Atlanta, Orlando, Tampa and the Carolinas.
These are markets with growing populations and thriving job markets. We plan to identify communities that align with our investment strategy, fuel growth through near-term operational initiatives and drive outsized returns through medium term redevelopment projects. As a part of this capital recycling initiative, we acquired two communities subsequent to quarter end; a 348 unit community in Tampa, and a 232 unit community in Columbus. These are two markets that demonstrate the fundamentals that are core to our investment thesis and where we are expanding our economies of scale. We have updated you in the past on the strength of Columbus, and this property is set to benefit from that same proximity to areas where job growth has thrived.
Turning to Tampa, this acquisition marks our second community in the market which is on track to add 65,000 jobs between the winter of 2017 and the end of 2018. The market benefits from a low cost of living, ideal climate, a thriving job market with companies like Citi and Publix investing in a major presence in the greater metro area.
Before I hand the call over to Jim, a quick update on leasing rates in Q2 and what we are seeing so far in Q3 for our 37 same-store properties. For Q2, new leases grew at a rate of 1.6% and renewals grew at 3.6% combining to a growth of 2.7% over the expiring leases. For Q3, it is early but we are seeing new lease rates growing by 6%, renewals growing by 5.3% combining to a growth of 5.6% over the expiring leases.
With that, I’ll now turn the call over to Jim for an update on the financials.
Thanks, Farrell. For the second quarter of 2018, net income available to common shareholders was $3.5 million, down from $18.7 million in the second quarter of 2017, a quarter in which we experienced $16.1 million in capital gains.
Year-over-year core FFO grew from $13.4 million to $16.4 million for the quarter ended June 30, an increase of 22%. Core FFO per share was $0.19, consistent with the second quarter of 2017.
Adjusted EBITDA for the quarter increased to $23.7 million, representing a 22% increase year-over-year. This bottom-line performance further demonstrates how 2017’s portfolio transformation efforts have been borne out in 2018.
For Q2 2018, we reported same store NOI growth of 1.7% and revenue growth of 1.8%, with property level expenses increasing 1.9%. On a year-to-date basis, we have seen same-store NOI growth of 2.3% and revenue growth of 2.1% with property level expenses increasing 1.9%. Please note the start of the capital recycling initiative and listing five assets as held for sale changes the composition of our historical same-store portfolio – property – same-store property portfolio. Now our same-store portfolio includes 37 properties aggregating 10,329 units.
In light of our value-add initiative and our continued effort to increase transparency we have added more disclosure to our quarterly materials, including details on each value-add project as well as same-store performance with and without communities actively undergoing value-add projects. We have also introduced a separate presentation on our investor website to update you on the state of the overall value-add initiative and provide a snapshot on how these projects are coming along.
Looking at our same-store results, when we exclude the four communities that had active value-add projects during the first half of 2018 NOI growth would be 2.3%. While there is a short-term impact from value-add on our portfolio performance we are confident that these projects are maximizing the value of our communities, while significantly upgrading our portfolio.
On a year-over-year comparison, our results lack the benefit of the mild winter that build momentum in driving rents and leasing in early 2017. I want to reiterate Scott and Farrell’s point that the table is set for sustainable long-term growth, some of which you will be begin to see later this year.
Turning to our balance sheet. We finished Q2 with 56 properties and total gross assets of approximately $1.7 billion. As of quarter end, our total debt to total gross assets remain constant at 53.4%.
From a net debt to adjusted EBITDA standpoint, our pro forma leverage remained 9.4 times after adjusting for the start of value-add projects. At the end of the second quarter, our debt was approximately 95% fixed rate with no significant debt maturing until 2021.
As of June 30, our unencumbered assets represented 40.6% of our portfolio while as a percentage of our total NOI unencumbered assets represents 40.4% of our portfolio. This represents a sequential 30 basis points and 120 basis points of increase respectively, which aligns with our goal of increasing our unencumbered assets over time.
As Scott and Farrell have discussed, we have announced the details of our capital recycling initiative. We have identified five assets, which we have started the sales process with a total range of value between $170 million and $190 million. At the midpoint, we will generate proceeds from the sales aggregating approximately $78 million after repaying property level mortgages and closing costs, and we expect gains on these sales of approximately $34 million again at the midpoint.
We will use those proceeds along with proceeds from our line of credit to acquire additional properties aggregating in value between $160 million and $180 million. We disclosed in our supplement that in July we acquired two properties as part of this capital recycling program aggregating $64 million. We will be opportunistic and may acquire additional properties in advance of completing the five property sales. This may increase leverage temporarily until the capital recycling process is complete.
Lastly, we are reiterating our guidance targets for 2018. We have included more detail in our earnings release this quarter to show our roadmap to achieve these targets. We are extremely excited as we look to the future. Our value-add initiatives are giving us a roadmap to increase NOI and ultimately enhance the quality and value of the portfolio. These projects remain on schedule to deliver the $8 million to $9 million of incremental annual NOI and a 20% return on investment.
For Q3 we are guiding same-store NOI growth to be between 1.5% and 2%. We are guiding Q4 to be between 5.5% and 6.5%, and we are reiterating our same-store NOI growth for fiscal year 2018 of 3% to 4%. I look forward to updating you on our progress as part of our third quarter earnings call.
With that, I'll turn the call back to Scott. Scott?
Thank you, Jim. we are excited as we look towards the second half of 2018 with multiple growth levers in place, not only are we on track to achieve full year same-store NOI guidance but we are well positioned to succeed in playing the long game and honor the tremendous value that we believe exists in our current portfolio.
David at this time, I’d like to open up the call to questions.
[Operator Instructions] Our first question comes from Drew Babin with Baird. Your line is now open.
Hi, good morning.
Hi Drew.
I was hoping first off, you could clarify what the first year and stabilized cap rate expectations are on the Tampa and Columbus acquisitions?
Sure. This is Farrell. On a blended basis, the year one is a 5.5 cap and the stabilized is a 6.25 cap.
Okay. And then to clarify the 5.6 economic cap rate you mentioned in the prepared remarks that is the midpoint of the dispositions potentially?
Correct. And we are trying to accomplish what we did in the prior recycling with moving out of the class Cs into better quality class Bs at similar cap rates.
Okay, thanks for that and then one more question on the guidance range for the full year, taking the first half same-store NOI growth and kind of blending what you get for the third and fourth quarters, it looks like you get NOI growth maybe at the lower end of the 3 to 4 range. I was just curious whether there was anything changing in the same-store pool assets held for sale, anything like that that I might be missing in that math?
No, you are not - there is no additional kind of expectations or changes in the same-store pool. I think, you know, depending on what assumptions you make or some of the value-add assets you begin to migrate further north in that range.
Okay. So, would it be the seasonality of a very strong 4Q that kind of pulls up that overall number for the year just because I'm taking the midpoints in the 3Q and 4Q you provided just doing kind of a straight average across the year does that miss something in terms of the math?
You are exactly right. It's the expectation for the stronger kind of fourth quarter pulling that average up.
Okay. Thank you. That's all from me.
Thanks Drew.
Thank you and our next question comes from Austin Wurschmidt with KeyBanc Capital Markets. Your line is now open.
Yes. Thanks guys. Good morning. Just as far as the transaction market and the thought or the fact that you're pursuing some of these value-add initiatives on the acquisition side an area where there's been a lot of strong demand and you've even talked about cap rates compressing. So I was wondering if you could just speak to the pipeline of opportunities you have the day and should we expect a similar type going in cap rate on these deals as the acquisitions you made this quarter?
Yes. So it's Farrell, Austin. We've talked about you know being a pretty competitive landscape. We're leveraging both our reputation and our relationships to source these transactions and you can expect your caps to be similar on what we're going to use the proceeds of the capital recycling of what we've shown in these past two transactions.
And then can you just clarify in terms of the timing around the stabilization of how long you think it'll take you to get from the five and a half to six in a quarter?
Yes. So we're going to – it's going to take one and a half years to get in there, get it on a platform and perform some of the light value add we anticipate doing.
Okay. So that includes the value add up side I guess was kind of what I was curious.
Yes and just to clarify so the property in Tampa is one that we went in specifically underwriting for value add. The property in Columbus we feel that we're just – we did not under write any value add. It's just a solid 2001 Class B property that will get it onto our platform and then evaluate in the future.
I appreciate the detail there Farrell and then as far as expenses I mean Drew touched a little bit on the revenue side maybe tracking towards the lower end depending on what you assume from a value add ramp but can you speak to expenses I mean it seems like you're tracking a little bit ahead there? Is there anything in the back half of the year that you expect to increase to get you towards the midpoint or you still maybe comfortable with that also coming in at the lower end of the range?
Yes, I mean. This is a good question Austin. Thank you. We're expecting obviously and still thinking that there's going to be some real estate tax kind of increase in the back half of the year that will drive that kind of expense growth a little bit more to the midpoint but certainly if that turns into be a little better we'll be at the low end of that range.
All right. Thanks for taking the questions guys.
Thank you.
Thank you. Our next question comes from John Massocca with Ladenburg Thalmann. Your line is now open.
Good morning.
Good morning John.
So I'm just curious what do you think 2Q ‘18 seems to on high-growth would have been if you guys included the properties held for sale?
Sure it would have been for the three months ended it would have been 0.7% and 1.4% for the first six months.
Okay. It may be that somewhat weaker performance sign that they've kind of maxed out their value and why you're looking to just sell those properties beyond also maybe kind of concentrating yourself geographically a little bit?
Yes. I mean it's what we described where we've looked at the fundamentals of those markets and see the first half by the property's performance there, one of the deciding factors and also as we look to grow scale and market that you have better long-term fundamentals is definitely a big decision factor.
Okay. And then what kind of NOI growth you are expecting from your phase 1 rehabs in 4Q 18 just kind of generally speaking and at that point in time would you think that the phase 2 rehabs are going to be kind of a positive or a drag on NOI growth?
So obviously to answer the first part we're expecting the 4Q value add for the phase 1 to be in that 14% to 15% range of NOI growth, Q4 over Q4. In terms of the phase 2 we are certainly expecting a slight drag on it but not that significant that would severely distort that range.
Okay, that makes sense. And then what was the impact to guidance from timing around the capital recycling program both kind of potentially the drag from I think the midpoint of your guidance as you're acquiring less than you're selling but also maybe the positive impact from closing the acquisitions before the sales?
Yes, I mean there's really hasn't been – there's really not expect to be a huge effect on this of the full year guidance in terms of per share or even the NOI range of 3% to 4%.
And that includes potential accretion from – you're not really including a potential accretion from capital recycle?
That's exactly right. We're not assuming there's going to be a tremendous accretion there by closing stuff ahead of selling.
That's it for me. Thank you guys very much.
Thank you. [Operator Instructions] Our next question comes from Craig Kucera with B. Riley FBR. Your line is now open.
Hey good morning guys. I want to talk about what the impact is of generating scale in Columbus or Tampa? What does that mean economically from the perspective of a margin standpoint and what kind of critical mass you need to get there concentration like four or five assets like you have in Louisville or Oklahoma City gets you there?
Yes. I mean we generally like to see at least three in the market Craig and then move up from there like you mentioned having four, or five, six we are now seven in Columbus. It helps on payroll. It helps on accreting leverage with local vendors. It helps in a variety of different factors. We will get you -- I can get you numbers for each market to give you a little bit more detail on what we think the savings are but it's significant which is why we're focused on exiting the markets that we don't see longer-term growth and looking to grow in markets like Tampa, Atlanta, Orlando where we think the long term prospects are much better.
And it seems like what you're talking about is somewhat exiting smaller markets and going into some of these larger markets. Is that sort of the direction of the company in general or is that just sort of a near-term we're deciding to sell these assets and rotate into these other markets.
I mean it's one factor but it really goes back to understanding the underlying fundamentals of each market and the job and population growth which drive occupancy and therefore rent growth. I mean one market we didn't mention was Huntsville which is our best-performing market of this quarter is just such a small piece of our NOI but there's – it's a smaller market which many people don't follow and we're only there because of the Trade Street acquisition but there's significant job growth and significant high-paying job growth and very little supply. So that may be a market that smaller we would have exited now that we're seeing significantly positive fundamentals it may be one that we choose to expand into and it's very easily covered from the Atlanta region.
Okay. One more for me. Just wanted to circle back to the new acquisitions getting from the kind of year one to stabilize. Did you say that there is an implied value add program there and kind of if so what is expected CapEx there?
You see the Tampa project is one that we purchased knowing we're going to implement a value add. The costs are $4.4 million to do unit interiors roughly 10,000 unit to get $250 rent increases. The property in Columbus is one that we purchased from a previous relationship with a seller that we knew and we're just going to put that on the portfolio and get it onto our systems and run as normal and there's no value add in that property.
Okay. Thanks guys.
And this does conclude today's Q&A session. I would now like to turn the call back over to your CEO Scott Schaeffer for closing remarks.
Thanks again for joining us today and we look forward to speaking with you after the third quarter. Have a good day.
Ladies and gentlemen thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.