Investors Real Estate Trust (IRET) Q2 2019 Earnings Call Transcript

Investors Real Estate Trust (IRET -0.88%)
Q2 2019 Earnings Call
Aug 08, 2019, 10:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Investors Real Estate Trust conference call to discuss the three months quarter ended June 30, 2019. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Jon Bishop, vice president of finance. Mr.

Bishop, please go ahead.

Jon Bishop -- Vice President of Finance

Thank you, and good morning. IRET's Form 10-Q for the second-quarter 2019 was filed yesterday with the SEC after the market closed. In addition, our earnings release and supplemental disclosure package have been posted on our website at iretapartments.com and filed yesterday on Form 8-K. Before we begin our remarks this morning, I need to remind you that during the call, we will discuss our business outlook and will be making certain forward-looking statements about future events based on current expectations and assumptions.

These statements are subject to risks and uncertainties discussed in our release and Form 10-KT and in other recent filings with the SEC. With respect to non-GAAP measures we use on this call, including pro forma measures, please refer to our earnings supplement for a reconciliation to GAAP, the reasons management uses these non-GAAP measures and the assumptions used with respect to pro forma measures and their inherent limitations. Any forward-looking statements made on today's call represent management's current opinions, and the company assumes no obligation to update or supplement these statements that become untrue due to subsequent events. With me this morning is Mark Decker on the cowbell; Anne Olson, our lead cat herder; and John Kirchmann, our chief bean counter.

At this time, I would like to turn the call over to Mark.

Mark Decker -- President and Chief Executive Officer

Thanks, Jon. Indeed, we need more cowbell. Welcome, everyone, to our second-quarter call. Results for the second quarter exceeded our expectations, with core FFO growing 9.9% compared to the second quarter of 2018.

I'm also pleased with our ability to raise guidance, reflecting our continued confidence in the business and outlook for the rest of 2019. Our team, many of whom are listening, come in every day to take good care of our customers and improve our results. Thank you, team, for your continued smart and hard work. As we've discussed in the past few calls, this quarter was going to be a tough comparison for us on the NOI line and with respect to margin expansion, but we continue to make progress on both, and we do expect to make progress this year in our campaign to rise by five.

To offer some greater transparency, you'll note added disclosure on our expenses on Page S5 of the supplemental. On balance, our business is thriving. Turning to capital allocation, portfolio end markets. I'd like to start by highlighting two victories that demonstrate the positive outcomes that can be achieved when you act with urgency and strategic purpose.

First, we settled our ongoing construction defect litigation which resulted in a gain of over $6 million. Resolution of this matter eliminates a costly distraction and gives us clear visibility on G&A, which we continue to manage vigorously. We also traded our Minot headquarters building where we had too much space in a multi-tenanted mixed-use building. We traded real estate with a larger user in town who needed room to grow.

This was a great win-win with a local business. For our part, we'll get great space for our Minot support team and net over $3 million. We compounded the wins by redeploying these sales and settlement dollars into the purchase of shares in our company at a significant discount to net asset value, growing core FFO and NAV. Buying our shares at close to a seven cap is a really compelling use of funds, especially when it comes from sales of land or inefficient properties.

Year to date through July 31, we've purchased over $26 million of shares in units at a significant discount to NAV. This saves over $1.3 million of dividends and further concentrates the remaining shareholders into a business that is improving and growing. Our capital allocation priorities remain assets in Denver and the Twin Cities, value-add investment and buybacks. Within the apartment portfolio and consistent with the last two years, we continue to look for opportunities to pair slower-growing and/or capital-intensive assets and markets and redeploy where we see better long-term growth.

While conditions over the last two years have been good, today is perhaps an optimal environment for us to continue our portfolio transition. In particular, we're seeing buyers look to some of our secondary and tertiary markets for cost basis and levered current cash flow. Our motivation is cash flow growth and liquidity, which we believe can be achieved through the redeployment of opportunistic sales. Broadly speaking, cap rates remained stable in our target markets but continue to decrease in our tertiary markets.

With respect to redeployment, we remain highly focused on real estate that has defining characteristics within the context of a portfolio construction that lends itself to durable pricing power, enhanced operating efficiencies and complementary toward our disciplined balance-sheet strategy. As we've said, we believe markets are key to our success, and we're encouraged that our NOI today is more concentrated in Minnesota and Colorado where we are seeing higher growth. Taking a closer look at our markets. Minneapolis continues to be driven by broad corporate growth and reasonable supply.

Denver, which has stronger job and population growth, continues to see supply on the high side, but our assets there are stable in great submarkets and are performing in line with underwriting. The balance of our markets are in equilibrium in terms of supply and remain driven by healthcare, education and government. Looking through to the end of the year, we're going to continue investing in technology and processes that improve our customers' experience and enable our team to be more outward-facing. We're also working hard to build a culture and a total rewards package that makes IRET a destination employer.

And certainly, we will grow the quality of cash flow for ownership while adhering to our goals to achieve per share growth while improving balance-sheet quality and flexibility. Now let's turn to some detail on how we're operating. Anne?

Anne Olson -- Chief Operating Officer

Thanks, Mark, and good morning, everyone. We continue to execute on our ability to drive organic growth through operational improvements, and we're pleased to have reported 2.6% same-store NOI growth in the second quarter as compared to second-quarter 2018 with our comparable year-to-date same-store NOI growth reaching 3.6%. Our NOI gains are being driven by increases in revenue, particularly in our strategic market of Minneapolis and across our Minnesota portfolio. Minneapolis led our same-store portfolio with a 7.7% revenue increase in the second quarter compared to second quarter of 2018, primarily attributable to a 5.8% quarter-over-quarter increase in rental revenue.

When looking at our Minnesota same-store portfolio in the aggregate, we achieved an increase of 7.1% NOI growth in second quarter compared to second-quarter 2018, and we are seeing strong rent growth, with average rental increases of 7.5% on new leases and 6.6% on renewal leases in the second quarter across the Minnesota market. Our nonsame-store portfolio, consisting of fully stabilized assets in Minneapolis and Denver, also saw significant growth, with Denver achieving rental increases on new leases of 4.7% and 4.2% on renewal leases during the second quarter. On the other end of the spectrum, we are experiencing continued weakness in our North Dakota markets, resulting in negative or flat growth in weighted average monthly rental rate year to date as compared to the same period in 2018. We do continue to see increases in other revenue across the portfolio and, as I mentioned on our last call, are optimistic that our revenue-generating margin expansion initiatives will continue to enhance our results.

Our initiatives focused on controllable expense containment are clearly proving out, as in the second quarter, we reduced same-store controllable expenses by 2.1% over the same period in 2018, and we've held our year-to-date controllable expense growth to 1.2% compared to 2018. We are confident that our initiatives to improve our margin are working, and we're happy with the results, but increases in noncontrollable expenses have masked our progress. We were expecting this. The good news is we are seeing improvement in our controllable expense management and are expecting margin expansion for the full year.

Our value-add pipeline continues to be one of many opportunities that we are strategically mining in our portfolio to enhance our rental revenue and, in turn, our margin. As of today, we have 271 units in Minneapolis that have completed renovations, with another 81 units under way for the remainder of 2019. Leasing of our renovated units has been strong to date, and we're achieving our underwritten premiums, as well as capturing market rent growth. We also continue our nonunit value-add in our Minneapolis portfolio and are undertaking major property enhancements at two of our suburban assets that will open our marketing windows and allow us to execute on further unit renovations.

Additionally, we're well under way with design and planning for our value-add renovations in the Omaha and Lincoln, Nebraska markets, consisting of over 1,000 unit renovations over the next three years. We anticipate these will start in earnest in the fourth quarter. Our team has demonstrated their commitment to continuous improvement, and I'm grateful for their ideas, efforts, flexibility and positive attitudes as we have and continue to navigate the demands of providing a great home for our residents and returns for our investors. Now for the really exciting news, which I will ask John to share in a summary of overall financial results and balance sheet.

John Kirchmann -- Executive Vice President and Chief Financial Officer

Thank you, Anne. Last night, we reported core FFO for the quarter ending June 30, 2019, of $1 per share, an increase of $0.09 or 9.9% over the same quarter in 2018. Year to date, core FFO is $1.77 per share, compared to $1.62 for the six months of 2018, an increase of $0.15 or 9.3%. The increase in core FFO was primarily due to multifamily NOI growth and reductions in interest and G&A expenses, partially offset by a decrease in NOI from sold properties.

Looking at our general and administrative expenses, total G&A decreased by 7.7% to $7.4 million for the six months ended June 30, 2019, from $8 million in the same period of the prior year. This decrease is primarily due to decreases of $558,000 in severance-related costs, $265,000 in legal costs and $200,000 in real estate taxes on land sales. These decreases were partially offset by increases in compensation costs as a result of a decrease in open positions and higher incentive compensation related to expanding the participant pool in our long-term incentive plan. For the remainder of 2019, we expect our quarterly G&A run rate to continue to be in the $3.6 million to $3.8 million range.

Property management expense was $3 million for the first six months of 2019, compared to $2.8 million in the same period of the prior year. For the remainder of 2019, we expect quarterly property management expenses to increase to approximately $1.7 million to $1.8 million per quarter as we implement new technology solutions related to improving the resident experience and empowering our community team members. Moving to capital expenditures, as presented on Page S14 of the supplemental. For the second quarter of 2019, same-store capex was $2.5 million, which was in line with the prior-year period.

Through the first six months of 2019, same-store capex was $3.5 million, a decrease of $500,000 compared to the same period in 2018. For the full year, same-store capex spend is expected to be in line with calendar-year 2018 at $11 million. Turning to the balance sheet. As of June 30, 2019, we had $90 million in total liquidity, including $72 million available on our corporate revolver.

During the quarter, we repaid $59 million of amortizing individually secured mortgages with a weighted average interest rate of 5.5%. Subsequent to quarter end, we refinanced that with a new $60 million interest-only mortgage that is priced at 3.88% for the full 12-year term of the loan. This loan also has collateral substitution rights, which maintain portfolio flexibility. This refinancing effectively increases our line of credit liquidity by $75 million.

Separately, IRET entered into a swap agreement to fix a $50 million portion of the variable rate debt on our corporate revolver for the remainder of its term as we opportunistically took advantage of a forward LIBOR swap rate dropping below the current LIBOR rate. Our operating platform, anchored by our dedicated team members, has produced strong results through the first half of 2019. We continue to see solid multifamily fundamentals across most of our markets and benefit from operational and balance sheet improvements. As a result, as laid out on Page S15 of our supplemental, we are raising our guidance.

We are increasing the midpoint of 2019 full-year core FFO per share guidance by $0.05 from $3.62 to $3.67. We are also increasing the midpoint of 2019 full-year same-store NOI and revenue guidance by 25 basis points from 3.25% to 3.5%. And finally, while we are maintaining the midpoint of same-store expenses, at 3.25%, we are narrowing the guidance range to 2.75% to 3.75%. With that, I will turn the call over to the operator for your questions.

Questions & Answers:

Operator

[Operator instructions] The first question will come from Rob Stevenson of Janney.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

Good morning, guys. Mark, are you guys currently marketing or have anything under contract for sale?

Mark Decker -- President and Chief Executive Officer

Good morning, Rob. We don't comment on things until they're done. But I mean I think you should look at what we've done over the last two years is thematically what we'll be doing. So if it's getting us more efficient, like, for example, the way we did in Minot, when we sold the 13 assets that had 327 units or if it's opportunistic, like when we sold Williston, I'd say that's the framework we're employing.

But we certainly think it's a good time.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. Because I was just curious as to how you were thinking about that given the economy, the markets, the fact that other than the North Dakota stuff, everything seems to be doing well in the portfolio. And so it seems like an opportunistic time, especially with the compression in cap rates in some of these tertiary markets to be selling. So on the land parcels that you guys have sold in the second and third quarters, are there gains on any of that? And is there any impact to FFO from that?

Mark Decker -- President and Chief Executive Officer

On the parcels?

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

Yeah.

Mark Decker -- President and Chief Executive Officer

On the land parcels?

John Kirchmann -- Executive Vice President and Chief Financial Officer

Yes. We had some small gains on there. They -- a small loss in one and a small gain on the other and that they were pretty much sold at book value.

Mark Decker -- President and Chief Executive Officer

We did pick up, as you pointed out, John, some taxes, we won't have to pay anymore that was in our G&A line. So that's a modest FFO benefit going forward.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. I didn't know whether or not that would have contributed to the increase in guidance, whether or not there was any impact on the -- the one that you've done this far in the third quarter that we needed to be thinking about in terms of FFO.

John Kirchmann -- Executive Vice President and Chief Financial Officer

No, the land parcel sales did not impact the guidance.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. And then the big increase in insurance, when did you guys renew? And is anything going on there different? And given the increases there, if you get another bump next year, are you guys exploring self-insurance or increasing deductibles, etc., as a means of lowering these costs that are noncontrollable?

Anne Olson -- Chief Operating Officer

Yeah. Great question. I think across the industry, we saw pretty good increases last year, and we were pleased with where we were able to hold our increase, although it was an increase. We renew -- our entire insurance program renews on January 1.

And so we're just about to kick off that process. And we do undertake a pretty thorough analysis of what the levers are that we can pull, whether it'd be increasing deductibles or changes in coverage, some self insurance, things like that every year. And so we'll be starting that process in September. We did make some changes last year that did keep our increase down, although, as noted, it was an increase.

Mark Decker -- President and Chief Executive Officer

And then Rob, launching the renter's insurance is a modest positive. I mean when we're out talking to potential insurers, they like where our portfolio is. We offer some real diversity relative to a lot of their other customers. So I mean it's something we work very hard at, but it's -- as they say in the insurance business, it's been a hardening market over the last couple of years.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. I mean, to that point, I mean if I take a look at your weighted average monthly rental rate versus your weighted average monthly revenue per occupied home, call it, $75 or so, I assume that all of that is basically sort of fee income that you're getting per unit. Are you pushing some of that more aggressively in your stronger markets? And should we expect to see the gap between rental rate and revenue per occupied home increase over time as some of your peers have?

Anne Olson -- Chief Operating Officer

Yeah. Absolutely. I mean that is one of our biggest rise by five. We have undertaken a look at all of our market fees, and now we're doing that on an annual -- and in our very strong markets on a semiannual basis.

So that includes everything from what we're charging to -- for application fees to pet rents to garages and parking. And then this year, as we indicated at our last call, we did roll out renter's insurance program. So that is starting to roll through. That will now as the leases roll, people are required to have the renter's insurance or to pay us a noncompliance fee.

So that will boost it some because some people just won't -- will pay the fee rather than actually obtain the insurance. And we also increased our utility build backs across the portfolio. And so that's rolling through too. We do expect to keep a close pulse on what the market fees are and really push the envelope there as far as we can to maximize our total revenue line as our goal.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. And then what markets are you seeing the biggest increases in property taxes. I mean which markets are the biggest issues that are driving the growth for you guys?

John Kirchmann -- Executive Vice President and Chief Financial Officer

Yeah, Rob, I would say it's really been across all the markets. And what we're seeing is in this environment, the valuations that they're placing on their properties are really driving the increases.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. And then last one for me. What's your year-to-date unit turnover rate, how does that compare to previous years? As you're going through all of the technology changes, pushing rent, etc., is unit turnover up relative to previous years, down, sort of flat? How should we be thinking about that?

Anne Olson -- Chief Operating Officer

We generally on a month-to-month basis are staying in the same range. It is up, I would say, on average, about 2%, probably where we're running closer between 46% and 50%, whereas I think last year at this time, we were running between 48% and 52%. So we are seeing a little bit more turnover. But we are getting the increases on the rental side.

So we're happy with that. And we don't feel any pressure or that it's going to impact occupancy overall going forward.

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

OK. Thanks, guys.

Mark Decker -- President and Chief Executive Officer

Thanks, Rob.

Operator

The next question will be from Drew Babin of Baird.

Alex Kubicek -- Robert W. Baird -- Analyst

Good morning. This is Alex on for Drew. Mark, kind of as a follow-up to your cap rate compression comments. Curious if you are seeing specific markets see a higher magnitude of compression? And just could you give us a ballpark estimate of what the spread looks like on the ground today between, say, Minneapolis and your North Dakota markets, just to give us kind of an understanding of kind of what that looks like?

Mark Decker -- President and Chief Executive Officer

Yeah. I mean to answer the first part of your question, I think it's really, as I alluded to in my comments, it's really about what is the buyer after. And there are a lot of pools of capital where someone's aggregating individual capital, putting leverage on it and paying kind of a -- let's get your principal back higher yield with probably some tax-advantaged elements to it, which is a different gain that I think folks are playing in the larger metros. But to answer your second question, I mean many in Denver -- the Twin Cities and Denver are really kind of 4.5% to 5% cap rate markets, speaking generally.

And when we look at the Dakotas, for our own NAV, they're really kind of 6.5% to 7% markets.

Alex Kubicek -- Robert W. Baird -- Analyst

Got it. That's some great color. And then kind of turning to the value-add program. What does timing look like for delivery of the units that are currently slated to be renovated? And can you remind us what markets those are in specifically? And then kind of just as a third part, curious if you could comment on how much additional downtime you guys underwrote just compared to your normal turn, as you guys are renovating those when they come available?

Anne Olson -- Chief Operating Officer

Yeah. Sure. So right now, the market that we're focused in and actually have construction work units under renovation is in our Minneapolis portfolio. We have two assets that are getting unit renovations right now.

And one of those is also getting pretty significant common area improvements and then we have another suburban asset that's also getting kind of exterior common area improvement. So we have a good mix of things going on here in Minneapolis. We do have one asset that had 130 units, that's been completely finished already. So we are delivering the units right now.

For example, we have a suburban asset, where we have 35 units completed in renovation, another 28 in progress, if 37 of those units leased. So as I said on the call, we have pretty strong demand there. The next market we're looking at is Omaha and Lincoln, so we'll be undertaking renovations on about 1,000 units down there, which is almost the entire portfolio. And we think that'll take -- we'll start that construction work in the fourth quarter, which means they'll start delivering units in the first quarter.

And that'll take about three years to kind of run through the whole roll. We are looking at 30 to 45 days, 45 days at the longest. And we really try to calibrate the amount of units that we take by taking ones that we have long notice. So when people give us a 60-day notice, that unit will go into renovation because we'll be able to have good lead time on the materials orderings and the things that are the prep work, so that when the unit becomes vacant, we can really get in and out of there in 30 days.

Alex Kubicek -- Robert W. Baird -- Analyst

That's really helpful. And then kind of lastly, looking at expenses. First, thanks for adding color on the same-property expense breakdown to the supplemental. It looks like controllable expense rather has been really tame year to date.

But since you're tracking toward the higher end of the range, curious where specifically you guys are anticipating some moderation to come in the second half? And kind of what this timing look like on that part?

John Kirchmann -- Executive Vice President and Chief Financial Officer

Oh, so -- hey, Alex, this is John. It's not really that we're expecting moderation. It's that just playing out where we're looking the budget to go. If you recall, in Q1, we had quite a bit of an increase in our snow removal costs.

So that's maybe making the run rate look higher than it really is. But as you kind of play that for the rest of the year in the same run rate, you'll come to -- right to where in our guidance. So really, we're not looking to do anything different or dramatic in the next six months to stay within our range.

Alex Kubicek -- Robert W. Baird -- Analyst

Got it. That's really helpful. Thanks, John.

Operator

The next question will come from John Kim of BMO Capital Markets.

John Kim -- BMO Capital Markets -- Analyst

Thank you. Mark, on the expedited dispositions that you discussed, given the demand, I think you talked about pricing a little bit, but can you give some more color on the volume and timing and whether or not this would impact your 2019 guidance?

Mark Decker -- President and Chief Executive Officer

Yeah. I mean the truth is that we're kind of early stages working through details on it all right now, but it won't affect our guidance.

John Kirchmann -- Executive Vice President and Chief Financial Officer

So our guidance is what we expect to happen for the full year, sort of no matter what.

John Kim -- BMO Capital Markets -- Analyst

Would you characterize the potential sales volume to be higher than it was perhaps three months ago?

John Kirchmann -- Executive Vice President and Chief Financial Officer

Three months ago, it was zero.

Mark Decker -- President and Chief Executive Officer

Sorry, I'm not trying to be coy. I mean what have we sold that's --

John Kim -- BMO Capital Markets -- Analyst

Are you contemplating selling more sooner, given the demand than you would have last quarter?

Mark Decker -- President and Chief Executive Officer

Yes. Yes, I'm sorry, John. Yes.

John Kim -- BMO Capital Markets -- Analyst

I think I heard this in a couple of your markets, but can you provide the blended lease growth rates for your overall portfolio in the second quarter, and how that's trended in July?

Mark Decker -- President and Chief Executive Officer

Yeah. Hang on, Anne is scribing that right now.

Anne Olson -- Chief Operating Officer

Yeah. Let me address July while we check the second-quarter numbers to make sure we give you the right information. But in July, we had new leases, our average replacement rent was about 1%. That is again, just like we saw in the second quarter, that's pretty high average replacement rents running from 6.5% in kind of the Lincoln and Billings.

Minneapolis has had really strong, 6.7% in Minneapolis, offset by some of the markets where we have seen continued weakening Bismarck and Grand Forks being most of those. On the weighted average monthly rental rate across our same-store portfolio for the second quarter, we were at 1.9%.

John Kim -- BMO Capital Markets -- Analyst

And for overall --

Anne Olson -- Chief Operating Officer

That's about what we expect. We've had more expirations in July, in June and July than we did in the second quarter. And so that's what we would expect to see a little bit of softening in that rate as we hold occupancy up.

John Kim -- BMO Capital Markets -- Analyst

OK. Minneapolis had a strong quarter on same-store revenue 7.5%. Is there anything one-time in the second quarter's results? Or do you expect that to continue for the rest of the year?

Anne Olson -- Chief Operating Officer

Yeah. There is no one-time or anything that stands out for Minneapolis. So the market has been very strong here, and we do expect that to continue.

John Kim -- BMO Capital Markets -- Analyst

OK. Great. Thank you.

Mark Decker -- President and Chief Executive Officer

Thanks, John.

Operator

[Operator instructions] Seeing no further questions, this concludes our question-and-answer session. I would now like to turn the conference back over to Mark Decker for any closing remarks.

Mark Decker -- President and Chief Executive Officer

Thanks, Kerry. Well, we certainly appreciate everyone's interest in the company, and we're going to continue to work the plan. I know before we got on the call, the stock had moved, but it's still trading around a 6.5% cap. So there's still lots of opportunity for us as a business and for potential investors.

So we'll talk to everyone after the next quarter. Thanks.

Operator

[Operator signoff]

Duration: 32 minutes

Call participants:

Jon Bishop -- Vice President of Finance

Mark Decker -- President and Chief Executive Officer

Anne Olson -- Chief Operating Officer

John Kirchmann -- Executive Vice President and Chief Financial Officer

Rob Stevenson -- Janney MontgomeryScott LLC -- Analyst

Alex Kubicek -- Robert W. Baird -- Analyst

John Kim -- BMO Capital Markets -- Analyst

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