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Preferred Apartment Communities, Inc. (NYSE:APTS)
Q3 2019 Earnings Call
Nov 5, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to Preferred Apartment Communities Third Quarter 2019 Earnings Conference Call. [Operator Instructions]

I would now like to introduce your host, Lenny Silverstein, President and Chief Operating Officer. Please go ahead, sir.

Leonard A. Silverstein -- President, Vice Chairman of the Board, Chief Operating Officer

Thank you for joining us this morning, and welcome to Preferred Apartment Communities third quarter 2019 earnings call. We hope that each of you have had a chance to review our third quarter earnings report, which we released yesterday after the market closed. In a moment, I'll be turning the call over to John Isakson, the Company's Chief Financial Officer, to share a detailed description of our third quarter operating results. Dan DuPree, our Chairman and CEO, will share his thoughts on the state of the company.

Following the conclusion of our prepared remarks, we'll be pleased to answer any questions you might have. Also, with us this morning is the Senior Executive Team of our company, Jeff Sherman, Executive Vice President and Managing Director of our Multifamily Business Unit; Joel Murphy, CEO of New Market Properties and CEO-Elect of PAC; Boone DuPree, President of Preferred Office Properties; Paul Cullen, Executive Vice President and Managing Director of Preferred Campus Communities; Mike Cronin, our Chief Accounting Officer; and Jeff Sprain, our General Counsel.

Before we begin, I'd like everyone to note that forward-looking statements may be made during our call. These statements are not guarantees of future performance and involve various risks and uncertainties and actual results may differ materially. There is a discussion about these risks and uncertainties in yesterday's press release. Our press release can be found on our website at pacapts.com. The press release also includes our supplemental financial data report for the third quarter with definitions and reconciliations of non-GAAP financial measures and other terms that may be used in today's discussion.

We encourage you to refer to this information during your review of our operating results and financial performance. Unless we otherwise indicate, all per share results that we discuss this morning are based on the basic weighted average shares of common stock and Class A partnership units outstanding for the period. A key component of our success has been our strategically designed and highly successful Series A and mShare preferred stock capital-raising programs. Through our broker-dealer, Preferred Capital Securities, we raised almost $134 million in gross proceeds from our preferred stock sales during the third quarter alone.

As these offerings come to our closed over the next few months, we will launch our next Preferred Stock, capital raising strategy designed to enable us to continue our solid growth objectives. The success of our preferred capital raising program has enabled us to acquire an aggregate of approximately $289 million in new assets in originate almost $15 million in new real estate loan investments during the third quarter of this year. As of September 30, this year, we now own an aggregate of 101 Class A multifamily, student housing, grocery-anchored shopping centers and office properties in 15 states and 56 markets primarily in the Southeast, Mid-Atlantic and Texas and have real estate loan investment commitments outstanding of almost $416 million. Through our 700 associates we continue to emphasize our goal of becoming the preeminent publicly traded REIT in the industry with particular focus on our operating performance, the training and development of our associates, our culture and our philanthropy of giving back to the communities in which we operate. We extremely pleased with the successes we've achieved in these areas and look forward to continuing this momentum.

And now I would like to turn the call over to John Isakson. John?

John A. Isakson -- Chief Financial Officer, Executive Vice President

Thanks, Lenny. For the third quarter 2019 PAC generated revenues of just over $120 million, FFO of $0.31 a share and AFFO $0.12 a share. You will note that our revenues are up over 15% compared to the third quarter of 2018, owing to the continued growth in all of our property verticals and our FFO was up over 10% from the same period last year as well.

For the third quarter, our preferred stock dividend increased by over $7 million to $29.4 million and our common stock outstanding was up by almost 4.5 million shares over the third quarter of 2018 to 44.7 million shares. In reviewing our financial statements, you may know, the decrease in operating income despite the growth in top line revenue. It is important to note that this line item includes gain on sale of real estate and we had a significant sale in Q3 of 2018 and no sales in Q3 of 2019.

Excluding the gain on sale. Our operating income was up 70% over the same period 2018. Our FFO can be highly variable, and from quarter-to-quarter or year-to-year we can have dramatic swings. The variability in our AFFO can be attributed in large part to two line items, accrued interest income received and amortization of purchase option termination revenues. You will note that for the third quarter this year compared to last year, we had almost $4.3 million less in accrued interest income received. While we book accrued interest income every quarter, the actual cash payment of this interest comes in on the borrower under the real estate loan investment has a capital event, meaning, either a sale or refinancing the property. Sometimes our developers pay us early from cash flow and sometimes we receive the cash payments upon one of these capital.

This quarter for example, we did not have any accrued interest income payments. The variance in this line item accounts for more than the total variance in our AFFO. For the third quarter 2019, we paid a dividend to our common stockholders of $26.25 per share almost 3% greater than the dividend paid to our common stockholders for the third quarter 2018. As we have previously discussed, we continue to focus on increasing the float of our common stock. During the third quarter of this year, for example, we issued an aggregate of over 1 million shares of our common stock in connection with redemptions of our preferred stock and the exercise of warrants previously issued under our Series A preferred stock and unit offerings. From a capital markets perspective, we have seen some interesting developments in the market interest rates again declined in the third quarter and currently sit almost 160 basis points off the recent peak in Q4 of last year, although that spread has narrowed in recent trading sessions.

We continue to believe that interest rates will be volatile at the end of 2019 with global and domestic pressures presenting unpredictable conditions, given the recent volatility and uncertainty in the environment, we have continued to take a cautious approach to our acquisition and portfolio financing strategy, almost 96% of our permanent property level mortgage debt has fixed interest rates or variable interest rates that are capped. Our borrowings in the line of credit as of today are zero and we believe the current capacity of the line will serve us well for the foreseeable future, including the additional $100 million accordion feature we have in the current facility.

The accordion feature allows us to expand the facility up to a total of $300 million. For our multifamily portfolio Freddie Mac and Fannie Mae, remain our primary lenders. We enjoy preferred borrower status and have excellent relationships with both agencies. As we noted last quarter, there was considerable concern over the caps for the GSEs and their production volumes going forward. In the third quarter, FHFA, Freddie and Fannie's regulator announced a new cap structure that will allow the agencies to produce $100 billion each from Q4, 2019 through the end of 2020. This generally sets the bar, the current production levels, the agencies have been generating and takes considerable pressure and uncertainty out of the market.

Due to the environment and the above mentioned concerns GSE spreads had widened significantly recently as the transaction volume remains strong and the ability for the agencies to do uncapped business has become more difficult. With this new cap structure, we expect spreads to contract somewhat, but in a measured way over a period of months, live company debt for multifamily assets continues to be attractive and competitive. Ultimately, the balance between spreads and loan volume will be dictated by the pace of transactions, which shows no signs of slowing down. The lender pool for our grocery-anchored retail product remains deep and the demand for our debt remains strong.

We have recently seen a contraction in spreads for these deals as the competition for grocery anchored debt has increased. Our office transactions are also financed through life companies with terms that are generally comparable to retail and multifamily, although the maturities may be longer. These are typically larger deals and the lender pool is smaller than the one for our grocery-anchored retail deals, which are a more manageable size. Nonetheless, we have seen strong lender demand for our office acquisitions and our deep relationships in the lending community continue to serve us well.

Let me now turn the call over to Dan DuPree. Dan?

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Thanks, John. As we have discussed previously each of our business units has a various specific strategy for creating value. Our multifamily business is focused on more recently developed Class A largely suburban properties and markets typically with greater than 1 million people and good growth. Nearly three quarters of our multifamily assets are in three states, Georgia, Florida, Texas. Overall, we have 34 communities with 10,245 units, average rents of almost $1400 per month or $1.34 a square feet. Our retail strategy is a 100% grocery-anchored, typically anchored by the number one or two market share grocer in the market and located within the Mid Atlantic, Southeast and Texas. At the end of Q3, we owned 50 shopping centers and nine states totaling 5,644,000 square feet.

Publix and Kroger/Harris Teeter are our two biggest major tenants, with 38 stores occupying a third of our GLA. We are now the fourth largest publics landlord in the country. Our office property strategy is more focus still with six target markets. Atlanta, Charlotte, Raleigh, Nashville, Austin and Dallas in which we seek to create a portfolio of Class A office properties. Our real estate loan business has been a driver of those growth and profitability for the company since the very beginning. Our loan book stands at $457.9 million with over $383 million of that drawn headquarters in. The current book covers 21 loans over 4,837 multifamily units, 1,895 student housing beds and 195,000 square feet of retail space and 187,000 square feet of office space.

Our loan book is relatively constant as loan to pay off, a new loans are initiated. At the same time, our total assets continue to grow with the result of a loan book that was once 25% of our total assets is now 10%. Each of our business units were built and operate with teams dedicated solely to the business plan for their respective business unit. This focus starts with a concentration on operating results. At the end of the quarter our asset composition was 48% multifamily and student housing, 22% retail, 20% office and 10% real estate investment loans -- real estate loan investment. For the quarter and our multifamily unit same-store set, we saw revenue growth of 3.5%. Expenses held to 2.3%, so same-store NOI up a very strong 4.4%.

Our same-store occupancy was 95.6%. All of this reflects a significant benefit from our portfolio being the youngest class A portfolio at 5.4 years old and our public peer group. Year-to-date same-store NOI growth is 3.7% strong operating results. In our retail business unit, we continue to focus on leasing, where our portfolio excluding redevelopment properties is 94.9% lease. Over the course of 2019, we had eight grocery anchors with leases rolling, all of which we have now renewed their leases at their contractual rates. We have also had very strong leasing results with our shop renewal efforts renewing 162,045 square feet year-to-date with strong rate spread.

Additionally, we've signed 80,000 square feet of new leases year-to-date, again very strong operating results. Year-to-date our office subsidiary Preferred Office Properties and signed leases totaling more than 255,000 square feet of leasable area or about 8% of the office portfolio, which together, bring the -- that portfolio to 97% leased.

Not only are we keeping our office buildings full, but we are materially driving lease economics at those properties. Of the 255,000 square feet of leases year-to-date a 150,000 square feet are second generation, meaning that we either relet a space vacated by a previous customer or renew that customer as compared to first generation vacancy which we inherit when we acquired the property. On those leases, we achieved an average cash rent roll -- roll up of more than 15% stunning number. Our portfoliowide weighted average lease term remaining is nearly eight years. The property level debt we have on our properties, our office properties has an average maturity of 13.1 years again strong operating results. Our internal operating results, therefore are solid and this is the foundation for the ultimate success of the company long term. With a good handle on operations, our focus has been to tackle major issues that we believe will transform the company and set it up for a long-term consistent growth and success.

First, in June, we announced that we had executed a contract to sell a significant portion of our student housing portfolio to a qualified buyer with considerable experience in this very specialized product. This deal continues to track and we anticipate a fourth quarter closing. We made this decision notwithstanding our current 97% occupancy across that entire student housing portfolio. We did this out of a belief that smaller cap publicly traded REITs such as PAC are disproportionally vulnerable to periodic oversupply of product and a given market and student housing creating uneven results over which we have no control. We have seen this in a couple of our markets. We will be retaining two of our student housing properties in order to focus on them to capture more of the value that we believe exists in each. Similarly, earlier this year we filed an 8-K announcing that we were beginning a process to determine the benefit of PAC internalizing our Manager into the public entity.

There is no doubt that the externally advice structure has been critical to the start and success impact to date. There is no way we could have been able to grow the company, both in size and results without this structure. We recognize at the outset, however, that there would come a time when the external manager would need to be integrated into the public company. We are currently following a process to help determine whether or not this is the correct time. A couple of weeks ago, we announced a succession plan that will result in Joel Murphy, assuming the role of CEO on January 1, 2020. I plan to remain as Executive Chairman of the Board for at least one year before ceasing day-to-day involvement and removing the Executive designation from the Chairman of the Board title.

Joel and I have worked together for over 30 years, initially, he was my attorney at King & Spalding, but from 1988 on we have been involved in both private and public companies together. When John Williams passed away 18 months ago, we knew we needed to identify the long-term successor. It is a complement to Joel that we knew, we wouldn't have to look outside of the building. Having worked with Joel for so long. I can say without any hesitation that the company will be in great hands. Beyond Joel the riches both the company is rich in both experienced personnel and young visionary talent, which bodes well for our future.

I'd like to talk about guidance for a minute. In the supplemental last night, we talked about internalization related direct and indirect costs that are housed in our numbers. These costs are extraordinary, and would be backed out of FFO. If we were reporting core FFO as we did in the past, because consideration of internalizing our external manager was not anticipated when guidance was originally provided a provision for these cost was not included. If we now adjust our guidance for these costs, adding these costs back to FFO, we expect that we will end the year at the low end of our original guidance of $1.44 to $1.50 a share.

Due to our unique source and ability to raise capital and our diversified product strategy. We are extraordinarily well-positioned in the REIT universe to grow through timely accretive investments. There currently is a lot of capital in the system that needs to get invested and that has resulted and a push in cap rates, particularly in multifamily sector to record levels. We have taken the position that we would rather have uninvested cash on our balance sheet and available for attractive opportunities then to use that cash in a way that does not add value to our portfolio.

Over the course of the year from time-to-time, we have had between $40 million and $70 million in cash on our balance sheet. Through the end of Q3, we have had an average daily cash balance after zeroing out our line of credit of over $27 million. Assuming the cost of this capital is equal to the preferred dividend this uninvested capital has cost back to date $0.036 per share. Having too much cash is the ultimate high class headache -- headache, but investment discipline does come at a cost. One final thought, and John Isakson touched on this briefly. AFFO is a tricky number for us because of our real estate investment loans. On these loans we receive current interest and additionally we receive accrued interest the current interest is book to both FFO and AFFO. On the other hand, the accrued interest is booked mostly monthly rather to FFO. But not booked to AFFO until the loan pays off, again John already covered this. This creates lumpiness in our AFFO, if you think about it, you may recall periods in the last several years on our AFFO payout ratio was less than 60%. This quarter the payout ratio was over 200%. The important thing to remember is that today we have over $27 million in earned, but not yet booked AFFO and accrued interest.

With all of that having been said, I would like to thank you for joining us on our earnings call -- earnings call this morning. I will now turn the call back over to the operator to open the floor for any questions you may have. Operator?

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Michael Lewis with SunTrust. Please go ahead.

Michael Lewis -- SunTrust -- Analyst

All right. Great. Thank you. I wanted to ask, how you decide how much asset management and G&A fees you waive each quarter. Is there a formula for that? Or targets? Or is that kind of a decision made by management during or at the end of the quarter?

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Well, it's on a case-by-case basis, Michael -- the key is -- we want to invest accretively and it has been determined by the owners of the manager that we would subordinate our fees in order to ensure that we're investing in an accretive way, you know it as we go through this process and exploring internalization, one of the -- the nice side benefits is we no longer will have the load of those fees when we're trying to evaluate the viability of an asset would be nice to -- to have that behind us.

Michael Lewis -- SunTrust -- Analyst

Great. Okay. And then on the dividend coverage. I understand the lumpiness of the AFFO and the accrued interest build up that you have. I wanted to ask about -- you're reporting about $2 million a quarter of maintenance capex. When I looked at the cash flow statement you've kind of consistently been around $12 million per quarter of improvements to real estate. I guess the question is, just given the lumpiness of the AFFO. I mean how should we, and investors kind of look at the cash flow coverage of the dividend and how comfortable you guys are with the level of the dividend here?

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Yes, what I would tell you on that, you know give you a classic example, in the third quarter, we had -- we had none of our mezz loans pay-off in the third quarter is not something that we frankly control. Already in the fourth quarter we've had two mezz loans pay-off and there's a good chance we will end up having a couple more this quarter. It is -- it is a, it is our mezz loan business, it has been a real driver for the company. But it creates this lumpiness on -- because we don't control when they're going to pay off. What I think is important is the fact that and it's continuing to increase. All of our mezz loans today appear to us to be very healthy. And we have $27 million of accrued interest that we, that we have not yet captured and that will get -- that will get spread out in a lumpy fashion probably over the next that $27 million probably over the next year, year and a half, two years providing more than adequate coverage of our dividend.

Michael Lewis -- SunTrust -- Analyst

Okay. Thanks. And then just one last one for me, I wanted to ask about the internalization decision and process here and ultimately the outcome. It looks like when I -- when I look in your filings and kind of follow the formula in there for the internalization fee, it looks like that could be quite high. Is there, is there a risk here that you have to -- you know that there is an internalization fee of $100 million or $200 million that takes kind of $4 a share out of this company? Or am I kind of over -- am I overestimating or over thinking on that?

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Well -- let me frame it a little bit different way. The best investment -- first of all, I don't know, I mean, we're not at a point of making any announcement about internalization, it's a protracted process that both we and the board -- we the manager and the Board want to get right, that's first and foremost. I think what we have done relative to deferring fees and other things indicate a real respect for our shareholder and in that regard, but I can tell you, it almost whatever price the best long-term investment. The best long term investment. The company will make this year or any year will be the internalization of the manager regardless of what the near-term impact is and I'm not suggesting that is going to be the numbers that you suggested. I'm just saying that regardless of the number, it will be the best investment that the company will make. John, do you have something you wanted to add to that?

John A. Isakson -- Chief Financial Officer, Executive Vice President

Hey, Michael, whenever you look at the -- paying one of the things to think about it's the Company's capitalization isn't just the common stock, but obviously the preferred stock as well. So when you start talking about that $4 a share, that's a little misleading. I mean the company from an equity standpoint is well over $2 billion now.

Michael Lewis -- SunTrust -- Analyst

Okay. Thanks for answering my questions.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Dan DuPree for any closing remarks. Please go ahead, sir

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Yeah, before we get off the phone. We allowed Joel Murphy to get a free ride on this call. And I can assure you that any of the questions that we just answered would have been answered far more astutely by Joel, and you can look forward in the future to Joel leading this call. I think all of us -- on our side of this call are excited to have Joel taking over the reins on January 1. As I mentioned in my comments, Joel is going to do a terrific job. So with that, let me say thank you all for participating this morning, we're available mostly Joel to answer questions that you have following the call. Again thank you, you all have a good day.

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

Leonard A. Silverstein -- President, Vice Chairman of the Board, Chief Operating Officer

John A. Isakson -- Chief Financial Officer, Executive Vice President

Daniel M. DuPree -- Chairman of the Board and Chief Executive Officer

Michael Lewis -- SunTrust -- Analyst

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