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Edited Transcript of APTS earnings conference call or presentation 30-Jul-19 3:00pm GMT

Q2 2019 Preferred Apartment Communities Inc Earnings Call

ATLANTA Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Preferred Apartment Communities Inc earnings conference call or presentation Tuesday, July 30, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel M. DuPree

Preferred Apartment Communities, Inc. - Chairman & CEO

* John A. Isakson

Preferred Apartment Communities, Inc. - CFO & Executive VP

* Leonard A. Silverstein

Preferred Apartment Communities, Inc. - Co-Founder, Vice Chairman, President & COO

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Conference Call Participants

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* Merrill Hadady Ross

Compass Point Research & Trading, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Preferred Apartment Communities Second Quarter 2019 Earnings Conference Call. Please note that today's conference is being recorded. (Operator Instructions)

I would now like to introduce today's conference call, Lenny Silverstein, President and Chief Operating Officer. Please go ahead.

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Leonard A. Silverstein, Preferred Apartment Communities, Inc. - Co-Founder, Vice Chairman, President & COO [2]

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Thank you for joining us this morning, and welcome to Preferred Apartment Communities Second Quarter 2019 Earnings Call.

We hope that each of you have had a chance to review our second quarter earnings report, which we released yesterday after the market closed. In a moment, I'll be turning the call over to John Isakson, our Chief Financial Officer, to share a detailed description of second 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 Jeff Sherman, Executive Vice President and Managing Director of our Multifamily Business Unit; Joel Murphy, CEO of New Market Properties; Boone DuPree, President of Preferred Office properties; 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 the 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 second 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.

Before I turn the call over to John, I wanted to take a moment to reflect on how PAC differentiates itself within the public REIT industry. When Preferred Apartment Communities was originated, it was designed as a multifamily company that could harness the power and the expertise of third-party developers. We anticipated that in the future we would want to diversify to some degree from owning and managing purely multifamily assets to include other real estate assets in an attempt to lessen the risk to our public stockholders and to manage the inevitable wave of business cycles. This strategy has held us in good stead. As you have heard before, and as you will later hear from Dan DuPree, we believe this is a transformative year for our company in several ways. In the end, we want to be abundantly clear that we're looking to continue to harness the roots of our entrepreneurial spirit to take us to the next level. No matter how much we focus on this effort, it is also abundantly clear that the successes we've achieved as a company since our launch and commencement of operations with our IPO a little over 8 years ago is due, in large part, to the strength and depth of all of our associates, top to bottom as well as the creation of a positive culture unique to our company.

This entrepreneurial effort also extends to our strategically designed and highly successful Series A and mShare preferred stock capital-raising programs. Through our broker-dealer, Preferred Capital Securities, we raised over $142 million in preferred stock sales during the second quarter alone.

We're already designing a successor preferred stock-capital raising strategy as these current offerings finish up the end of this year and early next year.

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

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John A. Isakson, Preferred Apartment Communities, Inc. - CFO & Executive VP [3]

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Thanks, Lenny. For the second quarter 2019, the company generated revenues of almost $114 million, FFO of $0.36 a share and AFFO of $0.22 a share. You will note that our revenues are up over 18% from the second quarter of 2018 owing to the continued growth in all of our property verticals.

For the second quarter, our preferred stock dividend increased by almost $7 million and our common stock outstanding was up by almost 4.5 million shares over the second quarter of 2018. In reviewing the reconciliation of FFO, you may note the decrease in amortization of intangible assets and deferred leasing costs. This line item was down approximately $3.4 million from the same period last year due to a slower pace of multifamily acquisitions.

Multifamily assets have the shortest lease terms so the amortization of these intangibles occurs quickly. As acquisition volume goes down in the segment, the amortization of these items becomes more heavily weighted on our other verticals, which have longer lease terms and thus longer amortization periods. Our bank AFFO decline is driven, in part, by the decline of almost $4 million in purchase option termination fees and related revenue adjustments due to more of the revenue been booked as accruals of these fees versus actual cash. We've booked these fees as accruals of expected payments over the term of the loan. Sometimes our developers pay us early and sometimes we receive the cash payments upon a capital event. In that cases where the accruals are greater than the cash received, that net amount would be a deduction in the calculation of AFFO. When the cash received exceeds the accruals, it would be added in the calculating AFFO. Please see the related Footnote 9 in our SFT for further clarification on this point.

Our results are also affected by the uninvested cash we had on the balance sheet at the end of the quarter. As we have said in the past, our transactions, both acquisitions and mezzanine loans, are lumpy and that sometimes unpredictable timing can affect both our pace of capital deployment and the realization of returns on our mezzanine loan program. For the second quarter of 2019, the company paid a dividend to our common stockholders of $0.2625 per share, almost 3% greater than the dividend paid to our common stockholders for the second quarter 2018.

As we have previously discussed, we continue to focus on increasing the float of our common stocks. During the second quarter this year, for example, we issued an aggregate of almost 1 million shares of our common stock in connection with redemptions from our preferred stock and the exercise of warrants previously issued under our Series A preferred stock in unit offerings. Overall, we had approximately 43.7 million shares of common stock outstanding as of June 30, 2019, representing an increase of 10.9% compared to the second quarter last year.

From a capital markets perspective, we have seen some interesting developments. Interest rates have declined sharply in the last 2 quarters and currently sit almost 125 basis points off the recent peak in quarter 4 of last year. We continue to believe that interest rates will be volatile in 2019 with domestic and global pressures presenting unpredictable conditions. Given the recent volatility and the uncertainty in the environment, we have taken a cautious approach to our acquisition and portfolio financing strategy.

Approximately 96% of our permanent property-level mortgage debt has fixed interest rates or variable interest rates that are caped. Our borrowings under the line of credit as of today are 0, and we believe the current capacity of our line will serve us well for the foreseeable future, including the additional $100 million accordion feature we have in the current facility. This feature allows us to expand the total facility up to $300 million.

We recently completed the refiling of our ATM program, which has been one of our favorite ways to raise capital when the stock price is accretive to doing so. The new program runs for 3 years and is set at $125 million. Remember that our growth is fueled by both the common and the preferred stock. So when the common stock price isn't as favorable, we are not limited in our ability to grow.

On the acquisition front, we continue to utilize longer-term fixed-rate debt for all of our property types and have taken advantage of the recent drop in the interest rates to refinance maturing loans with attractive terms.

The company recently converted a floating rate loan on a multifamily asset to a fixed-rate 10-year loan with the same lender. The loan extends our maturity, takes some refinance risk off the table and lowers our rate on the deal by approximately 90 basis points. In addition, the lender waived the prepayment penalties. So the transactional costs create only marginal expenses for the company. We have approximately $100 million maturing debt in 2019 remaining to refinance. We've already begun the process of securing new debt for the majority of these assets and in most cases have already locked the rate.

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. It is worth noting that the regulator for the GSEs has signaled that the caps for the agencies will not be raised in 2019 and that uncapped landing will be more closely scrutinized now and in the future.

While some of this is political brinksmanship, the prospects of the GSEs losing market share has increased considerably in the last few months. Due to the environment and the increasing restrictions, GSE spreads have widened marginally as the transaction volumes have remained strong and the ability for the agencies to do uncapped business has become more difficult.

We expect spreads to continue to widen somewhat and live company debt for multifamily assets to become more attractive and competitive. Ultimately, the balance between spreads and loan volume will be dictated by the pace of transactions, which, at this point, show no signs of slowing down. The lender pool for our grocery-anchored retail product remains deep, and the demand for that debt remains strong.

We have recently seen a contraction in spreads on 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 of these loans may be longer.

These are typically larger transactions and the lender pool is smaller than the one for our grocery-anchored retail deals, which are a more manageable size.

Nonetheless, we are seeing strong lender demand for our office acquisitions. And our deep relationships with the lending community continue to serve us well.

I'd now like to turn the call over to Dan DuPree.

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [4]

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Thanks, John. In our first quarter call, I referred to this as a transformative year, a year in which we intend to set a course and structure that over the next decade, we believe, will put us in a position to continue to deliver value for our shareholders in a consistent and more predictable way.

The first step down this road has been to focus on operational results. In the second quarter, our same-store multifamily set, which is comprised of 21 properties and approximately 63% of multifamily revenues, achieved total revenue growth of 2.9%. Operating expenses were only up 1.5% and same-store NOI increased by a very strong 3.9%.

At the end of the quarter, our same-store occupancy was 95.6%. For the first half of the year, same-store NOI is up 3.5%.

In addition to focusing on operating results, we have continued to be patient and disciplined in our ability to do investment. Each of our business units have specifically defined strategies and parameters in which they operate. In multifamily, we are looking generally at markets of 1 million people or more with solid job growth. Job growth leads to household formations. Our multifamily business is less geographically bound than our other 2 property types but the majority of our multifamily portfolio is located in the Sun Belt states in Texas. The portfolio is by far the youngest such portfolio, at 5.4 years old on average, in the publicly traded multifamily REIT universe.

In new market, Joel Murphy has carefully crafted his retail strategy to the Sun Belt and mid-Atlantic-only grocery-anchor and beyond that focusing on the #1 or 2 market share traditional grocer in a given market. He is proud that the strategy has allowed him to claim that on the heels of 5 years of numerous retail bankruptcies, New Market has experienced the loss of only 3 tenants to bankruptcies and chain-wide store closure, that being 2 RadioShacks totaling 4,000 square feet and 1 7,000 square foot Dressbarn. Put it in context, in the aggregate, these represent less than 0.2% of our 5.4 million square foot retail portfolio. The office strategy is simpler still. We're focused on 6 markets. Atlanta, Charlotte, Raleigh, Nashville, Austin and Dallas. Within these select growing markets, our focus is restricted to major submarkets with fragmented ownership where we can create critical mass and drive rates.

Our multifamily group closed on an aggregate loan investment of up to $7.2 million for the construction of a 204-unit Class A community in Tampa, Florida. This community is located within the 500-plus acre Hidden River Corporate Park, containing 1.2 million square feet of office, medical, hotel and residential uses.

Our mezzanine book -- loan book now has $443 million in loan commitments and 360 million -- $180,000 of that is funded to date. This program continues to be a meaningful source of revenue and an excellent pipeline for acquisitions. We now own 32 multifamily projects containing just under 10,000 units.

And speaking of business units, let's turn our attention to New Market. In the second quarter, we closed on 3 grocery-anchored assets, the first Free State shopping center is a 264,000 square foot center located in the heart of the Washington, D.C, Baltimore corridor in Bowie, Maryland. The acquisition of Free State marks our entry into the Washington, D.C. MSA and is our first center anchored by a Giant Food. This is a significant new relationship for New Market. As Giant is the #1 market share grocery in D.C. and is one of the leading U.S. banners for Ahold Delhaize, one of the largest grocers in the world.

The other 2 acquisitions are both publics-anchored centers located in Florida. Polo Grounds is 130000-square foot grocery-anchored center located in the high barrier-to-entry market of West Palm Beach.

Disston Plaza is a 129000-square foot grocery-anchored center, located in the densely populated submarket of St. Petersburg. With the addition of these 2 properties, we now own 25 publics-anchored centers in 6 states and are now the fourth largest publics landlord in the country.

Leasing space, renewing tenants and keeping tenants happy is a daily focus for us as evidenced by the fact that 15 of our 49 centers are 100% leased.

At the end of the second quarter, the total portfolio was 93% leased. And our portfolio, excluding redevelopments, was 95.4% leased. We also have had great results with our lease renewal efforts.

As of today, we own 49 grocery-anchored shopping centers in 9 states, 20 markets with over 800 independent operating leases. In our office subsidiary, Preferred Office Properties, we executed 3 leases, totaling 110,000 square feet with a total lease value of over $20 million at Ravinia, a project we own here in Atlanta.

At 150 Fayetteville in Raleigh, North Carolina, the U.S. attorney's office took occupancy of 56,000 square feet. And we continued our extensive updating of the lobby in common areas. Across the street from 150, we continued architectural design work for our proposed new office building on a site we obtained when we acquired the 150 Fayetteville office building in a downturn office market that is highly restrictive on new development despite being more than 95% occupied. We discovered in our due diligence, this site was already approved for up to 40-story office building. In essence, we got a prime development site for free. On June 30, we sold the senior construction loan held by us on the 8 West office development to a third-party for a $1.55 million fee. We continue to hold the mezzanine loan at $19.193 million on the development. In short, we sold a single-digit IRR return and retained a high-teens IRR return with this transaction.

At the end of the quarter, our office portfolio was 96% leased with a weighted average remaining lease term of 7.7 years. Subsequent to quarter end, we acquired a 300,000 square foot Class A office building in the robust North Hills submarket of Raleigh, North Carolina, one of our aforementioned target markets. This building CapTrust Tower was built in 2010 is 100% leased with 7.5 years of weighted average lease term remaining.

Our office portfolio today stands at more than 2.878 million square feet across 7 very well-located properties. Each of our business units are self-contained with teams in each of -- and each that are entirely focus on their respective businesses.

They are responsible for the development of strategies and are populated with experienced team members who come to the office every day intent on driving results in their particular business segment.

For us, a transformative year means a lot of different things, it means exploring the wisdom of internalizing our management. It means moving toward an equity capital stack that is more balanced and sustainable. It means taking advantage of our deep bench to create a multi-tier succession plan that perpetuates what we believe to be a unique culture that is driven to create outsized shareholder returns. Since the day we were first listed through the last day of the second quarter, we have given our common shareholders a 19.1% annual return assuming the reinvestment of dividends.

We're also taking a long look at the composition of our portfolio to make sure we're investing in asset classes, which we believe offer the best opportunity for consistent success.

During the second quarter, we received an unsolicited offer to acquire our entire student housing operating portfolio from a very qualified prospective purchaser. After serious consideration, and as disclosed in an 8-K filed on May 31, we entered into a contract to sell this 8-asset portfolio. At the end of the due diligence period, on June 28, the purchaser elected to terminate the agreement, and that's disclosed in an 8-K filed on July 5 and forfeited $1 million in earnest money.

As further disclosed in that July 5 8-K, they did later request to enter into a new purchase agreement. And yesterday, we signed a new agreement to sell 6 of the 8 properties on our student housing portfolio. After careful consideration, we elected to withdraw 2 of the assets from this deal, believing there was even more value to be harvested in these properties over time. This purchaser now has $3.25 million of earnest money at risk on these 6 assets with a closing date set for fourth quarter.

This is a consistent and prudent step -- strategic step for us to exit the student housing business segment, but also an election by us to do so with a more measured approach. Our strategic decision on this exit relates to our view that to be successful in student -- in the student housing segment, you need to have significant scale. And due to what we believe to be some out of balance supply metrics in this segment, we were unwilling to invest more financial or human capital into the segment. This is the second step in our transformation that we discussed at the outset of the call.

That third step of our transformative year, and as disclosed in an 8-K filed on April 2, our external manager, Preferred Apartment Advisors informed the company that it was considering making a proposal regarding internalizing the manager. The Board setup a special committee composed of independent directors to work through this process with the appropriate legal and financial advisers, and this process continues to be ongoing.

The company and the manager are aware of the many long-term benefits that could result from an internalized structure. As we continue to explore these long-term benefits, you'll note that the company will be incurring expenses in connection with this process. We're issuing between $40 million and $45 million of our preferred stock into the independent broker-dealer and RIA channels monthly. We have raised over $327 million year-to-date.

Our ability to raise attractive capital through this network allows us to have clear visibility to steady and predictable capital inflows and gives us tremendous competitive advantage in the marketplace. At the same time, this capital ability can periodically put pressure on us to efficiently invest this capital accretively. We remain steadfast to invest within the focused strategies of our verticals. The result of this discipline is that we have periodically uninvested capital on our balance sheet. Accumulative effect of these potential large and strategic moves articulated on this call and our filings that we believe will have a significant long-term positive impact on our company, but they may create some short-term volatility on our earnings and FFO per share. Until we have full visibility to it, as and when these moves materialize in the final form, we are now currently adjusting our 2019 FFO guidance of $1.44 to $1.50 per share.

The team is energized and excited as we move into this next phase of the evolution of the company. We will continue to exploit our entrepreneurial abilities and external relationships in order to seek to do what great real estate companies have done historically, which is to create outsized returns over time for our shareholders. I'd like to thank you for joining us in our earnings call this morning.

And I will now turn the call back over to the operator to open the floor for any questions and thoughts you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Merrill Ross, Compass Point Research.

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Merrill Hadady Ross, Compass Point Research & Trading, LLC, Research Division - Analyst [2]

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I'm wondering as you exit student housing and looking at your acquisition activity year-to-date, being it somewhat depressed, relative to maybe what I was expecting, which may have been aggressive. But then having a smaller balance sheet, I'm wondering if you open up into another vertical? Do you follow your developers into another property type? Or do you feel that there is sufficient opportunity in the 3 basic units that you have remaining?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [3]

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Merrill, this is Dan. At this point, I think we're really comfortable with the 3 remaining property types that we have. We have, as I am bumbling away explained, we have great talent, I think, at all 3 of those categories. And the key to success is having the talent to execute. This will shrink the balance sheet temporarily. We have a -- an extremely deep pipeline, I think, of multifamily projects that we're in the process of competing for. And of course in office when we do a deal, those deals tend to be larger. And Joel has been -- on the retail front, has been very active in his acquisition pipeline. I think he's got over $100 million of acquisition in the last 90 days. So I think we're going to be able to utilize the capital that we're going to get from the sale of the student housing. I think we'll be able to use it very, very quickly. But it does kind of point to an issue that we alluded to in the comments, and that is we ended the quarter with a fairly significant amount of cash on the balance sheet. We're going to stay as disciplined as possible to not buying assets just for the sake of buying assets and deploying the capital. There are a number of historical stories in the space where people raised considerable money in the broker-dealer channel and then just went out and bought whatever they could buy. We're not going to do that. We'll take our lumps, if we have undeployed capital for a short period of time. But this is a very wordy answer. And I think everything I've done this morning has been very wordy. But we're going to stay with the 3 verticals we have right now.

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Merrill Hadady Ross, Compass Point Research & Trading, LLC, Research Division - Analyst [4]

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I think this discipline is key. Just a follow-up on unrelated manner. Is there any timetable that the external manager and the Board are looking at in terms of (inaudible) data and internalization?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [5]

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No. I don't think we put a time frame on it. We want to be thorough and complete. We think it's -- it is an appropriate time to take a deep look at this. But we don't have a time frame. We are being diligent.

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Operator [6]

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Thank you. This concludes our question-and-answer session. I would now like to turn the conference back over to Lenny Silverstein for closing remarks.

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Leonard A. Silverstein, Preferred Apartment Communities, Inc. - Co-Founder, Vice Chairman, President & COO [7]

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Thank you very much. We appreciate the time you've all spent with us this morning. We look forward to an exciting quarter coming up for the third quarter, and enjoy the rest of the day. Thank you very much.