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Edited Transcript of APTS earnings conference call or presentation 5-Nov-19 4:00pm GMT

Q3 2019 Preferred Apartment Communities Inc Earnings Call

ATLANTA Nov 25, 2019 (Thomson StreetEvents) -- Edited Transcript of Preferred Apartment Communities Inc earnings conference call or presentation Tuesday, November 5, 2019 at 4:00:00pm 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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* Michael Robert Lewis

SunTrust Robinson Humphrey, Inc., Research Division - Director and Co-Lead REIT Analyst

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to the Preferred Apartment Communities Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note that this event is being recorded.

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

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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 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, 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's 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 2019, 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 a close over the next few months, we will launch our next preferred stock capital-raising strategy designed to enable us to continue our solid growth objective. The success of our preferred-capital raising programs has enabled us to acquire an aggregate of approximately $289 million in new assets and 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 center and office properties in 15 states and 56 markets, primarily in 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're extremely pleased with the successes we've achieved in these areas and look forward to continuing this momentum.

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 third quarter 2019, PAC generated revenues of just over $120 million; FFO of $0.31 a share; and AFFO of $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 is 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 note 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 AFFO 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 2 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 when the borrower under the real estate loan investment has a capital event. Meaning, either a sale or a refinance of the property. Sometimes, our developers pay us early from cash flow and sometimes, we receive the cash payments upon one of these capital events. 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 $0.2625 per share, almost 3% greater than the dividend paid to our common stockholders for the third quarter of 2018. As we have previously discussed, we continue to focus on increasing the float of our common stock. During the third quarter 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 under line of credit as of today are 0, 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 to the end of 2020. This generally sets the bar at 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 have widened significantly recently as the transaction volume remained strong and the ability for the agencies to do uncapped business had become more difficult. With this new cap structure, we expect spreads to contract somewhat but in a measured way over a period of months. Life 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?

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

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Thanks, John. As we have discussed previously, each of our business units has a very 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 in good growth. Nearly 3/4 of our multifamily assets are in 3 states: Georgia, Florida and Texas. Overall, we have 34 communities with 10,245 units, average rents of almost $1,400 a month or $1.34 a square foot.

Our retail strategy is 100% grocery anchored, typically anchored by the #1 or #2 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 in 9 states, totaling 5,644,000 square feet. Publix and Kroger/Harris Teeter are our 2 biggest major tenants, with 38 stores occupying 1/3 of our GLA. We are now the fourth largest Publix landlord in the country.

Our office property strategy is more focused still with 6 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 both 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 at quarter's end. The current book covers 21 loans; over 4,837 multifamily units; 1,895 student housing beds; 195,000 square feet of retail space; and 187,000 square feet of office space. Our loan book is relatively constant as loans pay off and 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 investments.

For the quarter, in 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 in 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% leased. Over the course of 2019, we had 8 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, has 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, 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 acquire the property. On those leases, we achieved an average cash rent roll -- roll-up of more than 15%, stunning number. Our portfolio-wide weighted average lease term remaining is nearly 8 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 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 disproportionately vulnerable to periodic oversupply of product in a given market in student housing, creating uneven results over which we have no control. We have seen this in a couple of our markets. We'll be retaining 2 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-advised structure has been critical to the start and success of PAC to date. There's 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 1 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 compliment 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 rich is 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 costs 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 in 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 than 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 PAC to date, $0.036 per share. Having too much cash is the ultimate high-class 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 booked 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 when 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 to AFFO in accrued interest.

With all of that having been said, I'd like to thank you for joining us on our 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?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from Michael Lewis with SunTrust.

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Michael Robert Lewis, SunTrust Robinson Humphrey, Inc., Research Division - Director and Co-Lead REIT Analyst [2]

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Great. 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 target? Or is that kind of a decision made by management during or at the end of the quarter?

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

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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. As we go through this process of exploring internalization, one of 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, it would be nice to have that behind us.

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Michael Robert Lewis, SunTrust Robinson Humphrey, Inc., Research Division - Director and Co-Lead REIT Analyst [4]

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Great. Okay. And then on the dividend coverage, I understand the lumpiness of the AFFO and the accrued interest buildup 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?

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

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Yes. What I would tell you on that, I'll give you a classic example. In the third quarter, we had none of our mezz loans pay off in the third quarter and it's not something that we frankly control. Already in the fourth quarter, we've had 2 mezz loans pay off and there's a good chance we'll end up having a couple more this quarter. It is a -- our mezz loan business 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 have not yet captured. And that'll get spread out in a lumpy fashion, probably over the next -- that $27 million, probably over the next year, 1 year, 1.5 years, 2 years, providing more than adequate coverage of our dividend.

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Michael Robert Lewis, SunTrust Robinson Humphrey, Inc., Research Division - Director and Co-Lead REIT Analyst [6]

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Okay. 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 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 a risk here that you have to -- that there's 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 overthinking that?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [7]

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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 in that regard. But I can tell you, at 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 it's 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, did you have something you wanted to add to that?

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John A. Isakson, Preferred Apartment Communities, Inc. - CFO & Executive VP [8]

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Michael, whenever you look at the payment, one of the things to think about is 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.

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Operator [9]

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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.

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [10]

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Yes, 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's 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.

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Operator [11]

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The conference has now concluded. Thank you for attending today's presentation. You may disconnect.