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

Q1 2019 Preferred Apartment Communities Inc Earnings Call

ATLANTA May 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Preferred Apartment Communities Inc earnings conference call or presentation Tuesday, April 30, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Boone DuPree

Preferred Office Properties, LLC - CEO

* Daniel M. DuPree

Preferred Apartment Communities, Inc. - Chairman & CEO

* Jeffery D. Sherman

Preferred Apartment Communities, Inc. - Executive VP & MD of Multifamily

* Jeffrey R. Sprain

Preferred Apartment Communities, Inc. - Executive VP, General Counsel & Corporate Secretary

* Joel T. Murphy

Preferred Apartment Communities, Inc. - CEO & President of New Market Properties LLC

* John A. Isakson

Preferred Apartment Communities, Inc. - CFO & Executive VP

* Leonard A. Silverstein

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

* Paul Cullen

Preferred Apartment Communities, Inc. - Executive VP & CMO

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Conference Call Participants

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* James O. Lykins

D.A. Davidson & Co., Research Division - VP & Research Analyst

* Merrill Ross

Boenning and Scattergood, Inc., Research Division - Senior Research Analyst of REITs

* Michael Robert Lewis

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

* Rick Murray

Sorin Capital Management - MD & Head of Equities

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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 First Quarter 2019 Earnings Conference Call. (Operator Instructions) This conference is being recorded. (Operator Instructions)

I would now like to introduce your host for today's conference call, Mr. Jeff Sprain, General Counsel.

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Jeffrey R. Sprain, Preferred Apartment Communities, Inc. - Executive VP, General Counsel & Corporate Secretary [2]

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

We hope that each of you have had a chance to review our first quarter earnings report, which we released yesterday after the market closed. In a moment, I will be turning the call over to Dan DuPree, our Chairman on the Board and CEO, for his thoughts. Following the conclusion of our prepared remarks, we'll be pleased to answer any questions you might have.

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 may be found on our website at pacapts.com.

The press release also includes our supplemental financial data report for the first 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 the 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.

I now would like to turn the call over to Dan DuPree. Dan?

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

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Thanks, Jeff.

We're pleased with our first quarter results. They represent excellent operational focus coupled with a disciplined approach to each of the strategies in our different business units. I want to take a minute this morning to talk about the quality of the senior management team we have at PAC. I've been in this business for over 40 years and have had the opportunity to work with some extraordinary teams, but I believe top to bottom, this team is the deepest in terms of both talent and work ethic that I've ever worked with.

You'll hear this morning first from Lenny Silverstein, our President and Chief Operating Officer, about our first quarter results. Lenny helped found PAC with John Williams in 2011 and helped create our unique capital structure. Next, John Isakson, our excellent Chief Financial Officer, will discuss capital markets. John enjoys a unique invaluable -- unique invaluable relationships in this space.

Joel Murphy is the Chief Executive Officer of our New Market subsidiary. He is also Chairman of our investment committee covering all property types. Joel and I have worked together across 3 platforms for over 30 years. He'll walk you through our active first quarter in terms of our retail activities. Jeff Sherman will report on our multifamily business, which he leads as Executive Vice President. He has been challenged on the acquisition front because multifamily cap rates have compressed so much, but he has championed the focus on operations and mezz loans, which I believe will bear fruit for many quarters to come. Jeff has over 20 years in the multifamily business covering acquisitions, development and asset management.

Next, you'll hear from Boone DuPree, Chief Executive Officer of our Class A office division. Boone has done an excellent job defining our strategy for this group, implementing it and growing our asset base. He came to us from Cousins Properties, where he played a key role in nearly $2 billion in Class A acquisitions.

Paul Cullen is the Chief Executive Officer of the Student Housing business unit as well as Chief Marketing Officer for Preferred Apartment Communities. As Chief marketing Officer, he leads our marketing team, which is a critical element of our branding efforts. Paul will speak about our successes in the operations and leasing of our various student housing projects. I should also say a word about our entire Preferred Capital Securities team. These are the folks who provide us with much of the capital we need to grow our business. Through the end of Q1 year-to-date, they have raised $142 million from the sale of our preferred stocks.

Not presenting today but equally important are Kim Hodge, our Chief Property Management officer; Mike Cronin, our Chief Accounting Officer; Jeff Sprain from whom you heard a moment ago, our General Counsel; and Randy Forth, who leads our excellent, very experienced asset management team.

When you invest in any company, it is the associates involved in running that company that will ultimately determine how successful your investment will be. From the day we went public in 2011, our common stockholders who invested with us that day and reinvested their dividends, assuming no transaction cost, would have achieved an 18.2% IRR due to the efforts of this team.

So with that, let's leadoff with Lenny.

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Leonard A. Silverstein, Preferred Apartment Communities, Inc. - Co-Founder, Vice Chairman, President & COO [4]

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Thanks, Dan.

We had a solid first quarter in terms of FFO growth and again produced a strong dividend. As you'll hear more about later, our multifamily same-store sales results were an impressive 3.1% on a quarter-over-quarter basis. We also continued our acquisition -- asset acquisition strategy during the first quarter through the acquisition of an 887-bed student housing community located adjacent to the University of North Carolina, Charlotte, and a 158,000 square foot grocery-anchored shopping center in Richmond, Virginia. To help fund our growth strategy, we originated 1 real estate loan investment for a new multifamily development in Destin, Florida, and raised an aggregate of over $142 million of capital from sales of our preferred stock through the independent broker/dealer and registered investment adviser channels during the first quarter this year.

As of the end of the first quarter, our real estate loan investment pipeline represents over $1 billion of prospective assets that we have the right to acquire. All in all, we are able to generate IRRs in the low to mid-teens through this program, while getting off market access to new quality assets through the purchase options embedded in these loans as well as rights of first offer.

On a more granular level, our revenues for the first quarter were over $111 million or over 23% greater than the revenues we earned for the first quarter last year. Our FFO for the first quarter 2019 was approximately $17 million or $0.39 per share, representing a 5.4% increase in FFO per share compared to the first quarter of last year.

These outstanding operating results for the first quarter of this year allowed us to pay a very solid common stock dividend equal to $0.26 per share or 4% greater than the dividend paid to our common stockholders for the first quarter in 2018. As we have previously discussed, we continue to focus on increasing the float of our common stock.

During the first quarter of this year, for example, we issued an aggregate of approximately 1.4 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 in unit offerings. Overall, we had approximately 43.2 million shares of common stock outstanding as of March 31, 2019, representing an increase of over 4 million shares or 10.3% compared to the first quarter of last year.

Switching to other financial statement metrics, we continue to add quality assets to our portfolio in a meaningful way. As of the end of the first quarter this year, our total assets net of depreciation were approximately $4.8 billion, or an increase of approximately $392 million or almost 9% compared to December 31 of last year.

As we've said many times before, our success is the result of our ability to function as a team.

So let me know call on John Isakson, our Chief Financial Officer, who will discuss our capital market strategy. John?

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John A. Isakson, Preferred Apartment Communities, Inc. - CFO & Executive VP [5]

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Thanks, Lenny.

For 2019, we continue to expect the cap rates on multifamily acquisitions will remain low, with grocery-anchored shopping center and Class A office acquisition cap rates higher. In 2018, the low cap rate environment contributed to our decision to sell 3 assets. One of these assets closed in the first quarter of 2018 and generated a substantial gain. We did not sell any assets in the first quarter of this year, so the variance in that line item will account for the notable variance in our net income number. And while not one of our most important metrics, the difference is worth explaining. Interest rates have been generally declining in the last 3 months and currently sit about 75 basis points off the recent peak in Q4 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 94% of our permanent property-level mortgage debt has fixed interest rates or variable interest rates to that caps. Already this year, we've refinanced 2 of our floating rate retail deals into fixed rate loans, in both cases actually reducing the interest rates on the debt and extending the maturity.

As we referenced last quarter, we recently closed on the extension of our $200 million corporate line of credit extending the maturity for 3 years and giving us flexibility for an additional year at the end of term. Our borrowings on the 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. In the event we need to increase the capacity of the line, we have an accordion feature that allows us to expand up to a total of $300 million.

We recently filed an updated shelf registration statement of up to $400 million. The shelf gives us the flexibility and optionality to issue common stock and otherwise access the public markets as we see fit when common stock prices are attractive.

On the acquisition front, we've been utilizing longer-term fixed-rate debt for all of our property types and have taken advantage of the recent drop in rates to refinance maturing loans with attractive terms. We have approximately $100 million in maturing debt in 2019 remaining to refinance. We've already begun the process of securing new debt to these assets. And given the current rate environment, we will look to lock in our interest rates as soon as practical.

For our multifamily portfolio, Freddie Mac and Fannie Mae remain our primary lenders. We have enjoyed preferred borrower status and have excellent relationships with both agencies. It is worth noting that the recent appointment and confirmation of Mark Calabria to head FHFA, the regulatory body for Freddie Mac and Fannie Mae, has raised the probability of GSE reform in the near future. In the current environment, GSE spreads have widened as volumes for debt have remained strong and the ability for the agencies to do uncapped business has become more difficult. We expect spreads to widen somewhat and live company debt for multifamily assets to become more attractive and competitive.

The lender pool for our retailer 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 live 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 retail deals, which are of more manageable size. Nonetheless, we have seen strong lender demand for our office acquisitions, and our deep relationships with the lending community continue to serve us well.

Jeff Sherman will now discuss our first quarter 2019 multifamily results. Jeff?

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Jeffery D. Sherman, Preferred Apartment Communities, Inc. - Executive VP & MD of Multifamily [6]

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Thanks, John. I'm pleased to announce strong operating results for the multifamily portfolio during the first quarter of 2019. Our same-store set achieved first quarter year-over-year rental revenue and total revenue growth of 3.1% and 2.8%, respectively, while total operating expenses were held to a modest 2.3% increase. This resulted in same-store net operating income for the first quarter increasing 3.1% with physical occupancy averaging 95.2%.

Revenue was driven by a combination of rental rate growth and improved occupancy. Our operating and maintenance expense was down 2.7% compared to the first quarter of 2018 as we began strategically rolling out cost-saving measures, including a national contract for our maintenance supplies. We did see an increase in payroll, with the additional expenses generally due to timing of adjustment for employee health care costs. Over the course of the year, we expect the annual payroll expense to moderate.

I also want to remind everyone that our 3.1% same-store net operating income increase is now calculated from 21 properties as compared to 10 properties in 2018. This new composition covers 8 states and 13 MSAs versus the 2018 same-store set, which included only 4 states and 7 MSAs. It is also worth noting that our complete multifamily portfolio now consists of 32 properties with an average age of 5.2 years old.

Turning to acquisitions. While we did not acquire any multifamily property during the first quarter, we continue to see a deep pipeline of quality product. We remain steadfast in our approach to purchase properties that are both a strong market and property level fundamentals and which are accretive during our period of ownership.

We did close on a real estate loan investment of up to $10.8 million for the construction of a 282-unit Class A multifamily community located in Destin, Florida. This community is located in the heart of Destin, and we believe will serve as the premier rental community in the area. With the addition of this investment, PAC's multifamily loan investment portfolio consists of 14 multifamily projects totaling over 4,300 units. We continue to see a strong interest in our real estate loan investment program and have been successful in expanding our developer relationships over the last few years.

As we've said before, this loan investment program has been an integral part of our business models since our IPO and provides us with the pipeline of new properties and carries embedded value of each loan that can be recognized in a variety of ways.

Let me now call on Joel Murphy, the President and Chief Executive Officer of New Market retail division. Joel?

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Joel T. Murphy, Preferred Apartment Communities, Inc. - CEO & President of New Market Properties LLC [7]

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Thanks, Jeff. We're pleased to report another strong quarter of overall operating performance. The continued solid result of our growing grocery-anchored portfolio are a result of the collaborative efforts of each of our team members, from acquisitions to asset management, leasing, accounting and property management, all working very hard every day to create value for PAC and our stockholders.

We continue to execute our focused strategy to acquire, invest in and operate grocery-anchored centers that fit our investment criteria in quality, suburban submarkets within the top 100 metro areas from the Mid-Atlantic, Southeast, Florida and now through Texas. We target centers that have market dominant grocery store anchors that maintain a #1 or #2 market share in that submarket and have high ingrowing sales per square foot stores. Leasing space, renewing tenants and keeping tenants happy is our daily focus. At the end of the first quarter, our 4.9 million square foot portfolio was 49.1% leased and our portfolio, excluding redevelopments, was 45 -- 95.6% leased. 14 of our 46 centers are 100% leased.

In 2019, we have 8 grocery store anchors that have leases rolling and 6 of them have already renewed their leases at their contractual rates. In early Q1, we closed on Gayton Crossing, a Kroger shadow anchored shopping center in Richmond, Virginia. This is our second asset in Virginia and our first in Richmond. It is located in a highly desirable West End submarket and Kroger has a very high volume store in the center. Gayton Crossing is an excellent example of the focused strategy we just described anchored by a market leading grocer that has high sales per square store and located in a quality, sunbelt or Mid-Atlantic submarket with solid demographics.

We continue to implement our capital improvement in major repair and maintenance plans. We are mindful to create long-term value for each of our assets, while providing a best-in-class environment from which our tenants too thrive. These projects included LED lighting and landscaping upgrades, signage, shopping center painting, facade upgrades and new parking lots and roof replacements. We executed on all cylinders in the first quarter. We leased vacant space. We kept our centers leased. We renewed at higher rates. We managed our expenses and had very little bad debt expense and we grew our portfolio. The combination of these positive trends allowed our new market subsidiary to obtain outstanding results to PAC.

As of today, we now own 46 grocery-anchored centers in 8 states and 19 markets totaling approximately 4.9 million square feet with nearly 800 independent operating leases. 23 of these centers are anchored by Publix and 13 are anchored by the Kroger, Harris Teeter banners. Both Publix and Kroger are market share leaders, with Publix reporting adjusted net earnings for 2018 of $2.5 billion and Kroger reporting 2018 adjusted net earnings of $1.7 billion. We remain active in the acquisition marketplace. And while we have a deep shadow channel pipeline and are very focused on new opportunities, we remain diligent to stay inside our tight geographic and product-type strategy, while also being very disciplined about our due diligence and our pricing.

Let me now turn the call over to Boone DuPree, the Head of our office division. Boone?

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Boone DuPree, Preferred Office Properties, LLC - CEO [8]

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Thanks, Joel. The first quarter for our office division featured an emphasis on asset management as we digest the more than 1 million square feet of Class A office properties that we acquired in 2018. We brought on several key new associates, including our Head of Development, Jason Frost; Vice President of Asset Management, Mahesh Mani; and Associate, Tim Peterson, who supports the team across our different endeavors. With these additions, our capacity grows exponentially and we are happy to have them join us.

Moving to the portfolio. Today, we own and operate approximately 2.6 million square feet of Class A office property. The portfolio is 93% leased with approximately 8 years of weighted average term remaining under those leases. Our most recent 2 investments, Capitol Towers in Charlotte and 150 Fayetteville in Raleigh reflect the geographic focus, which extends beyond Charlotte and Raleigh to include Atlanta, Boston, Dallas and Nashville. These 6 primary markets share 2 important qualities in common: First, each features long-term, high-growth trends in population, job creation and wage gains. This is driven generally by advantages and quality of life, cost of living and business-friendly political policy. The recent relocation and expansion announcements from AllianceBernstein, Honeywell, BlackRock, Google, Apple, Amazon, Facebook, and the list goes on, all serve to affirm our thesis.

The second shared quality is our team's individual and collective experience in investing, operating and developing in these 6 primary markets. In these markets, over the last 10 years, our senior leadership has acquired approximately 6 million square feet of Class A office, operated a cumulative portfolio totaling more than 11 million square feet and delivered new construction office development totaling more than 1 million square feet. Our business is at its core a leasing business and leasing is conducted at the local level. So this depth of experience, specific to our primary markets, is fundamental to our success.

Moving to updates from the portfolio, despite no new closed investments in the quarter, we had a lot going on in Q1.

Project construction for our 8 West real estate loan investment in Midtown Atlanta is well underway, with good preliminary interest to lease space in the 187,000 square foot building scheduled to deliver the second half of 2020. Like many of PAC's other real estate loan investments, we have an option to purchase the development upon its stabilization.

At Three Ravinia, subsequent to quarter end, we were able to execute on a strategic lease transaction to incrementally reduce exposure to State Farm's 2021 move out by taking back some space early, collecting a termination payment and partially backfilling that space with a high-quality, high-growth new customer. The new customer will initially occupy 1 of the 3 floors State Farm will return to us, although they have expansion options they may elect to exercise.

In Raleigh, we kicked off an expensive renovation of 150 Fayetteville, including the building's lobbies, plaza and other common areas, to elevate the 30-storey property to premier stature at the top of the Downtown Raleigh market. This project is scheduled to be substantially completed in late summer.

We are excited about the prospects of our business and confident in the strategy. Office demand is strong across our 6 primary markets and the pipeline in front of us is very full. We will continue to work hard to uncover and execute on good risk-adjusted opportunities to make money for our stockholders.

With that, let me now turn the call over to Paul Cullen, the Head of Preferred Campus communities, our student housing division. Paul?

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Paul Cullen, Preferred Apartment Communities, Inc. - Executive VP & CMO [9]

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Thanks, Boone. Our student housing strategy continues to focus on acquiring best-in-class properties, located within walking distance in the center of the respective university campuses that have strong enrollments. As of the end of the quarter, Preferred Campus Communities owned 8 properties in 5 states across 8 different universities, totaling 6,095 beds. Interestingly, the average age of our student housing portfolio is only 4 years old.

With increased performance across the portfolio and strong operating results in line with budget expectations, we continue to see the benefit from our student housing management team leasing efforts to gain additional spring leases and maintain stabilized occupancy levels. At the end of the first quarter this year, physical occupancy at our 6 stabilized student properties was 95.6%.

We see improved future performance at several assets related to the strong preleasing capacity for the 2019-2020 academic year, and are working toward stabilizing all of our assets to suffice the expansion of third-party inventory at some of our markets, as student housing management team is continuing its preleasing efforts and we expect the team to deliver another strong lease-up across the portfolio for the 2019-2020 school year. In fact, we have already passed 80% lease-up for the entire portfolio for the 2019-2020 school year.

I want to take a moment to thank and acknowledge this team for all their efforts, in particular Brian Harrison, our asset manager. Preferred Campus Communities most recent acquisition of Haven49, an 887-bed property located adjacent to the campus at UNC Charlotte with an enrollment of 30,000 students, was initially part of our real estate loan investment program. This property offers our student housing division the opportunity to enter the extremely well-located, new asset at a growing university.

Preferred Campus Communities has already begun implementing the takeover plan, including capital projects with a focused marketing campaign to win over current and future residents. In the brief period since acquisition, there has been a number of meaningful increases in the preleasing activity and the excitement around the new ownership is resulting in higher occupancy and rent growth.

Although there were no new loan originations for student housing in this quarter, we continue to pursue both debt and equity investments in new, highly amenitized properties neighboring top tier campuses as part of our student housing acquisition strategy, and we remain active participants in many geographic markets.

Finally, we look to grow our student housing portfolio through disciplined investments, while sustaining revenue growth and moldering expenses of existing communities. I look forward to updating you on the portfolio's performance on our next earnings call.

I will now turn the call back to Dan DuPree. Dan?

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

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Thanks, Paul. We expect 2019 to be a transformative year for PAC as we seek to build a sustainable program of excellence. We do this in part by leaning into our core strategy of investing into 4 distinct product classes. We believe this strategy has served us well. We are unique, in that we raise capital both through the sale of our common stock to the public market and also through the sale of our preferred stocks through the independent broker/dealer and RIA channels. We have significant capital coming in through the sale of the preferred every 2 weeks.

Imagine what would happen if over the past 2 years, our only option was to invest in multifamily assets, which have seen unprecedented cap rate compression. Through product diversification, we are able to invest efficiently and accretively. We are fortunate to have strong leaders at the helms of our various business units to execute on their well-defined targeted strategies. We've had some friends tell us that our cost of capital is too high with our preferred dividend at 6%. Our response is that if we were giving our stockholders a 3% to 4% total return over a number of years, as many people in the public space do, then we would agree that a 6% dividend was too high. But in our case, where we've given our common stockholders in excess of an 18% return since day 1, the 6% preferred cost is pretty darn attractive.

We're running an IRR business and a quarterly reporting structure, and we are okay with this. I hope we always take the long view on our investments even though that might create short-term lumpiness. Last quarter, we signaled FFO guidance for 2019 in a range of $1.44 to $1.50 per share. This guidance remains unchanged. We also indicated that the second half of the year would be the better half, that too remains unchanged. Quarter 1 was a pleasant result, but we do not expect a similar result in quarter 2. Our real estate loan investment program continues to grow in terms of the number of quality development groups, who have invited us to participate in the capital stacks of their developments. We currently have over $484 million in loan commitments to 13 developers, with approximately $338.3 million of the committed amount funded to-date.

Finally, several weeks ago, we filed an 8-K in which we acknowledge that we were, on a preliminary basis, exploring the feasibility of internalization. As you can imagine, there is a process to this, and we really can't say any more on that subject.

As always our overwriting objective is to create value through our investments. While we have grown considerably in total assets since spring 2011, we are not driven by size. We sold 7 multifamily assets in the last 18 months, simply because it was the right thing to do for the portfolio. We will continue to put our current stockholders first, and we expect we will continue to deliver on our promise of excellence.

With that, I'd like to thank you for joining us on our earnings call this morning. And I'd like to turn the call back to our 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) The question is from Mr. Michael Lewis of 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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Dan, I wanted to go back to something you just said about the guidance. The low end of that 2019 range now implies $0.35 a quarter the rest of the year, the high end still only $0.37. You just did $0.39 in 1Q and said that the back half is going to be better. I guess maybe walk me through that. That seems a little -- it seems a little confusing to me?

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

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The fuddling? Yes, Michael. Our guidance remains unchanged. I said at the beginning of my final statement that this -- we expected this to be a transformative year. There are a number of things that we're looking at to try to smooth out lumpiness. The lumpiness, as you know, is created by the mezz loans, they payoff when they payoff. So our outstandings on the mezz loan can vary fairly wildly from quarter-to-quarter. We're moving away from the notion of the purchase option discount. We're recognizing more consistent gain through increase in accrued interest.

These are things that are going to take time. And there are other fairly significant initiatives that we're looking into this -- that may impact earnings over the year. I think it may be a mistake. I think it's AvalonBay that basically has a policy where they don't alter guidance after first quarter results. And for us, with all the things that we're looking at, and we feel very good about 2019, but looking at -- but thinking of all the things that we're looking at, we just felt like making any change to guidance at this point would be premature.

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

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Okay. Understood. You're right about AvalonBay. And I appreciate the uncertainty. My second question. It looks like the deferred interest rate on a few of the loan investments decreased, including this one in San Jose, which is your biggest one. Could you maybe give a little color what's causing that? Do you expect that to happen to additional loans?

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

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Yes. Well, the main thing that's happening is there an awful lot of capital chasing a finite number of deals. There is no question that the mezz loans that we're doing today are less attractive than the ones we were doing at the beginning of the cycle. So it's a question of competition. That particular deal in California, there was a toggle in their loan with us that allowed them to put in more equity and materially reduce the interest rate and the amount outstanding. We basically renegotiated that deal midstream.

And you're right, it does show a reduction in the accrued interest part. But that's -- that is 100% a factor of competition for the mezz loan dollar. And -- or the mezz loan opportunity. That having been said, we've got more developers now, more high-quality developers now that are seeking us out. I think we've got 13 different development groups now, and we've got multiple others that we're working on loans for. So we're encouraged that we're going to be able to maintain the outstandings on the real estate loan investments, probably between $450 million and $500 million in commitments. But it's going to be spread out over a larger number of people, but the deals are very competitive.

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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. Then just lastly for me. Dan, you mentioned managing book, taking the long-term view within this construct of quarters that could be up and down. I think you've also said in the past that your apartments still offer the most attractive long-term risk-adjusted opportunity on IRR. I'm just wondering if you still think that's true? And how you kind of balance that with being accretive in the short term?

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

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Well, I mean, that's the trick. I mean we're talking about a real estate company that I think is somewhat opportunistic investing in real estate, which is a long-term investment and trying to fit it into quarterly results. And one of the challenges is to not go overboard, trying to force quarterly results at the expense of the long-term deal. But yes, generally speaking, the IRRs on multifamily, as we underwrite our deals, I think, are -- continue to be compelling relative to the alternatives.

We get different things from different of our product types. And for the moment I'd say student housing probably operates most like multifamily.

Joel at New Market, we're getting much better short-term accretion benefit from his deals. We're buying them at cap rates the -- I mean the retail at maybe 100 basis points or more better than what we can buy the multifamily at. But you've got the anchor tenant that's got a fixed rent, so you're not going to get the bumps over the whole. The multifamily, you get lower cap rates now, which puts real pressure on short-term accretion, but the IRRs are good. But the IRR is a calculation that's predicated on what your assumptions are for exit cap rates. We generally add about 50 basis points over the purchase price cap rate in the calculation, but cap rates for multifamily are so low right now that even if you add 50 basis points in your IRR calculation that may or may not be a realistic down the road.

The office portfolio right now, particularly with GAAP accounting on straight line rents, we get a nice pop generally on an acquisition from an accretion standpoint in the early years. That kind of levels out because of the straight line, but we've still been able to achieve 2%-plus growth in that portfolio. So our IRRs on the multifamily right now probably look as good or better than -- I mean, on the office look as good or better than the other areas. That having been said, we can properly underwrite an office building and assume that a tenant is going to move out in year 7, and we're going to have to put in TI and we're going to have downtime, and it can be baked into our IRR, but it doesn't change the fact in year 7, it kind of stinks.

So our challenge is to blend all of this together into a cohesive unit. And when I refer to the transformative aspects of this year, we're working to try to smooth out some of that while not losing the -- our commitment to value creation. We're very serious about and very proud of that 18.2% total return to our shareholders since day 1. I don't know that we'll be able to sustain that level, but I think we're going to outperform the market, I hope so, going forward. I don't know if I answered the question in there, but I talked a long time, Michael. Surely, there was some question that I answered.

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Michael Robert Lewis, SunTrust Robinson Humphrey, Inc., Research Division - Director and Co-Lead REIT Analyst [8]

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You're uniquely positioned to comment on all these properties.

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Operator [9]

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The next question is from Jim Lykins of D.A. Davidson.

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James O. Lykins, D.A. Davidson & Co., Research Division - VP & Research Analyst [10]

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So first with the difficulty in acquiring multifamily right now. When you talk about that, are you also including student housing or are you seeing some opportunities there versus the traditional multifamily?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [11]

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Well, it's not difficult to acquire multifamily, it's just -- it's difficult to pay what they want you to pay. But cap rates have compressed, I think, equally on multifamily and student housing. They really do operate completely differently. We put them together as a class because there are people sleeping in beds and units that we provide. But they operate -- they do operate entirely differently. So to answer your question, the difficulty that exists because of cap rates in multifamily extends to student housing.

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James O. Lykins, D.A. Davidson & Co., Research Division - VP & Research Analyst [12]

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Okay. And for the purchase options, are there -- is there any color you can give us on how we should be thinking about there, or if your assumptions have changed versus where we were last quarter?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [13]

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Well, it was always a source of frustration for us that particularly early in the cycle, there was significant value in the purchase options, and it was never reflected in earnings anywhere other than maybe being sort of amortized over the hold of an asset. We made a decision a while ago to start figuring out how we could recognize the value of those purchase options and monetize them into FFO, which we've done.

We've sort of moved from that point to the point where we're opting to increase our accrued interest in new deals that we're originating and eliminating the discount, which was always difficult to calculate, and coupling that with the right of first offer so that we continue to control the asset, but we're basically recognizing the economic value of the deals on a quarterly basis. And that goes, again, to my point that we want to smooth out some of the lumpiness in our earnings calls.

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James O. Lykins, D.A. Davidson & Co., Research Division - VP & Research Analyst [14]

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Okay. And one last one, Dan. You mentioned internalization. I know there's not a lot that you can talk about now, but is there just any kind of rough time line on when we might know something else or maybe what to expect?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [15]

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Well, Jim, I -- there are 2 lawyers that we have on staff, and 3 counting Lenny and 4 counting Joel. If I say anything more than what we put out in the 8-K, I'm going to be beaten up. But we always said that from time to time, this was something that we needed to look at. So that's what we're doing.

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Operator [16]

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The next question is from Merrill Ross of Boenning and Scattergood.

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Merrill Ross, Boenning and Scattergood, Inc., Research Division - Senior Research Analyst of REITs [17]

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I think over time, I've been following you for quite some time, the key has been in the mezzanine loan program that allows you to buy assets at relative discount in multifamily, and that's extended now to some development in the student housing and office. As you grow more group of contractors, is there any inclination to add another asset class and continue the path of diversification? Or is it more likely that you stay concentrated in the group of 4 that you're currently focused on?

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [18]

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Merrill, honestly, I would tell you that when we started -- when the company was started, even though John and Lenny left room for us to invest in something other than multifamily, the expectation is that we would be very much a multifamily-focused company. We diversified into retail when we realized cap rates were compressing, our ability to raise capital was increasing and candidly we had access to Joel Murphy with whom I had worked for a number of years in retail. So those things coming together let us to diversify into retail.

About that time, one of our developers that we had worked with wanted to get into student housing, we thought that was a logical extension of our multifamily business, which, as I mentioned a minute ago, has proven to be more different than we had originally thought. And then the office thing was more serendipitous. So what I would tell you is that, we have no plans at all at this point to expand beyond the groups that we're in right now. We're really lucky because we have, I think, excellent expertise leading the 4 units that we have.

But I can't foresee an expansion beyond where we are. But again, we're an opportunistic company and if something were to come along, it made lot of sense, then we would certainly explore it. And I want to stress the point that I made in an earlier comment, what creates the need for us being a diversified REIT is the fact that we have this money coming in every 2 weeks. We have to be able to invest that capital accretively and efficiently and quickly. And it's an absolute necessity that we have some level of diversification that gives us the opportunity to do that.

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Operator [19]

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This concludes the question-and-answer session. I'd like to hand the conference back over to Mr. Dan DuPree for any closing remarks. Excuse me sir, there's actually another question registered by Rick Murray of Sorin Capital.

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Rick Murray, Sorin Capital Management - MD & Head of Equities [20]

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I was just curious if you could help us understand a little bit better what your definition of recurring CapEx is because it just seems that the $1.2 million for quarter that you recorded this quarter is really low for a portfolio your size?

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John A. Isakson, Preferred Apartment Communities, Inc. - CFO & Executive VP [21]

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Well, Rick, I think the recurring CapEx is a function of the age of the portfolio as much as anything else. We focus on high-quality new assets, and those newer assets have lower CapEx requirements. And I think that's been a historical trend as well.

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [22]

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We think the real point of the fact that our portfolio in multifamily is by, our measure, far and away the youngest in the industry. Paul Cullen speaking on student housing mentioned 4-year-old on average portfolio. I think we're at about 5.2 years old on our multifamily. And that's not by accident, it's because it gives us the opportunity to control CapEx. We're not likely to have any roof that needs to be replaced. In fact, the 7 assets that we've sold over the last 18 months, they were in each case sequentially the oldest asset we had at that time, and it was because we didn't want to get involved in capital expenditures for which we would not receive increased rent.

People expect their roof to be good and sound and their space to be dry, they expect their parking lots to be paved and set up. And these are all things that require significant capital if you hold assets long enough. It is a material advantage to us. When you compare us against our great other multifamily companies in this space, you compare the ages of our portfolios, and you'll see a market advantage for us in this particular regard.

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Rick Murray, Sorin Capital Management - MD & Head of Equities [23]

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Okay. That's helpful. Is there a way you could provide us any sense of the distribution of the CapEx by sort of the property types?

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John A. Isakson, Preferred Apartment Communities, Inc. - CFO & Executive VP [24]

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No, we don't disclose that.

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Daniel M. DuPree, Preferred Apartment Communities, Inc. - Chairman & CEO [25]

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All right. I think that would conclude the call. We really appreciate your involvement, your interest in the company, and look forward to talking to you next quarter. Thank you.

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Operator [26]

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Ladies and gentlemen, the conference has now concluded. Thank you for attending today's presentation. You may disconnect your telephones.