Q2 2023 Clipper Realty Inc Earnings Call
Participants
David Bistricer; Co-Chairman & CEO; Clipper Realty Inc.
Jacob Joseph Bistricer; COO; Clipper Realty Inc.
Lawrence E. Kreider; CFO & Secretary; Clipper Realty Inc.
Aaron Randall Hecht; MD & Equity Research Analyst; JMP Securities LLC, Research Division
Buck Horne; SVP of Equity Research; Raymond James & Associates, Inc., Research Division
Craig Gerald Kucera; MD and Research Analyst; B. Riley Securities, Inc., Research Division
Presentation
Operator
Good day, and welcome to the Clipper Realty Second Quarter Earnings Call. (Operator Instructions)
It is now my pleasure to turn the floor over to your host, Larry Kreider. The floor is yours.
Lawrence E. Kreider
Thank you, and good afternoon, and thank you for joining us for the Second Quarter 2023 Clipper Realty Inc. Earnings Conference Call. Participating with me on today's call are David Bistricer, Co-Chairman of the Board and Chief Executive Officer; and J.J. Bistricer, Chief Operating Officer.
Please be aware that statements made during the call that are not historical may be deemed forward-looking statements, and actual results may differ materially from those indicated by such forward-looking statements. These statements are subject to numerous risks and uncertainties, including those disclosed in the company's 2022 Annual Report on Form 10-K and updated in the 2023 second quarter report on Form 10-Q, which are both accessible at www.sec.gov and on our website. As a reminder, the forward-looking statements speak only as of the date of this call, August 3, 2023, and the company undertakes no duty to update them.
During this call, management may refer to certain non-GAAP financial measures, including adjusted funds from operations, or AFFO; adjusted earnings before interest, taxes, depreciation and amortization, or adjusted EBITDA; and net operating income, or NOI. Please see our press release, supplemental financial information and Form 10-Q posted today for a reconciliation of these non-GAAP financial measures with the most directly comparable GAAP financial measures.
With that, I will turn the call over to our Co-Chairman and CEO, David Bistricer.
David Bistricer
Thank you, Larry. Good afternoon, and welcome to the second quarter 2023 earnings call for Clipper Realty. I will provide an update to our business performance and some exciting new developments. I will then turn the call over to J.J., who will discuss property-level activity, including leasing performance. Finally, Larry will speak about our quarterly financial performance. We will then take your questions.
Our operating results continued the positive trends we have reported in prior quarters. We continue to see strong rental demand at all our properties. In the second quarter, our properties were 99% leased, and new leases exceeded prior rents by 15% across the entire market-based portfolio.
At Tribeca House in Manhattan and the Clover House property in Brooklyn, new leases were $83 a foot and overall rental levels reached a record $76 per foot, 21% better than $63 at the end of December '22. At Flatbush Gardens, we have entered into a transformative new phase of the property, with completion in the quarter for a 40-year agreement with the New York City Department of Housing Preservation and Development under Article 11, which is available to all New Yorkers of the Private Housing Finance Law, under which we have submitted and maintained current rents as adjusted to annual rent guidelines based on RGB increases and made capital improvements over a 3-year period that will address many of the issues expected of a large 70-plus-year-old property.
As a part of the agreement with HPD to receive the Article 11 tax exemption, Flatbush Gardens has committed to a 3-year capital improvement plan at the property. Maintenance of rents within current categories is based on the area median income, set aside of vacant units for formerly homeless households, and an increase in pay rates to the nonunion employees at the property to prevailing wage guidelines. The 3-year capital improvement commitment could amount to $27 million and follows improvements over the last 3 years of about the same amount.
Operationally, we are pleased that a ground-up development at 1010 Pacific and Pacific House, now branded as Pacific assets, come online this quarter on schedule and on budget. The property is located in Prospect Heights, Brooklyn, about 1 mile from the Atlantic Terminal/Barclays Center Hub. Leasing is progressing well, and we'll lease up to a cap rate of about 7%. The property has 175 units, 70% free market, 30% affordable, and it has a tax abatement for 35 years.
As previously reported, in the first quarter, we replaced the property's construction loan ahead of schedule, a 5-year $80 million loan, $60 million drawn on closing, $20 million available upon achievement of financial targets after full lease-up. Initial interest of 5.7% was reduced 15 bps due to issuance of certificate of occupancy and will be reduced by a further 25 bps upon full lease-up.
Next door at 953 Dean Street, we have begun the ground-up development on the land parcels we bought in 2021 and 2022 into a 9-story fully amenitized residential building, with 160,000 rentable square feet of residential space, 240 total units, 70% free market, 30% affordable and 35-year tax abatement and an 8,500 square foot of commercial space. We paid $56 million to all the parcels, partially funded with acquisition financing of $37 million, which we are scheduled to convert into a construction loan shortly to take us through the completion of the construction.
As to the continued interest rate environment, we believe we are buttressed by a relatively long duration of debt on all our operating properties, of which 94% is fixed at an average rate of 3.82%, with an average duration of 6.23 years. Our debt is nonrecourse, subject to limited standard carve-outs and is not cross-collateralized. We finance our portfolio on an asset-by-asset basis.
With respect to the inflation, we look to a short duration of the high demand of our residential leases to show us -- to allow us to cover increased expenses on our operation needs at the properties from high construction costs, offset by higher rents.
With regard to our record second quarter results, we are reporting record quarterly revenue of $34.5 million, record NOI of $19.2 million and AFFO of $5.4 million (sic) [$5.5. million] as a result of the improved leasing, as I just mentioned. These results have been significant improvement over the second quarter of last year, and J.J. and Larry will further detail.
I will now turn over the call to J.J., who will provide an update on operations.
Jacob Joseph Bistricer
Thank you. I am pleased to report that our residential leasing performance at all our properties continues to improve. At the end of the second quarter, all our residential properties occupancy remained very high, above 96%, and rents are at record levels.
Overall, new lease rental rates in the second quarter exceeded previous rent by over 15% and renewal rental rate by over 8% at our free market properties. We continue to see particularly strong rental demand at our Tribeca House and Clover House properties, both free market buildings.
While leased occupancy has averaged 97% to 99% over the last 12 months, we have steadily increased average rent per square foot to $76 from $63 over the same period. In the second quarter, rent on new leases were $83 per foot, a 14% increase over previous rent; and rent on renewals was $76 per foot, an 8% increase over previous rents. We expect rent per square foot to continue to grow for at least another quarter as a result of continued strong overall demand.
Leasing at Pacific House is progressing well. The 70% free market and 30% affordable property came online at the beginning of the second quarter and was 77% leased at the end of the quarter. We expect full lease-up in the third and fourth quarters to a cap rate of over 7% in 2024 when initial leasing concessions run off.
At the Flatbush Gardens property, we are also very excited to begin operating under the new Article 11 agreement made with HPD of the New York City that we completed on June 29, as just described. We think this agreement will help us continue making the needed infrastructure improvements expected of a large 21-acre, 59-building, 73-year-old large complex.
At the leasing at Flatbush Gardens, we expect overall rent to continue to increase modestly as before under the Rent Guidelines Board limits. These have now recommenced over the last 2 years to allow annual increases of roughly 3% per annum. These are more stringent than the more generous 5.8% increases in area median incomes for 2023 provided by the Article 11 agreement. Overall, we are looking for our leasing activities to proceed smoothly under the modestly changed guidelines of the Article 11 agreement, including incorporating the 249 new subsidized residents as vacancies arise. Most importantly, we will seek to maintain full occupancy at the property, which was nearly 100% leased in the second quarter just completed.
In the quarter, new leases averaged $32 per foot, 9% higher than the previous rent; and renewals averaged $29 per foot, 3% higher than previous rent. As a result, overall average rent for the property has begun to increase again, rising to $26.17 per foot at the end of the quarter versus $25.04 at the end of last year.
Our other residential properties, 10 West 65th Street, Aspen and 250 Livingston Street continued to perform well. While average leased occupancy for these properties has been above 96%, average rental rates have increased 11% from a year ago. Rent collections across the portfolio remain strong despite the lingering challenges of the pandemic. The overall collection rate in the second quarter was over 96%, and we have continued to benefit but at a lower rate from remittances under the New York Emergency Rental Assistance Program, or ERAP; and the Landlord Rental Assistance Program, or LRAP, which totaled $400,000 this quarter versus $500,000 last quarter.
Looking ahead, we remain focused on optimizing occupancy, pricing and expenses across the business and fully implementing the Article 11 transaction to best position ourselves for growth.
I will now turn over the call to Larry, who will discuss our financial results.
Lawrence E. Kreider
Thank you, J.J. For the second quarter, reported revenues increased to a record $34.5 million from $31.9 million last year second quarter by $2.7 million or, excluding the impact of Pacific House that came online in the second quarter, an increase of $1.9 million.
NOI this quarter was $17.1 million, an increase of $1.0 million from last year, or $0.5 million, excluding the Pacific House. AFFO this year was $5.5 million, an increase of $0.4 million from last year, or $0.7 million, excluding the impact of Pacific House, which reflected full interest expense but only a partial initial lease-up. The $1.9 million 6% revenue increase, excluding the impact of 1010 Pacific, was primarily due to the higher residential rates for all properties from continued strong leasing, as mentioned by J.J., and slightly higher occupancy at Flatbush Gardens. Bad debt expense was substantially the same as last year, reflecting high and stabilized collections, as J.J. discussed.
On the expense side, key year-over-year changes were as follows: property operating expenses were $300,000 lower than last year, excluding the impact of Pacific House, primarily due to repairs and maintenance and fees at the Flatbush Gardens and 141 Livingston Street properties, partially offset by annual increases in payroll costs. We expect Flatbush Gardens payroll and other expenses to increase by approximately $250,000 quarterly as a result of our commitment to pay prevailing wages under the Article 11 agreement.
Real estate taxes and insurance increased by approximately $700,000 in the second quarter year-on-year, excluding the impact of Pacific House; $500,000 due to the regular increase in real estate taxes midyear last year; and $200,000 due to insurance cost increases. Future real estate taxes will not include those from Flatbush Gardens as a result of the Article 11 transaction, which were otherwise projected at approximately $1.9 million for the third quarter of this year.
General and administrative costs increased by $100,000 in the second quarter year-on-year, primarily due to higher payroll and LTIP amortization.
Interest expense increased by $600,000 in the second quarter year-on-year, net of exclusion of Pacific House, due to conversion of the debt at the 10 West Street property in Manhattan to variable rate according to its terms and the elimination of capitalized interest for Pacific House, partially offset by additional capitalization of interest associated with the 953 Dean Street development project and higher interest income on cash deposits.
With regard to our balance sheet, we have $16.3 million in unrestricted cash and $14.7 million of restricted cash. In February, we refinanced the Pacific House construction loan with an $80 million mortgage loan as previously disclosed, and the rate has since decreased from 5.7% to 5.55% based on issuance of certificate of occupancy. We expect to add to our construction loan for the 953 Dean Street property in the near future.
We finance our portfolio on an asset-by-asset basis, and our operating debt is nonrecourse, subject to limited standard carve-outs and is not cross-collateralized. We have no debt maturities on any properties until 2027, with an average overall duration of 6.23 years. At the end of 2023, 94% of debt at our operating properties was fixed at an average rate of 3.82%.
Today, we are announcing a dividend of $0.095 per share for the second quarter, the same amount as last quarter. The dividend will be paid on August 23 to shareholders of record on August 15.
Let me now turn the call back over to David for concluding remarks.
David Bistricer
Thank you, Larry. We remain focused on efficiently upgrading the portfolio. We look for operating improvements to continue to accelerate through next quarter and into 2023. We look forward to capitalizing on a myriad of growth opportunities, including optimizing Flatbush Gardens, the Pacific House and Dean Street developments and other possibilities that may present themselves.
I would now like to open the line for questions.
Question and Answer Session
Operator
(Operator Instructions) The first question is from Buck Horne with Raymond James.
Buck Horne
Congratulations on the new Article 11 deal, it's a big, big achievement for the property and I think to the company as well. I will just kind of ask, maybe just to start with, maybe could you just give us a little more background on how the Article 11 negotiation kind of came together, how you guys proceeded from that. And also just a little detail on how you think the revenue reimbursement program where you're getting some rental assistance from tenants but you get those enhanced reimbursements, how does that going to feather into the revenue over the next couple of years, if you can just give us a little more color on that?
David Bistricer
Okay. Nice to speak to you again, Buck, this is David. The transaction is not new. Article 11 has been available in New York City for quite some time. In fact, in June, the HPD closed on many Article 11 transactions, so we're just one of the many. And it's something that came to our attention, we applied for it. And the HPD came and inspected the property. They were particularly, I think, impressed by the investment the company has made over the last decade and is topping multimillions of dollars gross spend, and they were impressed by the management of the property. And J.J. spent a lot of time talking to them and showing them how we run the property, and that gave them comfort that this is a good property for them to approve an application such as the Article 11.
And the rents themselves, the subsidized rents, have various different programs, and some of them is quite new. So it's going to take the city some time to get it implemented. But they gave us the assurance that this is a real program. It's going to be implemented. It takes some time. But it's definitely added income to sort of balance out what the investments that the company has to make back into the infrastructure.
Buck Horne
All right. Fantastic. And as part of the $27 million projected CapEx over a 3-year period, should we think that, that level of spending is going to -- or how quickly will that spending ramp up over the next -- really, over the back half of this year and into 2024? Will it be kind of a pro rata $9 million per year kind of CapEx spend on Flatbush? Or how should we think about the timing of that? .
David Bistricer
So I think it's too early to get into that. J.J., you want to answer?
Jacob Joseph Bistricer
Buck, it's J.J. here. I'll try to give you some more clarity so you'll understand it. And just to add to what my dad said just a few minutes ago, the reason why the city likes this Article 11 for the Flatbush Gardens specifically is because the city had made it very clear that their mandate is to achieve as much affordable housing that is maintainable, especially the housing stock of generally rentable units are 70 years plus, and they are reaching a certain shelf life that they need to be upgraded. And there is some restrictions on the income side -- or a lot of restrictions.
So this is a creative way for the city to work with owners of properties so that they could keep these properties in good shape, comply with all the codes and all the other elements that go on in New York City and, therefore, not hurt the tenants in the process. So it's a win-win situation for everyone. That's how we look at it, and that's why we apply for it. And HPD liked it because this is 2,500 units. That's the size that they're benefiting from. And the Mayor has made it clear and, again, the city hall has made it clear that they want to do, I think they said, around 18,000 units. So 2,500 helps them a lot in this quarter to get there. So that's the reason for it.
Now in terms of the expenditure, of the CapEx, the way it works is we hired an engineer and that we've gone through a very deliberate process with HPD's oversight to demonstrate what are the things that need to be upgraded and repaired, whether replaced or repaired, depending on each individual item. And there is a time line for them, that they have to be done within a period of time of 3 years. Some of them are, let's call it, more pressing and they're going to be done in the first year; and the less pressing ones, less critical ones, are going to be done over the remaining 2 years. So we have a 3-year program to get this done.
We estimate that it's approximately somewhere between $8 million and $10 million a year on average. That's what we estimate it to be. Obviously, that's not exactly the dollar value, but it's pretty much what has been based on the estimates and the engineering that was done to reach at these numbers and that HPD approved. So if you're looking for an approximation, it's around $10 million per annum. That's how we're looking at it. Don't forget that this happened in June, so it's a half year. So we're adjusting to that as well.
Buck Horne
Got it. One last one for me. It looks like there were some transaction pursuit costs written off in the quarter. Just curious, is that potentially a new deal that you guys are looking at? Or is that just related to pulling Flatbush off-market and related to completing the Article 11 deal?
Lawrence E. Kreider
Buck, it's Larry. Yes, those transaction costs were exclusively related to the Article 11 deal. We had to write some of those expenses off, and it's our attorneys and some fees paid to having Preservation who is our nominal owner, the nominal sponsor.
Jacob Joseph Bistricer
Got it. All right. Very clear. Congratulations.
David Bistricer
Thank you.
Operator
The next question is from Aaron Hecht with JMP Securities.
Aaron Randall Hecht
On that agreement at Flatbush Gardens, wondering if you have to finish the capital spend requirement before you start being able to benefit from some of the components like the tax changes and the reimbursement rates for tenants receiving government assistance.
Jacob Joseph Bistricer
It's actually the opposite. The tax benefit -- or the tax abatement is immediate. In other words, the July 1 bill was not paid because it's no longer owed. We have to do the work, and we're going to -- we are starting to do the work already. But the abatement is immediate. The Section 610 benefits, which is the item -- the benefit that you get from having the subsidized tenancies and what the city is calling a rent standard, which is an increase in the rent above even the legal rent that you can charge if you were on a regulatory agreement, that is something that's going to phase in as we either remove existing tenants with subsidies or as we bring in new tenants with subsidies that are part of the regulatory requirements.
Aaron Randall Hecht
Great. And then are the benefits of the Article 11 transferable to a new owner if you ever decide to dispose of the asset?
Jacob Joseph Bistricer
Only if the city agrees to it, meaning it transfers, yes, it stays with the property, but a new owner will have to get approved by HPD.
Aaron Randall Hecht
Great. And how long did that process take you guys to execute on, if you thought about it from beginning to end?
Jacob Joseph Bistricer
From January to June.
Aaron Randall Hecht
Got you. Okay. And then at 1010 Pacific, what are you guys looking for on the yield of stabilization?
Lawrence E. Kreider
Well, I said roughly 7%. We think it might be a little higher, but that's the cap rate that we think we're building to, as it all shook out.
Aaron Randall Hecht
Do you have enough transparency now to give a projection on Dean Street as well? Or is it too early to tell?
Lawrence E. Kreider
I would estimate, it's only an estimate because we're just getting started, that it's going to be about the same as Pacific Street.
Aaron Randall Hecht
All right. Well, results look really good. It's nice to see earnings going in the right direction. And that agreement with the city looks to be significant in the company. So I appreciate your time, guys.
David Bistricer
Thanks.
Operator
The next question is from Craig Kucera with B. Riley Securities.
Craig Gerald Kucera
You go back a few years ago, you were excited about potentially expanding Flatbush Gardens by possibly going vertical. I know the last couple of years, you've been focused on other developments like 1010 and 953. But this Article 11 agreement, does that impact that process either way if you were to decide to go in that direction again?
David Bistricer
We don't think that we're going to be doing that kind of work there at the moment. We think that this Article 11 have allowed us to do, implementing what we just spoke about. At the moment, that's what we're going to be doing.
Craig Gerald Kucera
Okay. Fair enough. And obviously, a really rapid lease-up at Pacific House. I guess when do you expect that to be fully leased? And once that occurs, how close does that bring you to get into some of those financial targets where you're able to draw down an additional $20 million and see a reduction in rate?
David Bistricer
We think the market is very strong, as we've seen, and we've gotten to this point. And our best estimate in the next 60 days, we'll be there.
Craig Gerald Kucera
You'll be there on being fully leased? Or I guess at what point you'll be able to draw down that $20 million?
David Bistricer
Well, within 60 days, we should be able to draw it down, and we should be -- we're up into the 90% leased at that time.
Operator
This concludes the question-and-answer session. I would now like to turn the floor back to management for any closing remarks.
David Bistricer
Thank you very much for joining us on this call. I wish everybody a good, pleasant evening and hope to see you next quarter again. Thank you.
Operator
Thank you, ladies and gentlemen. This does conclude today's conference call. You may disconnect your lines at this time, and have a wonderful day. Thank you for your participation.
