Good day, ladies and gentlemen, welcome to the Q3 2018 Independence Realty Trust Earnings Conference Call. At this time, all participants are in listen only mode. Later, we will conduct a question and answer session, instructions will be given at that time. If anyone should require assistance during the conference, please press star then zero to reach an operator. As a reminder, this call is being recorded. I would now like to turn the call over to Alex Jorgensen, investor relations. You may begin.
Thank you. Good morning, everyone. Thank you for joining us to review Independence Realty Trust's third quarter 2018 financial results. On the call with me today are Scott Schaeffer, our CEO, James Sebra, our chief financial officer, and Farrell Ender, president of IRT. Today's call is being webcast on our website at www.irtliving.com. There will be a replay of the call available via webcast on our investor relations website and telephonically beginning at approximately noon Eastern today. Before I turn the call over to Scott, I'd like to remind everyone that there may be forward-looking statements made in this call. These forward-looking statements reflect IRT's current views with respect to future events and financial performance. Actual results could differ substantially and materially from what IRT has projected. Such statements are made in good faith pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
Please refer to IRT's press release, supplemental information, and filings with the SEC for factors that could affect the accuracy of our expectations or cause our future results to differ materially from those expectations. Participants may discuss non-GAAP financial measures during this call. A copy of IRT's press release and supplemental information containing financial information, other statistical information, and a reconciliation of non-GAAP financial measures to the most direct comparable GAAP financial measures is attached to IRT's most recent current report on the Form 8-K available on IRT's website under investor relations. IRT's other SEC filings are available through this link. IRT does not undertake to update forward-looking statements in this call or with respect to matters described herein, except as may be required by law. With that, it's my pleasure to turn the call over to Scott Schaeffer.
Thank you, Alex. The third quarter delivered results in line with our expectations, while also building momentum in our value-add initiative and strengthening our portfolio through capital recycling activity. Lastly, solidifying our balance sheet by extending our debt maturities with a new 5-year term loan subsequent to quarter end. For the third quarter, Core FFO was $0.19 per share, unchanged both year-over-year and sequentially, while same-store NOI grew at 1.9%, the high end of our quarterly guidance range provided with our Q2 earnings report. As we move into the last two months of the year and through 2019, our investment thesis remains on track. From the macro perspective, the recent softening of existing housing sales, along with a rising interest rate environment, is a positive for the multifamily rental market.
Further, when we look at our portfolio, we continue to be encouraged by the strong fundamentals and demographic trends in our markets that are driving consistent demand for multifamily product at attractive rental rates. Jobs and population growth continue to outpace both gateway markets and the national average, providing a strong foundation for continued acceleration. Our value-add program, which commenced in early 2018, continues to be a major initiative for IRT as we seek to organically unlock value in our portfolio. We have identified opportunities to improve unit interiors and, in some cases, building exteriors, which is increasing rental rates and reducing operating costs. We are confident that this program will continue to improve our renter profile, generate strong returns on investment, and increase long-term value for our shareholders.
To that end, we have transformative projects underway in 12 of the 14 phase one and phase two communities and are realizing the rent premiums and return on investment we projected for our renovated and leased units. Specifically, these new units are generating an average monthly rent premium of $173 per unit, and we are completing the projects at budget. This has enabled us to deliver an 18% return on investment. Even with these rent premiums, our units are priced below comparable new construction. Further, we continue to expect phases one and two of the value-add program to generate between $8 million-$9 million of incremental annual NOI upon completion. While the long-term returns are on track with expectations, during the latter half of the summer, the disruption from the renovation process caused increased vacancy due to lower than anticipated lease renewals at four of our value-add communities.
The occupancy impact has culminated in lower near-term top-line rent than we had originally anticipated. Concurrently, we also experienced some staffing challenges at these four value-add properties, including filling open positions and having the appropriate skilled labor to process the higher volume of unit renovations. These issues are resolved. Occupancy is beginning to rebound at these communities, and it is expected to stabilize in the first quarter of next year with a higher credit profile resident paying a higher rent. These challenges will delay the completion at these four properties, but do not falter the ultimate value creation for the program. We've learned from this experience. We have the right team in place. We've improved the processes of renovating units and delivering them for leasing.
We will continue to provide you with a detailed disclosure of the redevelopment projects going forward, and I encourage you to review the supplemental we posted on our investor relations website this morning. As a result of the occupancy drag at the four value-add communities, we are adjusting our Q4 and full-year same-store NOI expectations, which Jim will discuss momentarily. We now forecast that the completion of the phase one and phase two initiatives to be pushed out by approximately six months. This puts the conclusion of phase one into the second quarter of 2019 and the completion of phase two in early 2020. Turning to capital recycling, we are building critical scale in our core markets through new acquisitions, including four new communities since the start of the third quarter. Two communities are located in Tampa, one in Columbus, Ohio, and one in Atlanta.
All target markets that we have proactively chosen to increase our footprint and to build economies of scale based on the superior supply-demand fundamentals for middle-market rental housing. Additionally, the dispositions are on track, with 4 of the communities held for sale expected to close by year-end, and the 5th expected to close in January. Lastly, on the financing side, we are pleased to announce the issuance of a new five-year term loan, which strengthens our capital position and provides us with increased flexibility to continue to execute our accretive investment and operational strategies moving forward. The proceeds were used to pay down our revolving line of credit and therefore do not impact our overall debt levels.
Before passing the call on to Farrell to discuss our markets in more depth, I would like to take a moment to highlight the hard work and dedication of our teams on the ground in the Carolinas amid Hurricane Florence. We were fortunate to suffer no material damage to any of our communities, though our team was ready and available to help with any debris cleanup and outreach needed in the broader communities we serve. Farrell?
Thanks, Scott. In the third quarter, we made significant headway optimizing our portfolio through value-add activity and investing further in core markets through our capital recycling program. As Scott mentioned, we also continue to see strong macro fundamentals in key markets driving same-store NOI growth. We saw revenue growth of 4.7%, 3.5%, and 3.1% respectively in Oklahoma City, Memphis, and Raleigh-Durham. We continue to see significant improvement in the Oklahoma City market as the economy continues to stabilize. Occupancy averaged 95% for the quarter, compared to 92.2% for Q3 in 2017. We also saw lower turnover expense due to the higher occupancy, generating NOI growth of 10.8%. We experienced outsized growth in Orlando, a market targeted for expansion. Our community in this market had revenue growth of 8.7%.
As we've mentioned in previous quarters, this property will be competing with an adjacent newly built community that is expected to be in lease-up by the end of this year. We anticipate some impact to our property's performance and will update accordingly. The community is located in a very strong submarket with approximately 30,000 units and has historically performed well in times when there's an influx of new supply. Turning to a market that has been challenging, Louisville had a softer quarter on a same-store basis. In Louisville, we are seeing short-term occupancy disruption from the 2 value-add projects, but we expect these projects to be extremely valuable for the communities over the long term. Overall, our same-store rental rate growth is strong. In the third quarter, we drove a blended rent increase of 4.1% over the expiring leases, with renewals averaging 4% and new leases averaging 4.3%.
These growth rates demonstrate continued momentum, and we are seeing a similar trend in the fourth quarter. As of today, we have signed new or renewed leases at an average rental rate of 4.3% for the fourth quarter. Looking at our value-add program. We have projects underway in 12 of the 14 communities that are part of phase one and phase two. These projects are yielding returns on track with expectations, achieving approximately 19% rent premiums. The renovated units are in high demand, we've leased 807 of the 847 completed units. However, as Scott mentioned, we have experienced some occupancy challenges. At The Village at Auburn, the most impacted of our value-add communities, the renovations included extensive clubhouse amenity upgrades, which affected the 2018 leasing season. We are now carrying an inventory of 54 renovated units.
We've leased 135 of the renovated units at a $213 rent premium, which generates an 18% return on investment. With the exception of this community, the renovated units are either fully leased or experiencing premium demand. Our renovation program is providing our residents with an attractive value opportunity in contrast to Class A options. I wanted to provide an update on the capital recycling program. Currently, four of the five communities held for sale are expected to close by year-end for a total sale price of $137 million, representing an economic cap rate of 5.31%. We expect our final property held for sale to close in the beginning of 2019. Since our last call, we've acquired a 260-unit property in Atlanta. The Atlanta property is in the McDonough suburb and boasts a strong job market and a top school district.
We purchased this property from the same seller that we purchased the nine-property portfolio from in 2017, and we expect to have the same ability to expand margins through onboarding this property to our platform and implementing our revenue management and expense control processes. Today, we have a 276-unit property in Brandon, Florida, a mature suburb of Tampa, under contract, which is expected to close in November. This will be our third community in the Tampa market, bringing our total unit count to 840. We have highlighted Tampa as a core market with strong fundamentals. These two acquisitions are in addition to the acquisitions we discussed on the second quarter call. As a reminder, on July 11th, we acquired a 348-unit community in Tampa for a purchase price of $43 million. On July 26th, we acquired a 232-unit community in Columbus, Ohio, for a purchase price of $21.2 million.
Since the beginning of the third quarter, we have acquired four properties totaling $141.7 million at a 5.34 economic cap rate. We are continuing to accomplish our goal of expanding in markets that have better long-term fundamentals and have similar cap rates to our dispositions. I'll turn the call over to Jim for an update on the financials.
Thanks, Farrell Ender. For the third quarter of 2018, net income available to common shareholders was $4.8 million, up from $1.1 million in the third quarter of 2017. Year over year, Core FFO grew from $14 million to $16.5 million for the quarter ended September 30th, an increase of 18%. Core FFO per share was $0.19. Adjusted EBITDA for the quarter increased to $24.7 million, representing a 22% increase year over year. We continue to see the benefits of 2017's portfolio transformation on our bottom line in 2018. For Q3 2018, we reported same-store NOI growth of 1.9% and revenue growth of 1.9%, with property-level expenses increasing 2%. On a year-to-date basis, we've seen same-store NOI growth of 2.2% and revenue growth of 2%, with property-level expenses increasing 1.9%.
Not to minimize the challenges in our 4 value-add communities, the same-store portfolio, excluding the value-add communities, is performing with occupancy at 95.3% and Q3 NOI growing at 3% over last year. From a non-same store perspective, we continue to see positive results as compared to our expectations and the results from the prior owner. For example, the 9-community portfolio we announced in September 2017 has seen its NOI grow in Q3 2018 by 17% over Q3 2017. The majority of this growth has come from rent increases, with some reduced expenses. Looking ahead, our same-store portfolio will grow to 50 properties on January 1st, 2019, as we will include 13 properties that we acquired in 2017 and through the early part of January 2018. Turning to the balance sheet.
As announced this morning, we completed a $200 million unsecured 5-year term loan with an interest rate equal to LIBOR plus a spread based on our leverage. Today, that interest rate was equal to LIBOR plus 145 basis points, approximately 15 basis points inside the market for similar transactions. The maturity date of this new 5-year unsecured term loan is January 2024. We effectively fixed the interest rate on this floating rate term loan by purchasing an interest rate collar for the entire 5-year term on October 1st. The proceeds were used to repay borrowings outstanding on our revolving unsecured line of credit, which has the effect of both extending our debt maturities and freeing up liquidity on our line of credit. We finished Q3 with 58 properties and total gross assets of $1.8 billion. Our total debt to gross assets grew 70 basis points to 54%.
From a net debt to adjusted EBITDA standpoint, our leverage rose slightly to 9.7 times. Our leverage will decline later this year as we complete our capital recycling efforts. Our pro forma net debt to EBITDA will reduce to approximately 9.3 times once those capital recycling activities are complete. We continue to execute on our strategy of increasing our percentage of unencumbered assets over time. As of September 30th, our unencumbered assets represented 47% of our portfolio, while as a percentage of our total NOI, unencumbered assets represents 42.2% of the portfolio. This represents a sequential 200 basis point and 180 basis point of increase, respectively. Also, during the third quarter, we were active on our ATM and issued 1.9 million common shares at an average price of $10.32. We raised net proceeds of approximately $18.8 million. These proceeds were used to fund the capital expenditures of our value-add program.
Lastly, we are adjusting our fourth quarter and full-year guidance to reflect the occupancy impact at the four value-add communities that Scott discussed. We now expect our full-year 2018 Core FFO to be between $0.74 and $0.75 per share, which represents the low end of the guidance range we introduced at the beginning of the year. We reduced our 2018 dispositions to a range of $136 million-$139 million, and a gain on sale guidance to a range of $17 million-$19 million, as one asset held for sale is now expected to close in Q1 2019. From an NOI perspective, we are also adjusting our fourth quarter same-store NOI guidance to a range of 3.3%-4%. For the full year 2018 same-store NOI guidance, we are adjusting our guidance to a range of 2.5%-2.7%.
Despite the near-term impact of the value-add initiatives, we remain encouraged by the rent premiums we are seeing, as well as the enhanced credit profile of the tenants filling our completed units. We continue to look forward to the long term when it comes to our portfolio transformation, and we are confident that we are well positioned to maximize value for our shareholders. A full update of our revised guidance is available in the quarterly supplement we published today and available on our investor relations site. Scott, back to you.
Thanks, Jim. Operator, at this time, I'd like to open the line for questions.
Ladies and gentlemen, if you'd like to ask a question, please press star then one. If your question has been answered and you'd like to remove yourself from the queue, you may press the pound key. Once again, to ask a question, please press star then one. Our first question comes from Drew Babin of Baird. Your line is open.
Hey, good morning.
Hi, Drew.
Hi, Drew.
Farrell, you mentioned the personnel issues for the value-add properties, I guess I was hoping you could elaborate a little more on those issues. I would assume that they probably had something to do with the value-add program since those are the properties where that occurred. Could you just maybe give a little more color on that?
Since we're self-performing a lot of this work, it really was a component of just getting back to more units than we had budgeted for. The skilled labor that's really turning over these units that we just didn't have the capacity for, and we had to go out and find more to deal with the amount of units that we had handed back to us through the lower renewal process.
Okay, it wasn't kind of a more senior property manager type issue.
No
maintenance.
It was basically getting back more units than we had anticipated.
Okay.
Drew, this is Scott. Drew, can I just clarify that a little bit? It wasn't maintenance at all. We're doing this work in-house, and we've hired skilled labor to do it. To Farrell's point, the renewal rates were lower than we had anticipated on lease expirations of existing leases. That handed us back more units than, frankly, we had anticipated and were prepared for. We just didn't have enough skilled labor at those properties, which caused us not turning all of the units that came back as quickly as we would've liked, which has caused the occupancy impact.
Okay, that makes sense, and I appreciate the color. There's language in the press release, talking about how the $8 million to $9 million of NOI could be unlocked by the end of 2019, but Scott, it sounds from your comments like the second phase will likely not be done until early 2020. I was just hoping you could clarify that, and maybe give us a quarter where you would maybe expect that to be unlocked by on a run-rate basis.
Well, on a run-rate basis, I would say into the second quarter of 2020, where we had anticipated it to be in the first quarter of 2020. Remember, it's an ongoing cumulative effect of the increased rents from these renovated units. We will have the positive compounding through 2019, and then it should all be in place on a run-rate by the middle of 2020.
Okay. One last one on the expense guidance being revised down for this year. Was that entirely driven by lower property tax expense growth? I guess, can you talk a little bit about the appeals process? I'm assuming something went better than initial expectations. If you could talk about that, I'd appreciate it.
Yeah, Drew, this is Jim. We were pretty conservative in our original guidance around real estate taxes, just given the environment we're in. Fortunately, we just have not seen the level of tax increases that we were expecting, and therefore, the reduced guidance. At the same time, we also renewed insurance earlier this year that allowed us to kind of drive even further improvement in the expense savings on that as well.
Okay, great. That's all for me. Thank you.
Thanks, Drew.
Thanks.
Our next question comes from Austin Wurschmidt of KeyBanc Capital Markets. Your line is open.
Hi, good morning, guys.
Good morning.
I was just curious if the revised guidance and adjusted timing on the renovation completions assume any types of similar delays or occupancy disruption to account for any risks related to either labor shortages or slower releasing, moving forward.
It does. However, as I said in my remarks, Austin, we've learned from this, and we're taking positive steps or proactive steps, to minimize the effect going forward. We will make sure that we are appropriately staffed with skilled labor to handle the units that we get back. We also are more aggressively staggering leases so that we're not getting as many units back in the middle of each year. Yes, of course the guidance going forward does and will continue to reflect what we hope is a better appreciation for the value-add process.
Did you get any color as to what was driving the above-average move-outs or what the reasons for move-out was? Just curious if the disruption from the renovations is forcing people to kind of rethink their renewal decision, or was it something else you think that was driving that?
Well, we do poll our tenants, when they leave. We believe that for the most part, we get honest answers, but you can never really tell. We do believe it was really related to the renovations because we saw more normalized renewal rates at the properties that aren't going through the renovation process. Really what we were told by a number of the tenants leaving is that it was the noise, the traffic, the dirt, all associated with a construction program. In addition to some of them saw higher rents coming for the property as a whole and just thought they were going to go try to lease somewhere else and lock in a lower rent. Tenants who didn't want to pay the increased rent for the renovated unit.
We think it was all of those factors, but the fact that our non-value-add properties saw, again, more normalized renewal rates, it makes it pretty clear to us that it is the renovation process that caused the lower renewal rate.
All right. That's helpful. I know you provide kind of the quarterly same-store growth metrics excluding the renovations. If you were to kind of strip out the same thing for the guidance, how is the non-renovated portfolio performing relative to your initial expectations?
Austin, this is Jim. It's pretty much on target with our original expectations. As I think Scott mentioned, the same-store portfolio, and specifically the value-add, is still relatively small such that an occupancy impact might have a larger kind of percentage impact, although still relatively smaller dollars, but continues to perform as expected.
Great. Thanks. Then just last one for me is, leverage ticked up a little bit this quarter. Seems a little bit timing related. Just but curious when we should expect that to start to move in the other direction.
Yeah, you should see, once the capital recycling activities are complete later this year, you should see that beginning to kind of come back down closer to that 9.3 pro forma. The full pro forma certainly affect once that final capital recycling activity occurs in January of 2019.
Okay, great. Thanks, Jim. Thanks, Scott.
Thank you.
Our next question comes from Nick Joseph of Citi. Your line is open.
Thanks. Given the delays in near-term impact from redevelopment, when do you expect the dividend to be covered by cash flow?
Our projection was that it would be covered in the fourth quarter of 2018. I am still of the opinion that that will happen. As we go through the final two months, the impact of this value-add, vacancy may push that back into the first quarter.
When you talk about it being covered, that's going forward as well, right? It's not just a one-quarter phenomena.
No, it's going forward. When we cover it, we expect it to be covered in perpetuity.
Thanks. You issued stock around NAV in the quarter, which makes sense, but now you're trading at a discount. How do you think about issuing equity given the current dynamic?
We will not be issuing equity at the current pricing levels.
Great. Thank you.
Thank you.
Thanks, Nick.
Our next question comes from Craig Kucera of B. Riley. Your line is open.
Hey, good morning, guys. I back into about a 5.2 cap rate on the recent acquisitions you completed. Can you give us the individual yields on both the Atlanta acquisition and the Tampa asset?
Yeah. The Tampa acquisition was a 5.15, stabilizing at a six and a quarter. Craig, we're going to put that on our platform, and we believe there's potentially significant value-add there. The Atlanta cap rate was 5.8.
Got it. When we look at sort of your capital recycling, are you still of the mindset you're gonna get to accumulative $170-$190, with the remainder coming in early fourth quarter? Kind of where are those four assets that you expect to close here in the fourth quarter, in the process of being sold?
Sure. Yes, we do. We think we have the ability to purchase one more property with the capital recycling. Of the four properties, we have two under contract that are in due diligence. The other two will be under contract in the very near future. We expect those four to close this year. Like we said, the fifth is being marketed right now with a close in early 2019.
Got it. As far as recycling that incremental capital from that early 2019 disposition, have you soft-circled any assets that you think you're gonna acquire? If so, can you give us any color on maybe markets, or kind of what you're thinking could potentially happen?
I can give you color on markets. We haven't identified anything specific right now. We have a lot of things on the pipeline that we're looking at. It's obviously a competitive marketplace. We're trying to find the best opportunity. We are trying to grow in that Tampa, Orlando, Central Florida markets, Atlanta, Raleigh, Charlotte, markets that we're in, and create more efficiencies of scale.
Okay, thank you.
Our next question comes from Bob Napoli of William Blair. Your line is open.
Good morning, everybody.
Morning.
Morning, Bob.
As you look into 2019, what are your thoughts on the ability to increase rents on, let's say, the renovated versus the non-renovated breakout? Is it getting more difficult at the margin, to get those rate increases?
No. We're actually seeing the opposite. The renovated units as Farrell said, we're seeing 19% rent premiums over an unrenovated unit of the same style in the same market. That's very healthy, and we don't see that abating at all. Also, to follow up on his earlier comments, at all but one property, we have leased, basically all of the units that we've renovated, and in a number of properties, we have units pre-leased, waiting for the renovation process to be completed. We're also seeing very healthy rent growth in the unrenovated units. We attribute that to, again, being in markets where there's good job growth and now wage acceleration. We think we're well-positioned to continue pushing the rents on those unrenovated units.
You talked a little bit about where you're looking to acquire. As we go into 2019, are there additional divestitures we should expect?
Well, we will continue, or our plan is to continue the recycling efforts. We're not prepared at this point to identify specific markets. As we've stated in the past, there are markets where we only have one or two communities and, if we determine that those are markets where we're not going to grow, we will look to recycle out of those communities and to redeploy the capital in areas where we do see longer-term growth and want to generate additional economies of scale.
Great. Just last question, the cap rate trends in your core markets, are you seeing any changes given the interest rate environment, maybe, but any trend changes in cap rates?
Surprisingly, no. It's clearly, as you know, probably better than anyone, or as well as others, that cap rates typically tend to follow interest rates, maybe with a lag. We have not seen cap rate movement in the Class B assets, even with the recent increase in interest rates. We are very happy with the fact that we've been able to recycle out of markets that we believe do not have as strong long-term growth prospects. Jacksonville, Jackson, Little Rock, Arkansas, just to name a couple, and that we were able to sell those assets at the combined cap rate of 5.3%, I think is what Farrell referenced. At the same time, we've redeployed or we will have redeployed that capital in markets where we see longer, better growth and at very similar cap rates.
We're excited with the fact that we've been able to, what we believe is upgrade the portfolio in better markets, at cap rates that are no lower than what we're selling at.
Great. Thank you. Appreciate it.
Thank you.
Once again, if you'd like to ask a question, please press star then one. Our next question comes from John Massocca of Ladenburg Thalmann. Your line is open.
Good morning, everyone.
Hi, good morning.
Just looking back at guidance, just wanted to clarify one thing. Prior guidance had a little more acquisition activity baked in. Is the reduction in that all tied to the timing of capital recycling and kind of wanting to match fund with the sales that are going to slip into 2019?
Yeah. Certainly the reduction in guidance is certainly updated to reflect kind of obviously the updated capital recycling. The more so the kind of the one incremental acquisition that we could do being pushed into 2019 as well. Also just it's been updated for obviously the value-add and renovation kind of challenges we've talked about.
That hasn't affect your acquisition targets though. Long term, you're still kind of looking at that 160-180, but maybe it's just, it's now moving into the first half of 2019?
That's right.
Within that same kind of guidance, was the current capital recycling timing contemplated in the guidance you gave last quarter? Or has closing maybe been a little later than anticipated on the dispositions, than it was at the time of the 2Q18 call? Understanding obviously that you're having something slip into 2019, but just the other assets that are closing, were they always expected to be kind of this late?
We expected them to close in the mid fourth quarter. It's slightly later, but it's not dramatically later.
Kind of maybe broader, I know you guys have talked in the past about supply concerns in some markets outside of Orlando. Can you give us any color on if those supply pressures are still shaping up as projected?
This is Farrell. On a positive note, we're seeing deceleration across basically, with the exception of Charlotte, every market that we're in into 2019, 2020, which just makes sense based on what you hear in terms of lending getting tighter and material and labor getting more expensive. We think, looking forward for our Class A portfolio, we see some pretty positive results because of that.
Just Charlotte is still the only one that has some level of maybe supply weighing on performance.
It's decelerating, not nearly to the point of our other markets.
Understood. That's it for me. Thank you guys very much.
All right, thanks.
There are no further questions. I'd like to turn the call back over to Scott Schaeffer for any closing remarks.
Well, thanks everyone for joining us this morning. As we look ahead to 2019, we expect to gain further momentum in the redevelopment efforts to enter into a year of greater strength, strong market fundamentals, and organic growth initiatives in place. We're confident that we are working towards unlocking value for many years to come. Thanks again for joining us, and we'll speak to you next quarter.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.