Great. Good afternoon, everyone. Welcome to Citi's 2024 Global Property CEO Conference. I'm Eric Wolfe with Citi Research, and I'm very pleased to have with us today Scott Schaeffer of Independence Realty. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk. For those in the room or the webcast, you can go to liveqaa.com and enter code GPC24 to submit any questions if you do not want to raise your hand. Scott, I'll turn it over to you to introduce your team, your company. Tell us the top reasons an investor should buy your stock today, and then we'll go into Q&A.
Thanks, Eric. With me today is our CFO, Jim Sebra, and I'm Scott Schaeffer, the Chairman and CEO. Thanks, everyone, for taking the time to join us today. I want to just give a real brief overview of IRT, and then we'll get into the reasons to invest and take your questions. So IRT owns and operates 115 communities today, over 32,000 units, primarily Class B communities in non-gateway markets, which is a little bit of a differentiated strategy when we started 10 years ago, and we've stuck with it. And I'm happy to say it works very well. We have a meaningful value-add program, and I say meaningful because, relative to our size, it really does drive nice rent growth and NOI growth. We're delivering typically high teens unlevered returns on the cost of the renovation of the units.
We're going to do about 2,500 units this year, and we have about 16,000 units in our portfolio going forward. So we have a nice runway to keep this program going for a number of years. We have a simple capital structure, just common stock and debt. There's no preferreds or convertible debt or equity-linked securities. It's very easy to understand. We have limited debt maturities through 2028 or into 2028, I should say. So we have a nice maturity ladder and no floating-rate exposure at all. If you look at our total shareholder return, we are the best of the public REITs for three years and five years, and we are number three for one year. So we have delivered over time. And with that, I will now tell you why I think you should invest in IRT.
One is, as I've just mentioned, we have a proven track record of shareholder return and a strong portfolio that will continue to deliver. We have this well-established value-add program, again, that is meaningful. And as I said, 16,000-unit pipeline that we can continue it for many years to come. And we have a strong management team with operational experience that's managed through multiple cycles. I've been at this for 40 years. Jim is a little bit younger, so he can't say that. But I can take you back to the Reagan Tax Act and then the S&L crisis and the dot-com and, of course, the financial crisis. I've been through it all, seen it all, and I think that experience comes in handy when we find ourselves in a period like we have been over the last year and a half with crazy supply.
With that, Eric, I will turn it back to you.
Appreciate it. That was very helpful. I have to probably start with the news that you announced last Thursday. You announced that you entered in a cooperation agreement with an activist investor. You pointed Craig Macnab to your board. You opted out of MUTA. I guess my question is, what does that really mean to investors? I mean, does that mean that you're open to strategic alternatives? I know it's a very straightforward question. You're open to considering them. Maybe you should always be open to that as a public company. But just trying to understand sort of why you took the actions that you did. You could have obviously gone the other way and not done them.
Well, we're always open to strategic alternatives, as you said. But that's not what was happening here. We have a very capable, engaged board at IRT with many different expertise. One of our shareholders came to us last year and said that they could help us generate a higher multiple. And part of that was they proposed three people for our board. Our nominating and governance committee went through and interviewed those three, and Mr. Macnab was one of them. He has vast experience in real estate and the REIT world. He is well-respected and very capable. And we came to an agreement with the shareholder that we would add Mr. Macnab to the board. And that's the cooperation agreement. And as part of that, we don't have a staggered board. We were never going to have a staggered board.
Frankly, we should have opted out of MUTA earlier, but we just decided to do it at this time as part of this arrangement.
Makes sense. I guess you've had the benefit of a number of meetings with investors so far. What's been communicated to you so far? It seems like your balance sheet's in great shape. You've exited many of the smaller markets. Just curious if you feel like there's anything left that you have to do in terms of portfolio optimization, transforming the portfolio if all the heavy lifting is really done at this point.
So the portfolio optimization strategy that we announced is 10 properties that we were selling. I'll call them non-core assets, either because they are older and high CapEx, expensive to run, or they are just in smaller single-asset markets. So those 10 assets made up 5 of our markets. And 6 of those 10 have closed. The sales are done, and the capital was used or the proceeds were used to delever. The other 4 are all under agreement. They're all through due diligence, and the contracts and deposits are hard. 3 of the 4 are going through a loan assumption process because we had attractive financing in place that the buyers wanted to assume. And it's just taking a little longer than we had anticipated, but they are all slated to close and be finished by the end of this month, so still in the first quarter.
When we're through with that, we will be on a trajectory to have Net Debt to EBITDA of about 5.9 times at the end of this year and then through just organic growth into the low 5s at the end of 2025. So we think that we're in a very good place. Again, when you consider that we really have no debt maturities of any significance until 2028 and no floating-rate exposure, so our interest costs are fixed. So.
Jim, you want to add anything? You're the CFO. You want to add anything about the balance sheet? Your turn.
I mean, obviously, we just announced a Fitch picked up or put out an investment-grade rating for us on Monday morning, and we're looking forward to obviously adding either Moody's or S&P later this year. And we're looking forward to kind of just continue to execute for shareholders.
Yeah. I mean, I was thinking sort of the heavy lifting is really done at this point. The balance sheet's in good shape. You like the markets you're in. You're not going to expect to see another type of one of these transactions for the foreseeable future.
That's correct.
Could you maybe talk about G&A? G&A up a little bit year-over-year. I think it's like 8%. But if you exclude the $1.5 million that you mentioned in the call, it's like 5%. I guess as you reduce that asset base, should you see sort of G&A savings from that? And then I guess if not, why not?
Yeah. I mean, so I think right now, from the standpoint of the portfolio optimization transaction, obviously, the properties aren't sold. So we're not obviously, once all the transactions are sold, we'll certainly reevaluate the staffing level and just make sure it all makes sense. We do a really good job of actually focusing on G&A through time. If you look at the number of units we have per employee, we're one of the top of all the public REITs. So we're already pretty efficient as it is. But we're certainly looking forward to always being efficient and executing on that for our shareholders.
There's a slide in your deck that I think's pretty interesting and helpful. It shows the potential around your value-add program, which I guess I didn't realize was as large as it is or could be as large. I was just curious, in a typical year, how do you think your value-add program will sort of impact your NOI and same-store NOI? And based on what you put out in the deck, is that a sort of sustainable number for us to think about going forward?
Yeah. So last year, in 2023, we renovated 2,500 units and generated a kind of mid- to high-teens return. Our expectation for this year is to continue to do that same rough volume. And given this roughly 16,000-17,000 units that are able to be renovated in our portfolio today, we think we have several years of that pipeline left to go. We do think that it continues to provide good benefits from a same-store revenue growth and a same-store NOI growth, even though there's a short-term kind of reduction in occupancy when a property first enters the value-add program. If you look at last year, the NOI growth coming from the value-add communities was north of 10%. So it continues to add a lot of support to the overall same-store pool as we continue to execute on that.
We expect to be able to do the same in 2024.
For the units that you're projecting to start in the future, I mean, would the scope of the work look very similar to what you're doing today, or does it sort of change over time? I know that you're assuming sort of a similar, call it like 17% return on that. Just curious if the type of work you're doing is changing. Also, are any of those units being renovated for a second time, or are these all units that haven't had that sort of renovation within the last five years?
So the scope will remain similar. The whole strategy of the program is to take a Class B unit and, through this renovation process, create an apartment, a product that competes with the newer Class A product but at a better price point while still generating very healthy returns on our investment. So the scope is important. We have to turn this unit into something that looks and competes with a much newer unit. So the scope won't change much. We did ask our renovations team at the beginning of this year, as we were looking at our forward strategy, to really go in and re-engineer the materials that they're using. Is there a cheaper countertop that's still stone, but it doesn't have to be granite, for example, that we can put in? So they're looking at all of that in an attempt to control the cost of the renovation.
But it is a program that Jim said is very beneficial, and we're going to keep doing it.
Based on what you've outlined in your deck, I mean, there's at least another, call it, 6 years' worth of opportunity there.
I'm sorry. I didn't catch it.
I'm just taking what you're doing per year and then looking at the total number of units and then dividing it. I mean, there's at least another, call it, 5-6 years of opportunity to.
Absolutely. There is. And so the other part of your question was, are we doing any second-generation renovations? The answer is no, other than some of the STAR communities that came to us through the merger. They had done some light renovation. So we're bringing those up to our standard, if you will, as part of this program. So we don't have to spend as much because some of the work has already been done, but there's still more that we need to do.
Let's see. Actually, there's a couple of questions coming in here. I'm just seeing if they're based more on operations which I'm about to talk to in a second. So it says, "Historically, your organic growth and value-add redevelopment platform typically led to sort of mid, high, single-digit earnings growth." Is that a possibility as we think about next year, 2025? Everyone understands there's dilution this year due to the portfolio optimization. But as we get into 2025, do you think we can get back to a more normal type of AFFO and FFO growth rate?
Yeah. We do. We think, certainly this year for 2024, the portfolio optimization transaction is roughly a $0.03 of dilution kind of rolling through the core FFO line. We certainly expect that as we kind of enter next year, we should be able to see kind of more normalized core FFO and certainly AFFO growth. I will say, though, that on an AFFO basis, the portfolio optimization transaction is actually neutral simply because some of the properties we're selling were very heavy CapEx properties.
Got it. And then other question is, "Have recent supply deliveries in your markets impacted the return on your value-add program?
At the end of last year, in the fourth quarter, when we saw heavy concessions from our competition, we did offer some concessions on value-add units. So that did impact the return, but not beyond that. So the stated rents and the lease, and so far now, without concessions in 2024, we're seeing similar as to historical returns.
So switching to operations, and there's a couple of operating questions, so I'll get to those. But looking at your deck, you're 130 basis points ahead of where you were last year in occupancy, so in the first quarter. But your guidance is effectively expecting that you hold that gap through the year. And I guess my concern is just that if you look at the first quarter of last year versus the second quarter, you have a pretty big increase there sequentially, partly because you were taking a lot of strategies last year at this time to build occupancy. So I guess the question is really just, do you expect to be able to hold that gap even with your comp getting pretty tough in the second and third quarter?
Yeah. We do. We certainly expect that as the year progresses, certainly, we had a nice ramp from March into April of last year. We certainly expect to have a good ramp as well from where we are now into kind of certainly end of May. I'm sorry, end of March and April of this year. It doesn't need to be that big, but we think we'll be able to continue to hold that occupancy throughout the remaining part of this year without kind of less of a seasonal kind of decline in the second half of the year, still, again, to maintain that 95.2% average.
And.
Oh, and by the way, we are expecting to toggle renewal growth to achieve that better retention and, therefore, better occupancy.
What do you mean by toggle?
Right now, our retention rates for the first quarter. I'm sorry, our renewal rate increases for the first quarter are averaging 4.5%. Our guidance for the year in terms of rental rate growth for renewals is about 1.8%. So I plan for the potential or the need to toggle that down to stimulate better retention and, therefore, better occupancy.
Got it. And I guess one thing I was confused about in terms of your guidance on the call is I think you said that you're expecting like 2.2% sort of average rate growth through the year, effective average growth through the year. Is that right? 2.2%? So I guess my confusion is you have like 70 basis points, I think, of earn-in. I would think to kind of get to 2.2% average growth, you'd kind of need to see like north of 2, north of 3% kind of blended growth. But maybe I'm just not thinking about the right way. So just help me understand sort of what is embedded in your guidance in terms of blended growth through the year and how that gets you to 2.2% average.
Sure. This question will ask. So the 2.2% blended rental rate growth is made up of, obviously, new lease growth and renewal growth. Renewal growth, as I just said, average for the year is 1.8%, which means the new lease growth embedded for the year or average for the year is 2.4%. When you break that 2.4% new lease growth down into the non-value-add and the value-add pools, the non-value-add same-store new lease growth is only 60 basis points, whereas the value-add new lease growth is 7%. And again, that new lease growth on the value-add is coming from, obviously, the 2,500 units that we plan to renovate and the premium, the nice 15, 16, 17% premium we get there, as well as a lower rental rate growth, new lease growth on new leases inside the value-add communities that were not renovated.
Gotcha. Okay. So that 2.2% is a blended spread that you expect to see. By the end of the year, I take all the averages of what you've signed and effective, it should be about 2.2%.
That's the expectation.
Okay. Got it. I guess you've sort of switched this sort of focusing on retention. What does that mean for sort of the peak leasing season coming up? I think you said you're going to toggle renewals a bit. Have you already started doing that and sort of help us think through what you expect to see as we go into the peak leasing season?
We have started. What you'll see is you'll see more lease expirations because the expiration curve is about 15% in the first quarter, 15% in the fourth quarter, and then 70% in the second and third quarters. So we will see more lease expirations in the second quarter. And we've already started pulling back on the renewal rent growth because we want to keep more of those residents in place. So for the leases that we're now quoting going forward, we're at 3%, give or take, versus the 4.5% or so I think it was in the first quarter to date.
4.5%.
I guess based on the acceptance you're seeing there, you feel like the occupancy will build, meaning you look at.
We do. But we also guided that the year, on average, would be 1.8%. So we have a lot of room to come down on that renewal rent growth to still be at or above our guidance.
Gotcha. Yeah. So, meaning that you could be heavier on the renewals, and you get better growth there, but maybe the occupancy doesn't come up as much, and you end up in the same position.
I think it's more the other way. We're going to focus on occupancy. So we're going to pull back on the rental rate growth, the renewal growth, in order to stimulate higher retention, which just means there's that many less units we have to lease, new leases, which will support occupancy.
I guess what are you seeing in terms of your competitors? You have another good slide in here. It's a good deck that shows the percentage of supply that you'll be competing with for the next couple of years. So we can talk about that in a second. But what are you seeing from your competitors in terms of what their strategies are doing? Are they kind of pulling back on concessions a little bit? Are they increasing it? Just as supply comes, what are they doing, and how does that impact your strategy?
Yeah. I mean, I think what we're hearing from, obviously, a lot of the other public REITs is we are seeing that everybody continues to be focused on driving better retention and certainly better occupancy. From our on-site teams, what we're hearing locally is certainly, during the fourth quarter last year, we were using concessions to kind of continue to kind of support occupancy given the pressures of new supply and the concessions that developers were offering. Today, in the first quarter of this year, we've really kind of pulled back on concessions. Where we were offering them across the portfolio in the fourth quarter, we're now only offering them on targeted communities. And to the extent that we are offering them, they're not one month. It's more like one week, maybe two weeks, or $500. Concessions have pulled back significantly so far in the first quarter.
We're seeing occupancy continue to build. We're seeing good renewal growth. So we think the strategy is working.
And then I mentioned a second ago the chart on the new deliveries that you're projecting. Can you maybe just tell us sort of how you're coming up with those numbers, where you see supply going over time, and sort of how you're thinking about that competitive set that you're going to compete with for the next two years?
Sure. So the data comes from CoStar. It is the weighted average for all of IRT's submarkets, not markets or MSAs as a whole, submarkets, so where we have properties and the underlying submarkets. For 2024, the expected deliveries are 3.1%. If you look at the data granularly by quarter, the peak is in the first half of this year, pretty much ending in Q1, maybe kind of dwindling a little bit into April. But certainly, the deliveries are coming down into the second half of the year. So we're excited about what the second half of the year will bring. For 2025, the current estimate from CoStar is 2.3% for our submarkets.
You made a comment on the call that was like 2023 supply outpaced absorption. In the back half of 2024 and into 2025, you expect absorption to keep up with supply. I guess why would that be the case? I mean, I guess most people think that job growth might diminish a little bit from this. Just wondering why you sort of think that absorption might outpace supply as you get later into the year and into 2025.
Yeah. So again, the data is coming from CoStar in terms of what we see as the expected absorption given assumptions or inputs for job growth and population growth. Just keep in mind that a lot of our properties are located in the Sunbelt area that are still seeing good job and population growth. What we've seen from the data suggests that the wall of new supply and new deliveries that occurred in 2023 significantly outpaced the absorption levels or, effectively, the household formation. I think also last year, there was a lot of just concern out there in the marketplace, in the economy, just potentially what could happen. Is it going to be a recession? And I think the expectation now is that a soft landing or maybe even a better than a soft landing is certainly possible. Obviously, we'll get more color on Friday with the jobs report.
But I think the expectation right now for 2024 is that, again, given the data and what we see, is that absorption and the new deliveries are going to be very close to each other, that we're not going to have this huge delta between excess deliveries over absorption levels.
I know it's early in the year, but I guess are any markets starting to stand out to you in terms of being a bit weaker or better than expected? Or maybe if not, in terms of the data, the leading indicators suggesting that certain markets might end up doing a little bit better or worse than you're thinking?
So Nashville is still under pressure with new supply, and that's expected to continue through the year. And Atlanta has had a slew of problems from supply to fraud. And so unfortunately, that is one of our largest markets. But we do see the light at the end of the tunnel there as well. But those are the two that I think will be under most pressure in 2024.
Then on the upside, is it the Midwest markets that are sort of?
The Midwest is slow and steady. Obviously, it did not have the supply impact that the Sunbelt had. Our occupancy there has been very strong and stable. We're able to just continue with that 3%-5% rent growth, which is where it's been year-over-year. When you look at the Midwest, it's like a stabilizing factor within the portfolio. It's not sexy, but it performs. When you can compound 4%-5% NOI growth year-over-year over year-over-year, you can create real value. We like it, and we're happy it's part of our portfolio.
Most of those markets, if not all, are keepers at this point.
I'm sorry?
Most of your Midwest markets and the assets that you own there are things that you plan on keeping for the future.
Yes. Yeah. And we actually have some very good value-add program going on there in both Indianapolis and Columbus and Louisville. And we're seeing good returns. So not only do we get the steady year-over-year rent increase, we're seeing nice value creation through the value-add program.
Got it. We're getting a couple of audience questions on it. But one of the things I didn't see in the presentation was sort of where bad debt was in the first quarter. So maybe you could share that with us and then sort of how you think that's going to trend for the rest of the year.
Say that one more time. It was hard to hear.
Bad debt, just basically where bad debt is in the first quarter and how you expect that to trend for the rest of the year?
Yeah. Sure. So last year, we ended bad debt as a percentage of revenue. In 2023, it was about 2.1%. We estimate, given the data that we've seen, that roughly half of that is a result of "fraudsters," people who might have had a fraudulent ID or fraudulent income, etc. We've implemented a tool called Vero to help us kind of drive better resident ID, prospect ID verification, and prospect income verification. We're seeing great progress to date. We rolled out the ID verification late last year, earlier this year, and we're currently in the process of developing and rolling out the income verification. Hopefully, that's rolled out here in the next couple of 2-3 weeks. For 2024, our guidance assumes bad debt expense is about 1.75% of revenue. We're starting out a little higher in the beginning part of the year.
I expect to end the year lower. We're just north of 2% today. And again, quarter's not closed, so I'm not giving out perfect information.
How much of that 2% today is just from fraud?
How much of that 2% today is from fraud?
Yeah. I mean, it's mainly in Atlanta, I assume. So I'm just curious. I mean, obviously, there's tenants that just are not leaving and can't pay and have a hardship. And then there's those that you have a pretty strong likelihood are likely fraud. So I'm just trying to understand what the breakdown is between the two because, obviously, there might be a little bit of a different path to resolving that depending on the type of bad debt.
Yeah. I don't have the exact statistic. I don't have it in front of me, obviously. But I would probably harbor a guess that it's probably roughly half is probably from fraud. Again, the Vero tool was not rolled out until late last year. So it takes time for that tool to roll through as the prospects come in and the IDs are verified. For residents that we do have to kind of evict or go through the process of writing off their debt, they do have several months of bad debt that has built up that generates that call of 2%.
I guess I know it's early days. You just rolled it out. How is the enhanced ID screening working? Is there any sort of expectation around sort of when you would start seeing improvements in sort of fraud activity based on the initiatives that you deployed?
Sure. Yeah. So far for this year for Vero, of all of the leads that have come in because we forced the ID verification before the resident or prospect tours a unit, about 8% of the leads are failing or being denied by Vero. That's the one data that we can actually harden fast. See, now, it fails because of a fraudulent ID. But it could also fail because Vero is not able to verify it, and a human has to get involved to try to figure it out. The one data point that we don't have a clear line of sight on is, of all the prospects that have come in that do not tour, why they're not touring. Were they a fraudster and just got scared and ran away? Or were they a real lead, and they just found another unit to go rent?
How does it actually work? Someone has to put their ID. I go to your website now, and I want to schedule a tour. What am I doing? Am I putting my ID into the system? How am I doing that? I'm taking a picture of it and sending it to you. And then you compare that through some kind of. I'm trying to understand how the actual process works of screening out fraud.
Oh, yeah. Sure. So the way the tool works is, obviously, if you go on to do a prospect, which certainly feel free if you would like, the process would be that you'll come into our process as a lead. Our system will then kind of, should you want to kind of "schedule a tour," once the tour is scheduled, you will then be invited to kind of verify your ID. When you verify your ID, you will load your ID, both the front and back images, into the tool. The tool will actually also ask you to take multiple pictures from different directions. And then it will validate that information against known databases. It will validate the name on the front versus the barcode in the back.
Then it will look at the multiple pictures that it took to see if that resembles the actual human image that's on the ID itself. It uses a variety of different checkpoints to try to identify that the person is the ID is a real verifiable ID.
Yeah. I guess my thought is, is it so much work for an average person that some leads drop out just because they don't want to go through that process? But I don't know if you've tested that, but just curious.
So I tried it myself, and it was actually very easy and seamless. Literally, all it was was a few pictures, a front picture and back picture, like you're depositing a check, and then a few pictures around, and then the system takes it from there. It was very seamless.
Got it. I guess maybe we could talk about expenses. Where do you think sort of the best margin enhancement opportunities are over time, and where do you think your margins can eventually go?
Yeah. So obviously, for this year, the 2024 guidance, we continue to see or we're expecting a little bit higher increases in insurance, which is driving a lot of the non-controllable increases and certainly continual inflationary pressures on the controllable. We're doing a variety of different things across the portfolio, including technology as well as evaluating kind of different kind of staffing solutions where you could kind of pod approach, pod people, and allow people to kind of rotate around different communities. Still very early in the process. But again, as I said earlier, we really look at our number of units we manage per employee. And we're very high up on the list. We're number 3 of all the public REITs, which is great for us considering our size relative to all the major public REITs.
We think that given some of the technology solutions and just some of the efficiencies we garner from just how we kind of do with both Vero and other things, that we could add several hundred basis points to our NOI margins over the next 12-18 months.
You said several hundred basis points to your margin?
Yeah. 150-200 basis points, I'd say.
I think one of the things you were focused on was lead to lease conversion. Can you maybe talk about what you're doing there and if you've seen sort of an impact thus far?
Sorry. Say that one more time?
Lead to lease conversion. I think you were working on sort of increasing conversion of leads into tours and then, obviously, leases. I think there was an initiative there, but.
Our strategy has always been to convert 30% of the leads into tours and 30% of the tours into leases. So you end up with 9% of your leads turn into leases. That's the targets for this year. We did increase at the end of 2023, we increased our advertising spend, marketing spend to drive more leads. We're continuing with that increased spend through 2024. So the goal is to increase the number of leads, which will give us a little bit of cushion as we have implemented some of this technology that might put a little bit of pressure on that conversion rate.
We have about 2 minutes left. So I'm going to go into rapid fire in a second to see if there's any more questions. But maybe if you have any sort of parting words, things that we didn't cover today, things that you think are important that we didn't talk about, feel free to share them now. Otherwise, I'll go into rapid fire.
Yeah. I would just like, as we talk about supply, we always view our portfolio as one that's somewhat insulated just because it's Class B and no one's building Class B, so we're at a better price point. And since we're 12- to 15- to 20-year-old communities, we're in more of an infill location, if you will. So we're not really near the areas where there's a lot of new construction. But having said that, last year was a unique year with just the sheer number of units delivered and the heavy concessions that were being offered. And no one ended up being immune. But as we look forward, we believe IRT is well-positioned now as that supply increase starts to wane. And as we look into 2025 and 2026, we will be in a good position to push rents on more historical levels.
Great. What will same-store NOI be for the apartment sector in 2025?
You always get me on this, Eric. 5%-6%.
It's bullish. I like it.
I am.
It's the highest number so far, I think. We'll have to go back. But yeah, I think it's the highest number. Will your property sector have the same fewer or more public companies a year from now, so the apartment sector?
I think ultimately, there'll be fewer.
What is the best real estate decision today: buy, sell, build, redevelop, or repurchase stock?
Well, for us right now, it's clearly redevelop. We're getting, again, high teens on levered returns. And that doesn't even count the benefit of lower maintenance and CapEx costs. But after the redevelopment, I would tell you to keep deleveraging. And if our cost of capital stays where it is today, then I would say buy back stock.
Thank you.