Camden Property Trust (CPT) — Q2 2018 Earnings Call Transcript

Good morning, and thank you for joining Camden’s second quarter 2018 earnings conference call. Before we begin our prepared remarks, I would like to advise everyone that we will be making forward-looking statements based on our current expectations and beliefs. These statements are not guarantees of future performance and involve risks and uncertainties that could cause actual results to differ materially from expectations. Further information about these risks can be found in our filings with the SEC, and we encourage you to review them. Any forward-looking statements made on today’s call represent management’s current opinions. And the company assumes no obligation to update or supplement these statements because of subsequent events. As a reminder, Camden’s complete second quarter 2018 earnings release is available in the Investors section of our website at camdenliving.com. And it includes reconciliations to non-GAAP financial measures, which will be discussed on this call. Joining me today are Ric Campo, Camden’s Chairman and Chief Executive Officer; Keith Oden, President; and Alex Jessett, Chief Financial Officer. We will be brief in our prepared remarks and try to complete the call within 1 hour. If we are unable to speak with everyone in the queue today, we’d be happy to respond to additional questions by phone or e-mail after the call concludes. At this time, I’ll turn the call over to Ric Campo.

Thanks Kim, and good morning. Today's on hold music was selected by Austin Wurschmidt and his team at KeyBanc who won our contest on last quarter's call. Austin picked up on the accelerated pace of M&A activity in the REIT Industry in 2018 with eight deals totaling $56 billion in equity valuation either closed or pending. That's a lot of collaboration which led to his theme of famous collaborations of musical variety. Thank you Austin and your team. And for this quarter's contest be the first e-mail Kim Callahan 4 artists and/or bands featured on today's on hold music, and you'll have the honor of selecting our music for our next earnings call. Camden team members delivered solid earning results this quarter. We continue to create value through our development business and will be at the high end of our 2018 starts guidance. The acquisition environment is challenging with high demand driving higher prices and lower cap rates more than we anticipated in the beginning of the year. Rising interest rates and modest growth rates have not had any effect on buyer demand in the multifamily business. We've held our acquisition guidance at $500 million for the year, but have moved $300 million into the fourth quarter. We still believe we'll hit our acquisition targets while maintaining our discipline by the end of the year.

Thanks Ric. Today marks Camden's 100th quarterly earnings call and Ric and I've had the privilege to be on every one of them. A lot has changed in the REIT world over the last 25 years, but one thing that has always been true is that good numbers make for good earnings calls. I'd like to acknowledge and thank our Camden team members for producing another quarter of good numbers for us to discuss on our call today. We are indeed pleased with results this quarter, which were better than our expectations for both the quarter and year-to-date. Overall conditions remain healthy across our entire portfolio. Sequential revenue growth was up 1.8% led by Corpus Christi at 6.4%. And importantly, in second place was DC Metro of 2.6%. Every other market posted a positive sequential result. This was a very routine quarter for Camden and with this in mind and the fact that we're at the end of earnings season, I'll keep my remarks brief to allow for more time to discuss what interests you all about the quarter. Starting with same store results. Revenue growth was 3.2% for the quarter and 3.3% year-to-date. Second quarter revenue growth was led by Corpus at 4.54%, Orlando by 5.2%, Phoenix 4.7%, Tampa at 4.5%, Raleigh at 4.3% and Houston at 3.7%. As we expected, our two largest markets posted better revenue growth compared to the first quarter with Houston up 3.7%, DC Metro up 2.5%. Rents on new leases and renewals continue to look encouraging versus our original guidance. In the second quarter, new leases were up 3.3% and renewals were up 5.9% that produced a blended growth rate of 4.5% versus 3.3% in the second quarter of 2017 and 2.7% for last quarter. July prelims are running at 4.8% for new leases, 5.6% for renewals for a blended rate of 5.2%. As we expected, new lease pricing has seen good improvement during our peak leasing season. August, September renewal offers are going out on at about a 6.1% increase. Our occupancy rate averaged 95.8% in the second quarter versus 95.4% in the first quarter and was above 95.3% from the second quarter of last year. Our July occupancy rate actually reached 96% slightly better than our 95.71% last July. Our net turnover rate continues to see all-time lows at 49% for the second quarter, and 44% year-to-date. The lower turnover rate in tandem with our historically low number of move outs to purchase homes continues to contribute to our strong and somewhat better than expected operating results.

Thanks, Keith. And before I move on to our financial results and guidance, a brief update on our recent real estate activities. During the second quarter of 2018, we began construction on Camden Lake Eola, a $120 million 360 unit, 13-storey building in the Lake Eola sub-market of Orlando, Florida. During the second quarter, we also began leasing at our Camden McGowan Station development in Houston, our Camden North End development in Phoenix, and our Camden Washingtonian development in Gaithersburg, Maryland. In the third quarter, we began construction on Camden Buckhead in Atlanta. This $160 million, 365 unit development will be the second phase of our existing Camden Paces community and will consist of one 8 and 9 storey concrete building. Previous cost estimates in our supplement for this development were based upon the construction of one four-story wood frame wrap building. Due to these projects’ irreplaceable location in the heart of Buckhead and the success of our Camden phase one high-rise, we've made the decision to significantly enhance this development including moving to two type one concrete high-rise structures. Turning to financial results, last night we reported Funds From Operations for the second quarter of 2018 of $116.1 million, or $1.19 per share exceeding the midpoint of our guidance range by $0.01 per share. Our $0.01 per share outperformance for the second quarter resulted primarily from approximately $0.05 in higher same-store revenue and a $0.05 in higher non-same-store net operating income which was primarily driven by better than expected results from both our recent acquisitions and our development communities. In the aggregate, our same-store operating expenses were in line with expectations, although property taxes were $1 million higher than anticipated entirely due to Atlanta property tax valuations. This negative tax variance was entirely offset by lower than anticipated expenses in almost all other categories, particularly lower repair and maintenance expense and lower levels of self-insured employee healthcare costs.

On the merchant build product, we continue to see concessions, and it's just very typical in this kind of environment. It's interesting because the market is very bifurcated from that perspective. So just to give you an example on our Camden McGowan station project, we are 30% leased after opening up in the first quarter, so our velocity is very good, but the concession environment is basically two months free in that product. When you think about the operating portfolio overall, 9,000 apartments that we have, more or less in Houston, our operating portfolio is doing really well from a revenue growth perspective. But merchant builders are very typical when they start out with an empty building — they focus on pushing the occupancy as quickly as they can, and their view is that free rent gets you there and it's a very typical thing used in the marketplace. So it hasn't negatively impacted the overall market. It’s just the development market and once the project's leased up, obviously the concessions are hoped to burn off given the supply situation the fact that there are only 7,000 units being delivered this year, and then less next year. We expect that the free rent will dissipate by probably the end of this year, maybe the middle of next year in the new development properties.

Hi, there. This is Michael Griffin in for Nick. First question on Houston for the merchant build product. Are you still seeing concessions, or has vacancy dissipated in the leasing environment meaningfully improved?

So as I mentioned in my prepared remarks that the previous cost estimates for that development were based upon a four-story wood frame wrap building, and due to its location in Buckhead and the success of our adjacent Camden Paces high-rise, we made the decision to significantly enhance that development including moving to two type one concrete high-rise structures.

Hi, this is actually Shirley Wu on for Sanabria. So I want to touch on Houston a little bit more. For the back half of 2018, what do you think will be the trajectory or the path for occupancy comp this year? And also what's the range of your occupancy losses built into guidance for the second half?

I didn't get the second part of that question, Shirley. So let me address the first part first which is the on Houston and sort of the trajectory. We will have some very difficult occupancy comps in Houston in the fourth quarter as you — some of you may recall, we actually at one point last year as a result of the aftermath of Hurricane Harvey, we actually hit 99% occupied in the fourth quarter. Obviously, we'll be nowhere close to that. While we continue to make good gains, our new leases have picked up since the beginning of the year and we're basically up about 1% in the second quarter. Our renewals are running 5% to 6% in Houston. We do expect to see that new lease rate continue to tick up throughout the end — from now through the end of the year, but offsetting that will be the fact that we'll be nowhere near 99% occupied. I think we closed out July at about 95.5% occupied in Houston; it's a more typical occupancy rate. We’re likely to see something more akin to that as we roll out through the end of the year. We’ll continue to get better results on the new leases and renewals.

So I was just wondering in terms of occupancy losses, is that built into your guidance and as I mostly focus on 4 Q, like you were saying, or is it like a bit in 3 Q as well?

Well, it's not occupancy losses but occupancy relative to our same store results last year. It's obviously going to be much less probably about 350 basis points plus or minus less than what our occupancy was at this time than the fourth quarter of last year, but we're not projecting occupancy losses from where we are today throughout the end of the year. It's just that we're going to have a really tough comparison in the fourth quarter, late third and into the fourth quarter of 2018. So for the second quarter new leases 3.3%, renewals 5.9%, the blended rates 4.5%.

Hi, good morning. I was just curious if you could give a sense on how 2019 supply outlook is shaping up as one of your peers had indicated supply growth will be down in the high teens next year. And I was curious if you were seeing a similar decline.

So our two data providers are Wheaton and RealPage that we have, we look at completions for 2018-2019 and honestly there's not a nickel's worth of difference in their forecast between 2018 and 2019. Wheaton is basically at 138,000 deliveries, and I'm talking only in Camden's market, it's not nationally but only in Camden's markets. And he's got that drop into 136 in 2018. RealPage numbers a little bit less than that at 142 in 2018 and drops to 140. So you're less than a 1% difference between the two data providers that we have on what we think completions will be between 2018 and 2019. So I think that both of them, at least in our conversations, have attempted to capture what has been a phenomenon that's been going on for two years now, which is the delay in getting completions to the finish line, but they think they've made their best guess that things that may shift between the projected 2018 completions that roll over into 2019. So we'll see how good they were able to forecast that, but it’s certainly been a trend for the last two years. My guess is it's going to continue, and they tell us that they’ve made their best guess factoring in delays of 2018 and 2019. But I think for our purposes from the standpoint of our planning, we're assuming 2018 and 2019 are roughly equivalent across our platform.

With the exception of Houston obviously. That's just a different animal given the nature of Houston when supply is just falling off the edge of the earth in 2018 and 2019.

Yes, appreciate the detail there. And then separately, you talked about the competitiveness in the acquisition transaction market, but it sounds like you're pretty comfortable with your acquisition guidance. So we're just curious what gives you that level of confidence and do you have anything under contract today?

Well, what gives us the confidence is that we're working on lots of transactions, and while we don't really talk about what we have under contract or not at this point level in the game, we feel that we'll be able to hit that target by the end of the year. It was somewhat surprising to us that with the 10 year hitting 3% and markets' prices being where they are that there wasn't a little less frothiness in the market, but like I said in my beginning comments that hasn’t been the case. People are either lowering their terminal IRR numbers to get to where they're going, but our specific box that we're looking for is newer construction with below replacement cost with some embedded concessions so we can grow those cash flows going forward. It's just harder to find. There's still a massive bid for value-add and — good news for us is that we're not really looking at value add. We're looking for that sort of a different product, but there is still a huge bid out there for multifamily. I think part of it stems from the whole issue that this is the 10 years at 3% or 3.5% because we have great growth going on in the country, and you have inflation sort of picking up some — the idea that multifamily re-prices pretty much every day their product and the leases roll over on average of 8% to 10% of the whole portfolio rolls every month. Some investors are banking on higher inflation and therefore cash flow is growing faster than cap rates rising. If you do have longer-term interest rates rise. So that's just getting them over the hump on multifamily sides. Hotels, it's the best inflation hedge as long as you're growing the economy and not having sort of stagflation which doesn't look like that's on the horizon.

Hey, good morning down there. Just two questions. First Ric or Keith on California just given it's about 8% of your portfolio. Do you have any sense in your markets there, the municipalities what their sense is for if Costa Hawkins is repealed, if you think that any of your markets will face rent control measures, or do you feel pretty good with where your communities are right now and understanding the issues especially as it revolves around vacancy decontrol?

Yes. So, Alex, the two things, the two comments. One would be they are sort of the state-level initiative that there's a lot of attention on right now. We certainly are participating in the fighting the good fight on the repeal effort at the state level. If you put a gun to my head I'm probably thinking that the state-level initiative may actually get through, but that's not really where the game is won or lost on this issue; it’s going at the municipal level which you're correct to point out. Obviously, you have a different dynamic in San Diego, Orange County, and Inland Empire than you do in Northern California and then LA County. So there was a piece done by one of the good analyst firms and I'm not going to mention the name, but it's pretty well done, and it stratifies all of the REIT holdings in California by municipality and sort of assigns a high risk to low risk value to those and in our portfolio only about 10% of Camden's assets fall into what would be called a high risk bucket or a municipal level adoption of some kind of rent control measure. So now 10% of our—11% of our NOI and roughly 10% of that’s in the high-risk bucket. I think our specific exposure is pretty limited to the Costa Hawkins thing. But obviously, it's a huge thing. There's a lot of attention. We're participating with all the other REITs and NAREIT and MHC, but there's a lot of energy on both sides of this issue in California. And it'll be interesting to see how it plays out.

Okay. I guess it makes you happy that you're Texas-based. And then the second question is Denver. Suddenly, it's become everyone's popular market. You guys have been there a long time; you never left, but I recently haven't seen as much on the investment side there. So what are your thoughts on Denver? And then overall I think your footprint is much broader than just Denver. Your properties extend out. So are you thinking about the market any differently and how you invest there? Meaning maybe concentrate more on infill or do you like the market as a broad market to invest in?

We like the market as a broad market to invest in. If you look at what we've been doing with our developments, our developments have been transit-oriented development. We currently have a development underway in RiNo which is the River North Area, which is right adjacent to downtown. The challenge that we've seen in the — and trying to get more urban in Denver is that it sort of hurts my head paying sub for cap rates for new development there, and that's what they're tricking at today. So we like where we are in Denver, and our properties— so we have a nice balance between new transit-oriented development, some urban and then suburban. So that when you do have a correction in the Denver market someday, we have a balance between A and B properties and suburban and urban properties, but generally Denver is definitely on everybody's list of getting into, and if you liked for a long time for lots of reasons, it continues to be a good market.

Good morning, guys. Beyond the Buckhead development, how many of the other pipeline communities are you planning to start in the second half of this year? And where are at this point you think stabilized returns are for the current pipeline and then on stuff that you would start?

So the starts that we've announced, including the Buckhead, is we might start one more, but it would be right at the end of the year, maybe beginning of next year. Our pipeline with the ones we've announced were at $280 million plus or minus and just really close towards $300 million guidance. In terms of yields, clearly development yields have come down from some pretty lofty levels that they were at. Our yields today instead of sort of seven and some change, there are six and some change. Construction costs continue to rise 4% to 8%, maybe 10% in some markets, and rents are going up 3%. So that definitely has compressed those yields. On the other hand, we still have a 150 to 200 basis point positive spread between our going-in yields versus what we can buy going-in yields from an acquisition perspective. So you still have a nice spread for taking a development risk.

Yes, absolutely. So we don't appeal every single thing, but we do appeal a lot. In fact, in getting some form of reduction, we were typically about 70% effective. So it's a pretty good winning rate.

Thanks, good morning. For over 20 years and I haven't won anything. So I don't know what's going on here. One thing I do remember way back when there was a signal of a healthy multifamily market was when new rents exceeded new rent growth exceeded renewal rent growth. That hasn't really happened in a while and I'm wondering if there is a systemic reason why it won't happen again, or do you think that there's a chance that you could see your new rent growth cross with your renewals at some point in the next couple of years.

Rich, I think it's certainly possible. Some of it has to do with when you look at new and renewal rents. A big part of it is what happened at the last 12 months ago when that person signed a lease. If you're in an increasing market that's constantly increasing upwardly in rents then it doesn't surprise me greatly that you would continue to see renewals — renewal rents above new leases. The weird part or the odd part about where we have been for the last seven or eight years is you've been in a constantly increasing rent market, although the second derivative has moved around a little bit on the rate of growth, but the fact is rents have been growing for eight straight years which is unusual. When you have — you think about what the experience that we had in Houston with the downturn in the oil markets and rents actually going negative. There's no question that we were renewing rents in many cases at below what we were offering new rents at. And part of it had to do with at some point you're just trying to maintain occupancy. So it depends a little bit on where you are in the cycle, but I would expect that as things continue to get as this cycle unfolds and moves into the next cycle, yes, I my guess is you'll see that happen again.

Hey, good morning, I wanted to touch on Southern California briefly. It looked like while revenue growth is still strong there, it looks like it decelerated a bit sequentially in both, the LA Orange County, San Diego, Inland Empire markets. And I was just curious if that’s the result of pockets of supply? Is that a result of sort of a tangential effect of more urban supply? What are the dynamics driving that?

Yes. So in LA, for example, it looks like 2018 we're going to end up getting around 60,000 jobs this year. And that's against about 14,000 new apartments. So that's relatively in line, a little bit of pressure implied. If you go out into 2019 in LA, the drop—jobs are forecast to drop to about 40,000, but unfortunately the supply maintains pretty constant at about 14,000 additional apartments. It’s just the ramp of supply that’s finally getting to the marketplace in LA. A similar story in Orange County, in 2018 it looks like we’ll get about 30,000 jobs, and we will have to absorb about 7,000 apartments in 2018, and the math is pretty similar in 2019. So from my perspective, our portfolio is actually doing pretty well and we’re pleased with the performance. It’s actually outperforming what our original plan was. Some of that has to do with our location; it’s just not nearly as impacted by the high levels of deliveries that are going on across the Southern California platform.

I don't think you're rolling dice. HQ2 is a wild card, and I don't think we can throw the dice on that.

Great, thank you. Just a curiosity question Camden Buckhead, you have the total development cost last quarter as a wrap product at about $277,000 a unit. And then going with type one vertical, you're up to about $438,000 a unit. Is there really a $160,000 a unit increase when you go from wrap to concrete?

Well, there are two pieces. So the answer is yes. There's a big differential between a wrap and a concrete, no question about it. And then second when you do go to a concrete product and a high-rise product you start — you improve the interior quality of the property and the amenity space as well. If you're trying to get a premium rent, you're going to have to put in premium finishes, more than you would do — than you were doing in a wrap product. So part of it is just the differential between wrap and high-rise. And then the amenity packages and the finishes and then third between both of those is that sort of the wrap product was a placeholder, and since — so it's probably not a great comp because construction costs have continued to rise and we have not tried to tweak our sort of future development numbers very much. So that number that was put in for the wrap product was put in a couple of years ago. As you've definitely had some construction price creep in that number.

Yes, good morning, everyone. Can we go back to the Fulton County tax increase? Were you entering this year well below your target rate? Did they overshoot or is it just a case where a municipality is trying to plug their budget using commercial real estate?

Wes, there's actually a lot of really interesting articles online where you can read about this, but effectively what happened is the State of Georgia has sued Fulton County alleging that their valuations are under market, and so this is Fulton County's way of responding to it. I will tell you this is not a Camden unique issue. In fact, at last count, there are over 40,000 appeals of property tax valuations in Fulton County; that's over 8% of all property owners. There's actually an 8% threshold where if you go over 8% of appeals, the county actually has to get the courts to certify their tax register. So this is a sort of across-the-board Fulton County issue. I will tell you that clearly we believe they've overshot. We've filed all of our appeals, but once again if you have 40,000 appeals that they have to work through, I think it's going to be highly unlikely that we're going to get any resolution until 2019.

Okay and then looking at the acquisition guidance be pushed to the fourth quarter. Is that just a function of developments taking longer to build maybe getting a little bit of a delivery delay pushing that the timing of a lease-up acquisition later? Or is it just trying to figure out which one you want to buy?

It's more trying to figure out which one we want to buy. There are too many—we're going through more and more transactions trying to find the right one. It's not so much a delay in deliveries.

Okay, a real quick follow-up to that. And how many people do you run into for competition when you're trying to buy a lease? I would say I get that value add, and core may have a lot of competition, but when you look at the lease, is such a bit-ask spread or is it just a lot of people chasing these?

I think it's both. You have — you clearly have—so on a value-add you may have 20-30 bidders in a sort of core below replacement cost type of asset and we might have 10 or 12, 10 or 15, but you still have — trust me there's still a lot of competition. It is just less competition in that space, and there is in value-adds. Right. We appreciate your time today. Have a great rest of your summer. And we'll speak to you in the fall. Thank you.