Invitation Homes Inc (INVH) — Q1 2018 Earnings Call Transcript

Thank you. Good morning, and thank you for joining us for our first quarter 2018 earnings conference call. On today's call from Invitation Homes are Fred Tuomi, Chief Executive Officer; Ernie Freedman, Chief Financial Officer; Charles Young, Chief Operating Officer; and Dallas Tanner, Chief Investment Officer. I'd like to point everyone to our first quarter 2018 earnings press release and supplemental information, which we may reference on today's call. This document can be found on the Investor Relations section of our website at www.invh.com. I'd also like to inform you that certain statements made during this call may include forward-looking statements relating to future performance of our business, financial results, liquidity and capital resources and other nonhistorical statements, which are subject to risks and uncertainties that could cause actual outcomes or results to differ materially from those indicated in any such statements. We described some of these risks and uncertainties in our 2016 annual report on Form 10-K and other filings we make with the SEC from time to time. Invitation Homes does not update forward-looking statements and expressly disclaims any obligation to do so. During this call, we may also discuss certain non-GAAP financial measures. You can find additional information regarding these non-GAAP measures, including reconciliations of these new measures with the most comparable GAAP measures, in our earnings release and supplemental information, which are available on the Investor Relations section of our website. I'll now turn the call over to our President and Chief Executive Officer, Fred Tuomi.

Thank you, Greg, and good morning, everyone. We are eager to update you on our latest results, but first, I'd like to share a few high-level observations that I think are important to understand about Invitation Homes and our ability to create long-term value for our shareholders. First, we continue to believe the fundamentals of our business remain extremely strong. The dynamics of supply and demand remain very favorable and seem to be improving for the single-family rental business, especially across our unique, high-growth locations. In our markets, 2018 household formation is forecast to grow at a rate 90% greater than the U.S. average. And single-family home completions are forecast to be almost 30% below the historical average since 1985. We believe this helps position us to achieve same-store NOI growth of 5% to 6% and core FFO growth near the top of the REIT sector for this year. Beyond this year, demographics in the United States should become increasingly impactful to our sector and should support strong single-family rental demand for years to come. The average age of the head of household in our homes is 39 years, meaning the millennial generation is just starting to reach the life stage where their needs align with our product. And although it is early, many believe it's possible that tax reform and rising interest rates will have a further positive impact on single-family rentals. In fact, turnover in the first quarter of 2018 declined to 7.6% from 8.1% in the first quarter of 2017, driven primarily by our year-over-year decrease and move-outs to homeownership from 25.7% to 22%. On the supply side, we believe that construction of new single-family homes is likely to remain muted for the foreseeable future due to the value of well-located land and the rising cost of materials and labor. We think this is especially true in our markets. The second point I want to make is that we believe our portfolio is one of the most desirable in residential real estate. Our locations are high growth, high quality, and infill. It is a unique advantage to have 70% of revenue derived from the Western United States and Florida. We have carefully selected our submarkets and homes to be in high value locations with proximity to employment centers, good schools, and transportation corridors, the 3 things residents tell us are most important to their families. With over 4,800 homes on average per market, we have unmatched scale and density that is critical to our best-in-class operating efficiencies. Third, our business is built for all parts of the macroeconomic cycle. Single-family rental homes are well-positioned if interest rates continue to rise and the cost of homeownership increases. Relatively short-term leases allow us to quickly optimize revenue in the strong demand environment that typically coincides with rising interest rates. In addition, our homes are part of the most liquid real estate asset class in the world and represent value to both investors and traditional homeowners. Last but not least, our people are top-notch, from our Board of Directors to our corporate teams, to our associates in the field that interact and earn the loyalty of our residents. It is our people that enable us to deliver the exceptional quality of service that we commit to our residents every day. And it is our people that will drive us to higher levels of success as we continue to discover more ways to improve the experience of our residents and further optimize our operations. I thank all of our associates for making Invitation Homes a great place to call home. In short, families want to live in our desirable neighborhoods and homes. We think demand could increase and housing options could remain limited. We provide an opportunity which might not otherwise exist for families to thrive in a neighborhood of their choice. With that, I'll now provide a brief update on our start to 2018. We remain on track with our plan for the year. Our unique ProCare service delivery model continues to produce high resident satisfaction survey scores and first quarter revenue growth of 4.1% was in line with our expectation. One-time expenses contributed to higher overall expense growth in the first quarter; however, the outlook for the remainder of the year remains positive. On merger integration, we remain on track with our plan to deliver the benefits we committed to our residents, associates, and shareholders. Development of the systems and technology to support our new operating platform is on schedule. We continue to expect the rollout of our unified field operating model to begin in the second half of 2018. Our investment management team remains on track with its capital recycling plan with approximately $50 million of acquisitions and $50 million of dispositions in the first quarter. We have also ramped up investment in select value-enhancing CapEx opportunities to deliver residents more of the features they desire while simultaneously enhancing our risk-adjusted returns. On the balance sheet, we've continued progressing towards investment-grade status with refinancings since SWAT transactions in the first half of 2018 to increase unencumbered assets, improve our maturity profile, lower future floating rate debt exposure, and reduce our overall borrowing cost. In summary, we have accomplished a lot already in 2018, and we continue to be excited about the growth of this business in both the near and the long term. According to Case Shiller, home prices in our markets continue to appreciate almost 7% per year. When you consider the value already embedded in our assets today, we believe there is no more compelling way to acquire a scale and high-quality portfolio of single-family rental homes than through the investments in Invitation Homes. So with that, our Chief Operating Officer, Charles Young, will now provide more detail on our operating results in the first quarter as well as the current trends.

Thank you, Fred. We continue to enjoy strong fundamentals that pave the way for another solid quarter of growth in the first quarter of 2018. Our team is working well to keep field operations running smoothly at the same time that merger integration progresses according to plan. I'd like to thank our associates for their continued commitment to making 2018 a successful year with respect to both core operations and integration. It's been truly impressive to watch our teams in action, and I look forward to taking resident service to the next level when we empower them with an even more efficient, unified operating platform in the second half of 2018. I'll now spend some time walking you through the details of our first quarter 2018 operating performance. Same-store core revenues in the first quarter grew 4.1% year-over-year, in line with our expectations. The revenue increase was driven primarily by average rental rate growth of 4% and average occupancy remained strong at 95.7%. Same-store NOI grew 3.6%, a solid result considering one-time items that resulted in higher-than-normal same-store core and expense growth of 5.1% in the quarter. A key contributor to this expense increase was elevated repair and maintenance expense, which was atypical in nature attributable to a timing delay in completing routine non-storm-related service requests in markets impacted by the September 2017 hurricane. Service requests related to hurricane damage were prioritized in the fourth quarter of 2017, pushing non-critical routine service requests that otherwise would have been resolved last year into the first quarter of 2018. Harsher winter weather in the first quarter of 2018 compared to the first quarter of 2017 also contributed to higher repair and maintenance expenses. Next, I'll cover first quarter 2018 leasing trends. Same-store rent growth remained strong in the quarter with renewals again up almost 5%. Renewals represented two-thirds of the leases we executed in the first quarter. At the same time, turnover was even lower year-over-year at 7.6%, a testament to the value we believe residents continue to find in our first-class service on high-quality homes and highly desirable locations. Same-store new lease growth was 2.5%, accelerating over the course of the first quarter as expected and blended rent growth was 4%. The Western U.S. markets continue to lead the way for our growth as Northern and Southern California, Seattle, and Phoenix were our strongest markets from a rent growth perspective in the first quarter. I'm also happy to report that we're seeing great momentum as we enter peak leasing season. Average occupancy increased to 96.1% in April 2018, up 20 basis points from April 2017, which puts us in an excellent position for growth. After increasing sequentially in each month of the first quarter, new lease rent growth accelerated to 4.5% in April 2018. Renewals also remained strong in April at 4.7%, resulting in a solid blended rent growth of 4.6%. Main engine renewals have been quoted in the mid-5% range, and we expect new lease growth to continue accelerating as we move further into peak season. Finally, a few words on how we're enhancing our resident experience. Our team members remain committed to providing every resident with the opportunity to live the leasing lifestyle they prefer in good neighborhoods close to their jobs and great schools, and we continue to innovate and enhance our property management operations to provide residents with even more outstanding service. In the first quarter of 2018, we installed smart home technology in an additional 2,000 homes, bringing the total to almost 24,000. Smart home technology allows us to operate with greater efficiency and enables residents to enjoy their homes in a more convenient and energy-efficient fashion. We're also achieving high resident satisfaction scores as we continue rolling out our proprietary ProCare service model. As field integration takes the next step later this year, we'll roll out more enhancements to our platform that will make the leasing lifestyle we provide to residents even better. I'm proud of what we have delivered so far and I look forward to working with all of our team members to continue enhancing the experience of our residents as we move forward. I will now turn the call over to our Chief Financial Officer, Ernie Freedman.

Thank you, Charles. Today, we'll cover the following topics: portfolio activity for the first quarter, balance sheet and capital market activity; financial results for the first quarter and changes in our supplemental disclosures. I'll start with portfolio productivity. As we continue to recycle capital to further enhance the quality of our portfolio, in the first quarter of 2018, total home count decreased by 61 to 82,509 homes or approximately 4,850 on average per market. We bought 190 homes for an estimated $53 million at an average cost basis of $277,000. And we sold 251 homes for $55 million at an average disposition price of $220,000. I'll now turn to an update on our balance sheet and capital markets activity. As previously communicated, we remain committed to working toward an investment-grade rating. Debt markets remain highly favorable for issuance, and we took advantage by refinancing approximately $2 billion of debt year-to-date to increase our unencumbered assets, improve our maturity profile and reduce borrowing costs, all on a leverage-neutral basis. In February, we closed a 7-year securitization with a principal amount of $917 million at total cost of funds of LIBOR plus 124 basis points. We used net proceeds to repay in full all of our remaining 2019 secured debt maturities. In May, we closed another seven-year securitization with a principal amount of $1.1 billion at total cost of funds of LIBOR plus 138 basis points. We used net proceeds and cash on hand to repay $1.2 billion of secured debt maturing in 2020. Pro forma this latest refinancing, our weighted average maturity was extended to 5.0 years, and we increased the number of homes in our unencumbered pool by 10% since the beginning of the year. Net interest expense as a combined result of the February and May transactions is expected to decrease by $14 million on an annualized run rate basis. In addition to the refinancings, we entered into $2.5 billion of forward interest rate swap agreements subsequent to quarter-end. After giving effect to these swaps and based on our current capital structure, the percentage of our debt that will be fixed or swapped to fixed rate beginning in January 2019 will increase to 87%. It will be between 90% and 100% for the years 2020 through our debt's final maturities. We had over $1.1 billion of liquidity at quarter-end through a combination of unrestricted cash and undrawn capacity on our credit facility. I'll now touch briefly on our first-quarter 2018 financial results. Core FFO and AFFO per share for the first quarter increased 13.7% and 7.3% year-over-year, respectively, to $0.29 and $0.24. The primary driver of the increase was growth in NOI in addition to lower interest expense per share. Supplemental Schedule 1 provides a reconciliation from GAAP net loss to our reported FFO, core FFO, and AFFO. As of today, we have earned approximately $24 million of merger synergies on an annualized run rate basis, which includes $9 million of share-based compensation expense, mainly due to duplicate cost synergies. We continue to expect the majority of NOI-related synergies to be realized later this year after the implementation of an enhanced operating platform for our field and corporate teams that combines the best of both legacy organizations. Therefore, we do not expect our achievement amount to increase materially during the next 90 days. The last thing I will cover is changes in our supplemental disclosures. As we noted in our last call, we updated our definition of same-store to consider homes that were acquired as part of our merger with Starwood Waypoint. Our supplemental reporting provides information concerning our same-store pool of 72,109 homes as of March 31, 2018. On Supplemental Schedule 6, we are providing additional detail on our total portfolio capital expenditures. You will notice two categories of capital expenditure that have been part of our business: initial renovation CapEx that we invest in homes upon acquisition to bring them up to our standards and recurring CapEx that we invest in on an ongoing basis to maintain the quality of our homes. We are also providing detail on a third bucket, value-enhancing CapEx, which we've more recently introduced. Value-enhancing CapEx refers to investments we make in stabilized homes to enhance risk-adjusted returns. For example, we might see an opportunity to upgrade a kitchen or a higher end finish or expand a living area in an allocation where data tells us residents will pay a premium for these types of amenities. Recurring CapEx is the only portion of our CapEx that we deduct from core FFO to arrive at AFFO. It is the component of CapEx included in total cost to maintain. I'll close by reiterating what Fred mentioned in his opening remarks, that we've accomplished much already in 2018, thanks to our top-notch team of associates and the energy they bring every day, and we are excited for the future. Fundamentals remain strong, and our best-in-class portfolio and resident service continue to be an advantage, making us confident and excited as our teams move forward in 2018, seeking to further elevate the value of Invitation Homes to both shareholders and residents. With that, operator, would you please open up the line for questions?

Ernie, I was just hoping on the cost side for the same-store expenses that would be higher than you expected. Can you help us quantify that? And was that more in the sway portfolio just given their taxes exposure?

Sure, Juan, I'm happy to provide some clarification. Actually, we weren't surprised by the 5.1% expense growth year-over-year. The net impact of the one-time items we disclosed in the supplemental was about $700,000. Actually, more of that came from the Invitation Homes side rather than the Starwood exposure with regards to the hurricane. Without those expense growth would have been 4.5%. The other driver for the expense growth was real estate taxes. We disclosed in Supplemental Schedule that real estate taxes are up 7.3% year-over-year, which is a pretty high number, but Prop 13 in California wasn't the culprit behind it. The benefit of Prop 13, as you know, is that going forward, state tax increases are statutorily capped at 2%, which is great for almost 13,000 homes that we own in California. Both our IPO in February 2017 and the merger with Starwood Waypoint late in the year were triggering events for valuation reassessments. Q1 was a particularly difficult comp for these California taxes as we could not book our Prop 13 tax adjustment in Invitation Homes until the second quarter last year, as we disclosed in last year's second quarter earnings release. In Q1 '18, we had higher California taxes from both the IPO early in the year, as well as from the Starwood Waypoint merger late in the year. Without that noise from Prop 13, real estate tax growth would have been 4.5% year-over-year for the quarter, which is better than the 5% expectation for the year for taxes prior to the impact of Prop 13. So actually, we had a good result in real estate taxes before Prop 13. Without Prop 13, our overall expense growth would have been about 150 basis points more favorable. So expense growth would have been about 3% for the quarter year-over-year versus the 5.1% that we reported after taking into account the impacts from the one-time items as well as Prop 13.

That's very helpful. And then just switching gears to the balance sheet, another one for you, Ernie. Leverage ticked up a bit quarter-over-quarter. What drove that? And how do you think about the tools to reduce leverage outside of retained cash flow and given your view of cost of capital today, what are the alternatives or how you're thinking about that?

Yes, sure. You did see that our net debt-to-EBITDA went from 9.5x in the last quarter to 9.7, a modest change. That really just comes down to where adjusted EBITDA was for the two periods, and there was a refinancing transaction in the first quarter when we actually had proceeds also that cover the financing costs. I fully expect by the end of the year, as we've talked about, we'll reduce that ratio by about one turn. We'll definitely be in the high 8s to about 9x and expect that to happen. In terms of tools that are available to us, certainly the most important one is what you pointed out, which is the retained cash flow; our NOI is still projected to be 5% to 6%, and adjusted EBITDA growth is starting to grow very strongly. Along with our dividend payout ratio, we are using that retained cash flow. Additionally, we periodically assess opportunities for capital recycling and decide what makes sense in terms of capital recycling with those proceeds. And today, we've had some modest purchases in the first quarter, which we discussed in the prepared remarks. We are very pleased with our plan and continue to stay on track regarding acquisitions and dispositions to balance those in 2018. We'll keep all our options available to us broadly to raise capital and will consider that as well if it makes sense to improve the leverage profile.

Yes, this is Charles, thanks for the question. We actually did exactly what we wanted to do in Q1. In the last call, we mentioned that we were a little behind on where we wanted to be at the end of the quarter, wanting to build occupancy through Q1. We added about 40 basis points, moving us up to 95.7%. We continue to add, actually in April, so we're north of 96% on average in April, which is great news overall. It puts us in a really good position for peak leasing season. More than 90% of our markets added occupancy in Q1. We did exactly what we hoped. Because of that, blended rent growth came in stronger as renewals carried the growth, and we were just shy of 5% in Q1. We're seeing solid, continued renewal growth as renewals represent two-thirds of all the new leases that we do. We’re seeing growth in new leases as well, and we ended April at 4.5%. So we're positioned very well going into peak leasing season. Yes, overall, our program has really been great for us. It's not only the ability that we can actually charge additional fees, but there's also ancillary revenue that we're able to generate. Ultimately, it's as much about the operational efficiencies we gain from being able to provide self-showings, letting our vendors in, and knowing when they're on-site. This technology assists in utility management while we own the homes and they are not leased, reducing costs on an ongoing basis. Our residents enjoy the convenience of self-showings and the ability to manage their utilities while living in our homes.

Yes, the original idea of the smart home technology was to address some operational challenges that we face in the single-family rental space, namely key control and access to the home by vendors and our field employees. The technology also helps maintain control over utility costs during renovation processes. Furthermore, we've discovered that prospects greatly appreciate the opportunity to interact with the system and utilize self-showing experiences. A significant portion of our prospects, around 70% to 80%, prefer self-showing options. They can, of course, choose a guided tour from a leasing professional if they prefer. With the trend towards smart home technology sweeping the nation, we recognize that many either have access or are considering adding smart home capabilities to their homes. This demand drives us to incorporate these features into our offerings. We make it optional for our residents to control various aspects of their homes through the smart home system. Additionally, we foresee expanding this offering to other aspects in the future.

I was just hoping we can talk about CapEx a little bit and your expectations there, both on the R&M side and the revenue enhancing side?

Sure. So what specifically is your question, Doug?

Just wondering about the outlook for 2018. It looks like the year-over-year growth in CapEx in Q1 was fairly high. Just wondering if that was just a tougher comparison or if that's the level we should be expecting.

Sure, this is Ernie. I'll handle the question around the current CapEx. On the recurring CapEx, we think there is a real opportunity for us to better leverage the two former organizations, which had differing spend levels regarding CapEx. Our expectation is to achieve a blended number that reflects a more efficient approach over time. We did achieve a closer blended number of about $1,200 to $1,300 per door in our first quarter. We previously indicated that $1,200 to $1,400 is a good benchmark for us, and there's potential for us to improve on that. The number was a bit higher in the first quarter due to carry-over from the work orders related to the hurricane, which contributed to a tougher year-over-year comparison. Overall, we expect to reach these new targets over time.

As we look for ways to optimize customer experience moving forward, we've found that the revenue-enhancing CapEx can be very effective. For example, we recently implemented projects within one of our big neighborhoods, typically spending between $5,000 and $6,000 per home for enhancements, which our customers are willing to pay a premium for. This would yield an ROI of approximately 15% to 20% on an unlevered basis. Examples include kitchen upgrades, hardwood flooring, and other ways to enhance the property while providing residents the choice in their living spaces. This approach not only helps the customer feel more invested in their home but also creates a win-win situation for both parties.

First question just has to do with the work orders that were delayed from the hurricane. I know you guys perform many surveys with the residents after reports are completed. Has there been any impact on the overall happiness of the residents due to the wait times?

Yes, we prioritised urgent work orders to ensure we were addressing emergencies or habitability issues first. While there was some delay with the more routine work orders, such as fencing or landscaping, we do track interactions with residents, and the scores did decrease slightly but not materially. The main effort has been on resolving these issues quickly, so overall, perhaps a slight uptick, but no significant impact on our service goals.

Given what you learned in hindsight, would you change the way you structure your repair and maintenance efforts in the event of a significant weather event again?

We are integrating the best practices from both organizations, using a technology platform for maintenance management that will allow us to work through service requests more quickly. This advancement should enhance response times and service quality in future cases. We have already begun implementation and are proud of what our teams have been able to accomplish based on our scale.

Yes, absolutely. We view the instant offer program as just one of many innovative channels for improving customer transactions. We're starting to see a shift as customers look outside traditional brokerage avenues to buy and sell homes, and our program has evolved significantly since we launched it. By partnering with platforms like Zillow and others, we’ve established a foothold in this growing segment and have found ways to optimize our lead funnel.

I wanted to revisit the integration discussion. It sounds like the merger integration plans are on track. Could you share insights learned so far and what might be coming in the second half?

The integration is proceeding according to plan, and we are pleased with our team's performance. We are now moving towards the implementation phase, which will enhance customer life cycles and service delivery. We anticipate around $45 million to $50 million in cost synergies on an annualized basis from this merger by early 2019. We are keen on identifying best practices, especially in procurement and efficiencies at market scale as we further develop our integrated operating platform.

Regarding same-store expenses, I've noticed your guidance implies a level below the current 3% growth trend for the balance of the year. Is there anything additional we should be aware of that might help keep those costs down?

Yes, good question. Real estate taxes should be more manageable in the second quarter, improving our visibility against last year's comps. We expect new NOI-related synergies to kick in later this fiscal year, primarily in the fourth quarter that should support our efforts. Hence, we see a path to achieving our previous guidance in the range of 2% to 3%, and we remain optimistic about controlling our spending efficiently.

Can you elaborate on the initiatives to introduce other revenue products that could enhance tenant lifestyle but also generate revenue for Invitation Homes? Can you provide some examples?

One such example is further expanding our smart home capabilities. We currently offer basic systems but envision adding video monitoring and security systems to our options. Additionally, we are exploring landscaping services for residents and partnerships with large vendors for joint marketing campaigns. Our aim is to create tailored product offerings that meet the preferences of our residents and enhance their lifestyle while generating revenues.

I guess another question on the same-store expense side. Ernie, you outlined a core same-store expense growth of approximately 3% ex-one-time items and tax implications. Does that imply something below that level for the balance of the year?

Yes, we expect a relatively better performance on our real estate taxes, especially with what we saw last year. There are several factors that we believe will offset the higher baseline, including the expected revenue and operational efficiencies stemming from our merger's synergies, so I can see a path to remain in that range.

That's really helpful. Finally, Ernie, on your outstanding senior notes, can you explain the sentiment among investors on your interest coverage? And what are the plans for refinancing?

Many investors remain receptive to our story given our strong operational metrics and are often optimistic about our future. We will continue to monitor interest rates and refinancing opportunities without sacrificing our credit profile. Each refinancing opportunity is assessed against its impact on our overall cost of capital along with growth strategies.

Thank you all for your questions and your participation today. I'd like to reiterate my gratitude for your continued support of Invitation Homes. We are keen on executing our strategies throughout the year as we drive further value for our residents and shareholders alike.