UDR Inc (UDR) — Q4 2015 Earnings Call Transcript

Welcome to UDR's fourth quarter financial results conference call. Our fourth quarter press release, supplemental disclosure package and updated two years strategic outlook document were distributed yesterday afternoon and posted to the Investor Relations section of our website, www.udr.com. In the supplement, we have reconciled all non-GAAP financial measures to the most directly comparable GAAP measure in accordance with Reg G requirement. Prior to reading our Safe Harbor disclosure, I would like to direct you to the webcast of this call located in the Investor Relations section of our website www.udr.com. The webcast includes a slide presentation that will accompany our two-year strategic outlook commentary. On the Safe Harbor, statements made during this call which are not historical, may constitute forward-looking statements. Although we believe the expectations reflected in any forward-looking statements are based on reasonable assumptions, we can give no assurance that our expectations will be met. A discussion of risks and risk factors are detailed in our press release and included in our filings with the SEC. We do not undertake a duty to update any forward-looking statements. When we get to the question-and-answer portion we ask you that you respect everyone's time and limit your questions and follow-ups. Management will be available after the call for your questions that do not get answered on the call. I will now turn the call over to our President and CEO, Tom Toomey.

Thank you, Shelby, and good afternoon, everyone. Welcome to UDR's fourth quarter and 2016 and 2017 strategic plan update conference call. On the call with me today are Tom Herzog, Chief Financial Officer, and Jerry Davis, Chief Operating Officer, who will discuss our results, as well as senior officers, Warren Troupe and Harry Alcock, who will be available during the Q&A. During this call, we will present our updated two-year strategic outlook as we have done in the last three years. In 2015 we again met or exceeded all primary objectives of our strategic plan and to-date have meaningfully outperformed in each of our prior plans. Tom will address this outperformance and the next two years strategic outlook in detail later in the call. Turning to 2015, it was another great year for UDR and we continue to see strength in all aspects of our business. A quick recap of the team's accomplishments during the year. First, our operations continue to run on all cylinders and delivered strong same-store results across the board, with same-store NOI growth of 6.7%, a full 220 basis points ahead of our initial expectation. Second, we delivered over $300 million of development which leased up well and we expect to hit our targeted returns of 6.2% or better at stabilization. Third, we entered into two accretive problem-solving transactions, mainly the $559 million West Coast development joint venture and the $901 million Washington, D.C. acquisition, in which we kept to our principles of self-funding, accretive cash flow growth, and continued strengthening of our balance sheet. Last, we grew AFFO per share by 12%, a strong rate, which resulted in a 7% dividend increase and meaningful consensus NAV per share growth of 15%. We continue to believe that growth in these two metrics translates to strong total shareholder returns over time. Looking towards the future, we feel very positive about our business and our prospects. Multifamily fundamentals remain extraordinarily strong. The positive demographic trends amongst our prime renters, the 22 to 35 year-old population cohorts, is expected to grow through 2030 and is not reversible. This coupled with steady job growth gives us confidence that our operating platform, which is our primary driver of our cash flow growth, should continue to generate impressive results in the future. Our self-funded development pipeline is expected to generate the incremental cash flow and value creation we originally forecasted. Expected additions to the pipeline in 2016 will maintain our targeted size at $900 million to $1.4 billion and our forecast to be highly accretive. Our ability to fund this pipeline with asset sales reduces our dependency on capital markets and, as we stated in prior years, we will continue to focus on improving our debt metrics. In summary, there remains a long runway for growth of UDR, and we have the right plan and team in place to capitalize on the opportunity. With that, I'd like to express my sincere thanks to all my fellow UDR associates for their hard work in producing another strong year of results. We look forward to a great 2016. And now I'll turn the call over to Tom.

Thanks, Tom. Our fourth quarter earnings results were in line with our previously provided guidance. FFO, FFO as adjusted, and AFFO per share were $0.41, $0.42 and $0.37, respectively. Fourth quarter same store revenue, expense, and NOI growth remained strong at 6.2%, 5.2%, and 6.6%, respectively. For the full year 2015, FFO, FFO as adjusted, and AFFO per share were $1.66, $1.67 and $1.51, respectively. Full year same-store revenue expense and NOI growth are 5.6%, 3.0%, and 6.7%, exhibiting continued strong demand for apartments and above our initial expectations provided last February. At year-end, our liquidity as measured by cash and credit facility capacity was $987 million, our financial leverage on an undepreciated cost basis was 34.6%. Based on our current market cap, it is approximately 26%, and inclusive of JVs it was approximately 30%. Our net debt-to-EBITDA was 5.7 times and inclusive of JVs was 6.7 times. All balance sheet metric improvements were ahead of plan. On to first quarter and full year 2016 guidance; full year 2016 FFO, FFO as adjusted and AFFO per share is forecasted at $1.75 to $1.81, $1.75 to $1.81 and $1.59 to $1.65, respectively. For same-store, our full year 2016 revenue growth guidance is 5.5% to 6.0%, expense 3.0% to 3.5% and NOI 6.5% to 7.0%. Average 2016 occupancy is forecasted at 96.6%. Other primary full year guidance assumptions can be found on Attachment 15, or Page 28 of our supplement. First quarter 2016 FFO, FFO as adjusted, and AFFO per share guidance is $0.42 to $0.44, $0.42 to $0.44, and $0.40 to $0.42, respectively. Finally, with our release today, we've increased our 2016 annualized dividend to $1.18 per share, a 6% increase from 2015 and represented a yield of approximately 3.25%. With that, I'll turn the call over to Jerry.

Thanks, Tom, and good afternoon, everyone. In my remarks, I will cover the following topics. First, our fourth quarter portfolio metrics, leasing trends and the continued success we've realized in pushing runaway growth again this quarter and into January. Second, the performance of our primary markets during the quarter, and expectations for 2016. And last, a brief update on our lease-up developments and the Washington D.C. acquisition. We're pleased to announce another strong quarter of operating results. Our fourth quarter same-store revenue growth of 6.2% was driven by an increase in revenue per occupied home of 6.5% year-over-year to $1,794 per month, while same store occupancy of 96.5% was 30 basis points lower versus the prior year period. Our fourth quarter strategy of holding rates high along with aggressive rate increases throughout 2015 benefits us in 2016, as we entered the year with almost 2.75% of our revenue growth already baked into our rent roll. Our robust full year same store revenue growth of 5.6% was driven by a 5.5% increase in revenue for occupied homes and flat occupancy. We see a strong growth rate continuing in 2016. Turning to new and renewal lease rate growth which is detailed on Attachment 8-G of our supplement. We continue to push rate in the fourth quarter, new lease growth totaled 3.8% or 170 basis points ahead of the fourth quarter of 2014. Renewal growth remained resilient, improving 170 basis points year-over-year to 7%. This year-over-year acceleration was accomplished with only a 40 basis point increase in fourth quarter turnover. Next, move-outs to home purchase were up 120 basis points year-over-year at 14%, in line with our long-term average. Importantly our full year 2015 turnover rate increased by just 20 basis points compared to the full year 2014. Even with renewal increases at a seasonally strong 7%, only 7% of our move-outs gave rent as the reason for leaving in the fourth quarter. However, we expect turnover to increase roughly 100 basis points in 2016 as our revenue growth is highly predicated on the rate growth and not year-over-year occupancy gains. Moving on to quarterly performance in our primary markets, which represent 69% of same-store NOI and 75% of our total NOI. Metro DC, which represents 18% of our total NOI posted positive full year revenue growth of 1.7%. We expect improving full year revenue growth in 2016 of around 2.5%, as we continue to benefit from our diverse exposure of 50% B assets and 50% A assets located both inside and outside of LA. Orange County and Los Angeles combined represent 15.4% of our total NOI. Orange County posted sequential revenue growth of 160 basis points and continues to outperform our budgeted expectations early in 2016. LA is materially stronger due to our heavy concentration in the Marina Del Rey submarket as new jobs have continued to migrate to this highly desirable submarket. Fourth quarter revenue growth in LA was an impressive 10.2%. Our current expectation is that both of these markets will generate revenue growth in the 7% range in 2016. New York City, which represents 12% of our total NOI, posted full year revenue growth of 5.6%. We saw seasonal weakness in the fourth quarter and early January, but future trends are pointing to strength within our submarkets. We continue to expect new jobs in technology, finance and media, which will benefit our Lower Manhattan properties. Our 2016 forecasted revenue growth of 6% is above 2015. I would remind everyone that View 34 is on same-store approval beginning in the first quarter of 2016. San Francisco and San Jose, which represent 11% of our total NOI, posted full year revenue growth of 9.7%. Although we saw weakness in the fourth quarter it is indicative of the first quarter and fourth quarter seasonality that we have seen in this market in the past. With that said, we believe this weakness is possibly more than just seasonal and do not expect this market to post double-digit revenue growth that it has in recent years. For 2016, we have forecast a deceleration in revenue growth to 8% or so. Future trends are slowly improving from what we saw in the fourth quarter but we are keeping a close eye on the job growth and absorption levels within our submarkets. Keep in mind, San Francisco job growth has been above 4.5% for the past few years. Axiometrics' current forecast calls for job growth to decelerate to 2.5% to 3% but still well above the national average of 1.75% to 2%. Seattle, which represents 6% of our total NOI benefitted from strong growth from suburban B assets who are less exposed to new supply than A assets Downtown. Although new supply will challenge us somewhat in Downtown Seattle and to a lesser degree in Bellevue, we expect 2016 to see growth slightly below our 2015 numbers, or roughly 7% growth. Boston, which represents 7% of our total NOI, should continue to see new supply pressure downtown but our suburban assets in the north and south shores should fare well and lead better in 2016. Long-term we like the downtown submarket and look to continue to grow through development in this submarket. Most recently GE announced the relocation of their global headquarters to the Seaport district. This will bring another 800 jobs into the submarket which should directly benefit our 369-home community and our future 345 Harrison development in Boston South End. Our forecast calls for revenue growth to accelerate slightly from the 5.5% growth posted in 2015. Last, Dallas, which represents 5% of our total NOI, posted 5.1% year-over-year growth in the fourth quarter. We expect new supply pressure in uptown and Plano in 2016. January results indicate that these submarkets are performing slightly better than initial budgeted expectations and 2016 revenue growth is projected to improve to roughly 5.5% from 5% in 2015. As you can see on the Attachment 7-B of our supplement, our 320-home Los Alisos community located in Orange County, our 196-home Waterscape community located in Seattle, and our 740-home View 34 community located in New York City are joining the same-store pool in the first quarter of 2016. Turning to our in lease-up developments; Katella Grand I, our 399-home lease-up in Anaheim, California in the West Coast development joint venture was 16% occupied at quarter-end and as of today is 20% occupied and 27% leased. We are currently offering less than one month of concessions at this community and leasing has been very strong in January with 25 applications. CityLine, our 244-home lease-up in Seattle, Washington was 9% occupied at quarter-end. We are on budget and meeting our lease-up expectations. Finally, 399 Fremont, our 447-home lease-up in San Francisco, began leasing during the fourth quarter. At quarter-end we were just 2% leased and today we are over 10% leased with rents exceeding pro forma. We will have our first new rents in March of 2016. Now a quick update on the Washington, D.C. acquisition. We are three months into owning these communities and everything is going as planned. Currently we're making CapEx improvements to two of the properties to either cure deferred maintenance or drive a higher return through revenue-enhancing improvements. We still expect these communities to perform in line with our D.C. portfolio this year, with revenue growth right around 2.5%. Currently, we would expect five of the six communities in this portfolio to enter our same-store pool in the first quarter of 2017. With that, I will remind those listening that there is a link to our updated two-year strategic outlook document on the Investor Relations page of our website. We'll pause for a moment so that everyone can gather the two-year outlook materials. Well, I'll now turn the call back over to Tom Toomey.

Thanks, Jerry, and please turn to Page 3 for some high-level thoughts. Firstly, we view this year's update as a continuation of the last three plans. We believe this continues to be the right path for UDR, here's why. The plan's primary objective is to drive high-quality cash flow growth while incrementally improving our balance sheet and portfolio. In other words, consistent sustainable growth that is funded in a safe low-risk manner. We believe that successful execution of these objectives will drive strong total shareholder return. There are four key points I'd like to highlight, why we think there's a long runway of accretive growth ahead. First, fundamentals; you've seen plenty of published data on this and clearly demographics and supply-demand characteristics are in our favor. Any good business with solid growth for a number of years means solid fundamentals. The second is strategic position; our portfolio is positioned in 20 markets with a 50% A and B quality mix. We like this position. We believe it solves for the number one critical element of any future growth, which is the positioning of our portfolio such that our residents will continue to pay higher rents. Third is the team and the skills; operationally we continue to innovate and invest in technology and training programs all designed to increase our margins, which now stand above 70% at the NOI line, extraordinary for any business. On the development side, we'll remain focused on looking at our risk-adjusted returns and staying disciplined. The fourth is problem-solving; we operate in a cyclical economy where there will be challenges and opportunities. We have a team that is very experienced in managing through these cycles, if not anticipating them, and I feel confident that the team has the ability to capitalize on these opportunities as they become available. Lastly, and just as important, is managing risk, which we see ourselves managing through a diverse market mix, discipline around our development, and certainly a continued improving balance sheet set of metrics along with transparency and communication style. We believe these main objectives can continue our cash flow growth and optimize our total shareholder return. We remain fully focused on executing them. With that, I will turn over to Tom to discuss in detail the updated outlook.

Please turn to Page 4. As Tom mentioned earlier, we have met or exceeded all of our primary financial and operational objectives to date, as set forth in our prior three-year plans published in 2013, 2014, and 2015. In particular, our same-store growth and development deliveries have outperformed over the past three years and served as primary drivers of our better-than-expected cash flow growth and improvements in balance sheet metrics. Turning to Page 5, perhaps the most critical driver of UDR's value creation strategy is our best-in-class operations. We're continuously implementing new revenue growth and cost efficiency initiatives throughout the organization to improve how we do business. As noted on this page, we have consistently produced better overall top-line growth versus peers and the U.S. average since the initiation of our three-year plan in 2013. During this time, we've grown our total revenue per occupied home by 26%, increased occupancy by 100 basis points, reduced turnover by 310 basis points, and improved our NOI margins by 220 basis points. So, how are we maintaining our operational advantage and how do we plan to keep it in the future? Please turn to Page 6. Many who listen to this call are familiar with the primary revenue generation and expense control initiatives that are underway. These initiatives, along with potential future ones, are presented in the table on this page. Importantly, all of our growth and efficiency initiatives have one thing in common: they either provide our customers with wanted service or allow our associates to do their jobs better. Current initiatives should continue to drive our bottom line, and our list of potential future initiatives is extensive. Please turn to Page 7. This page lists some of our operational projects that have been implemented over the past couple of years and their impact on our NOI. As is evident, we have made solid progress in each initiative to date, and our bottom line has benefited greatly. We will continue to capture additional NOI efficiencies from these initiatives. Operations have been and will continue to be a significant competitive advantage for us, not just because of our superior blocking and tackling in the field, but also because of the creativity that our operations team employs to continuously improve the business. Turning now to capital allocation and development on Page 8. Development remains a vital component of our value creation strategy. While not as many deals are penciled in today's environment, development remains accretive and will continue to be a primary means through which we continuously improve our portfolio. At year-end, our underway development totaled $670 million, for which the equity requirement was 55% funded. Additionally, our share of the West Coast development joint venture going in value was $271 million, wherein 100% of equity has been funded. This pipeline is concentrated in our primary coastal markets. Inclusive of the West Coast development joint venture, we expect to deliver $375 million and $220 million of projects in 2016 and 2017, respectively. Our annual targeted spend of $400 million to $500 million per year and our targeted spread versus cap rate of 150 to 200 basis points have not changed. While construction costs continue to increase, so do rents. To mitigate market risk around new development projects, we employ several disciplines. First, prior to development financing, we generally seek and title the land, demand full drawings, and a GMAX contract, thereby locking in costs and reducing risks. Second, we diversify our geographic exposure. Our goal is to commence new development in a target market as the previous one is leasing up. Third, we utilize conservative top-line growth assumptions to underwrite our projects. Lastly, we deploy our self-funded strategy to fund our development pipeline and reduce reliance on capital markets. Through our free cash flow and non-core asset sales, we can fully fund our annual development spend. In other words, we are match-funding our risks as we recycle older non-core assets to develop new core assets in our primary markets. In 2016 and 2017, we will continue to mine our current land bank as well as acquire new land sites. We are planning two to three starts in 2016, which include one large wholly owned project at 345 Harrison in Boston and one or two smaller 50-50 JVs with MetLife. As of year-end 2015, our shadow pipeline was approximately $900 million at our pro rata ownership and represented $425 million to $475 million of value creation assuming current spreads. Please turn to Page 9. We anticipate that upon full stabilization, which occurs at different periods for each project, the pipeline of underway and completed developments is expected to generate accretion of $0.07 per share with growth thereafter. On an NAV basis, we expect our pipeline to generate $1.75 per share at stabilization, approximately 35% to 40% value creation over costs. Page 10 exhibits some of our recent developments. Please turn to Page 11. As focused as we are on operations and development, maintaining a strong balance sheet along with a self-funded plan is just as important. We exceeded the balance sheet metric goals provided in our 2013, 2014, and 2015 strategic plans. We expect further improvements in 2016 and 2017. This has also been acknowledged by the rating agencies. In 2014, we received a credit upgrade from Moody’s to Baa1 and in 2015 received one from S&P to BBB+. On the capital markets front, our 2016 or 2017 capital needs will be funded through a combination of asset sales, new equity, and debt, utilizing the most advantageous source depending on our strategic objectives, market conditions, and pricing at the time the capital is needed.

Thanks. I'm just wondering what the two-year plan assumes for the broader macroeconomic environment and has it baked in any sort of recession over the next 24 months?

Nick, this is Jerry. We really look at the Axio and Moody's data to start with. What they are forecasting is continuation of job growth, not too far off from what it was in 2015, call it a little over 200,000 per month. Supply is going to impact this year, probably a little bit more than it did last year, and then in '17 there is a drop-off. So we look at the macro data and then we start looking at specific submarkets where we operate and take into account how directly we're going to be affected by that. In addition, when you really go through—actually there's a few other things to consider. We'll continue to spend about $35 million to probably low $40 million on revenue-enhancing improvements to our properties that will add probably between 15 and 25 basis points into 2017 and probably about that much in 2016. As we look further out into 2017, a couple of markets look to us like they would be decelerating from the growth rates that we anticipate in 2016. Those are Northern California and Seattle for the most part, and then we see some that we think are going to be improving, like the Mid-Atlantic, and we also see Boston most likely improving for us. The rest of our portfolio, whether it’s SoCal or the Sunbelt, we expect to be modestly down. When you blend all of that together, it takes you from our midpoint this year of about 5.75% growth down to that 5%. So, again, we don't really anticipate a recession; we don't claim to be economists. We subscribe to what they say, but that's how we're looking at the business.

Yes. Sure, Nick, this is Tom Herzog. To your point, the same-store comes in at a $0.12 positive number; development comes in at $0.02, which is lower than what we had in 2015, and that's purely due to timing on what got delivered. In 2015, we had View 34, 27 Seventy Five, and other projects. In 2016 we're looking at Pier 4, Beach & Ocean, which has got some drags from 399 Pac City, Jamboree, 3033, and Domain Mountain View; all great projects but at this point there's some drag. So that lowered the development by a bit from what we would have seen in 2015. Some of the items that would lean against the FFO growth relative to the NOI include; floating interest rates being up by about 40 basis points in our model as a penny. The average revolver balance is going to be down, call it $150 million or so, that's a penny and a half; that was just due to the timing of that mid-September debt issuance. The tax benefit goes from $3.9 million to $1.5 million, and that's a penny. Non-interest exchanges pick up another penny. Then to your point earlier, that's partially offset by the accretive West Coast JV and some accretion on the Home transaction—those are all the moving parts. This is as we would expect, our core and basic growth going forward is still strong but we had a few items that caused FFO to come in a little bit lower relative to the same-store.

Thank you. I was wondering if you could expand upon the comments you'd made earlier about the first quarter softness in San Francisco and San Jose. What you're seeing that could mean it could be more than just seasonal?

Yes, it's hard to tell at this point in time. We did see some occupancy and pricing power pressures in the fourth quarter, but as we rolled into January, we started to see signs of improvement. Now new lease rate growth in the fourth quarter was 5.2%, renewal growth was 9.3%. As we look at January, our January new leases are up 4.2% in San Francisco and San Jose and that compares to 3.3% in December, so it is improving. Our January renewals are still well above 8% at 8.4%, and our occupancy is at 97%, so it has strengthened. As we look at job growth, which is the primary concern in those markets right now, it's been running about 4.5% for the past couple of years and when we've talked to Axiometrics, they are forecasting for job growth to decelerate to 2.5% to 3%, and while that's about a 150 basis points to 200 basis points deceleration, it's still well above the national average of job growth of 1.75% to 2%. We like to think it's all seasonal. We're going to know in the next 60 days if it is and over the last three to five years there have probably been two or three times in the first quarter when I grew concerned about the strength of San Francisco only to see things turn around as we got into March and April. It's just a little bit early to tell, but on the ground, we are not seeing any significant job loss from any single employers; as I've said, as we've come out of the fourth quarter and entered the first quarter, we have seen fundamentals start to strengthen again.

Hi, good afternoon, it's Austin Wurschmidt here. I was just curious, given the continued focus on driving rate in 2016, does the 2017 outlook assume a similar level of revenue, I guess is earned in headed into 2017 as you entered 2016?

Austin, this is Jerry. I would expect it to be a little bit less. We do not anticipate, as you get to the back half of this year, to have quite as much ability to drive new lease rates or renewal rates. Our expectation when we did our budgets was that market conditions would be a little bit weaker across the board, well, not across the board, but in aggregate call it 70 to 80 basis points. If I guess right now what I think we would go into next year with, that will be in the 275; it's probably going to be closer to the 240, 250 in order to get that deceleration for midpoint-to-midpoint of about 75 basis points.

Good afternoon, guys. Jerry, in terms of what you've been saying in the third and fourth quarter, what is baked into your 2016 guidance? Is there any real bifurcation between the various D.C. submarkets these days, operating performance wise?

Yes, I think your Bs are still continuing to outperform. They have compressed at times and then widened, but our B product outside the Beltway continues to carry us versus our inside the Beltway. When I look at our As, they're currently coming in around 1% revenue growth in the fourth quarter, and our Bs, which are predominantly in the suburbs, came in about 2% revenue growth. So, on a revenue growth basis, I'd call it about 100 basis points.

Well certainly, and again thank you for your time and interest in UDR today. Certainly wrapping up, 2015 was a great year, and as we talked throughout that year, we're positioning the company for great 2016. I think we're off to a very solid start on that front, and we look forward to updating you after the first quarter.