Investors Real Estate Trust (IRET) Q2 2019 Earnings Conference Call Transcript | Fox Business

Investors Real Estate Trust (NYSE: IRET) Q2 2019 Earnings Conference CallDec. 11, 2018 10:00 a.m. ET

Prepared Remarks:

Operator

Good morning, and welcome to the Investors Real Estate Trust second-quarter 2019 earnings conference call. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Mark Decker, president and CEO. Mr.

Decker, please go ahead.

Mark Decker -- President and Chief Executive Officer

Thank you and good morning. IRET's Form 10-Q for the second quarter of our fiscal-year 2019 was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted on our website at iretapartments.com and filed yesterday on Form 8-K. Before we begin our remarks this morning, I need to remind you that during the call we will discuss our business outlook and will be making certain forward-looking statements about future events based on current expectations and assumptions.

These statements are subject to risks and uncertainties discussed in our release and Form 10-Q and in other recent filings with the SEC. With respect to non-GAAP measures we use on this call, including pro forma measures, please refer to our earnings supplement for a reconciliation to GAAP, the reasons management uses these non-GAAP measures and the assumptions used with respect to any pro forma measures and their inherent limitations. 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 that become untrue due to subsequent events. Joining me this morning are John Kirchmann, our chief financial officer; and Anne Olson, our chief operating officer.

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As I'm sure many of you saw in our press release and supplemental, the results for our second quarter ending October 31 were outstanding and led the multifamily industry for the comparable period. After the last two years of heavy transactional activity and change management, our fourth quarter -- our fourth straight quarter of NOI growth and the headline of 8.7% same-store NOI is compelling. We are focused on the quality of our earnings, so the balance we achieved across the portfolio and the methods employed to get us there, specifically continued top-line growth and demonstrable expense discipline, are what encourages us. As we've simplified our business, our task has gotten easier as well: take care of our customers, take care of our people: grow revenues and mind expenses.

With revenue growth in 10 of 11 markets and expense reduction in eight of 11 markets, we are progressing toward our goal to rise by 5%, increasing our margin by 5% this quarter, producing a year-over-year gain of 230 basis points. Even so, there remains a large organic opportunity embedded in our portfolio that continues to make IRET a compelling investment opportunity. In addition to the things we're doing to improve margin in our day-to-day operations, our value-added initiatives are under way. And as we commented in the past, we expect to begin seeing results from value add in the next few quarters.

Also noteworthy, we were able to grow core FFO per share sequentially by 1%, even though we've sold just shy of $50 million of assets that produce $630,000 of NOI in the first quarter, and we continue to dispose off noncore assets. Today, over 98% of our NOI comes from our multifamily properties. Our balance sheet is in excellent condition, and as John will further detail, our debt structure and levels put us in a position to play offense. Most importantly, the changes to our operations team, which occurred just before the beginning of this quarter, are going as planned.

In our last call, we discussed how these changes would advance the speed at which we harness the full earnings power of our business and this quarter provides evidence that this is happening. We are committed to constant improvement, and you will continue to hear from me about our initiatives to improve our portfolio results. Turning to our markets. It is clear that our capital allocation strategy makes sense.

With our Minnesota markets, Twin Cities Rochester and St. Cloud combining for 12.3% same-store NOI growth, 3% in North Dakota and all others producing 8.8%, we continue to see lack of absorption and marginal rent growth in our North Dakota markets. However, on balance, we see gains coming out of a B and B+ portfolio that serves the largest population of potential customers in our markets. Focusing on the Twin Cities in Denver, two top-25 markets that other public owner operators have very low exposure to, differentiates us from our competitors and we believe provides great promise for cash flow growth.

Looking at our nonsame-store portfolio, which accounts for all of our Denver exposure and around a third of our Twin Cities' assets, we're pleased with how we are progressing. On the supply side, Denver is well documented as both a destination for immigration and new supply. We are not immune to either of these and remain confident in the long-term prospects of the market and our assets there. Denver continues to be a concession-driven market, and we are seeing on average one to two months free rent being offered at most of our competitors due to lease-ups and seasonal decrease in traffic.

Minneapolis continues to be a healthy market with strong employment and incomes and supply that is fairly concentrated to a few submarkets and almost exclusively in A assets. We continue to closely monitor the supply and its effect on our investments. So to continue the theme from last quarter, good markets, a good economy, improving operations and a sound balance sheet, these are the ingredients for a good business. When we take these ingredients and mix in our team-focused environment that attracts and retains the best people, and we put our customer in the middle of everything we do, great things can happen.

Anne, perhaps you can offer a few more details on operations.

Anne Olson -- Chief Operating Officer

Thank you, Mark, and good morning, everyone. Last quarter, I mentioned that we were optimistic about our revenue growth and our expense containment measures, and this quarter's results demonstrate the focus and rigor that we have brought to bear on our operations. We ended our second quarter with our same-store occupancy at 95.4%, a 140 basis point increase over the first quarter, which we believe positions us well headed into our low lease expiration months of November through February. Mark mentioned that we have a goal of expanding our margin by 5%.

We achieved 3.6% overall same-store revenue growth and a same-store expense reduction of 2.4% year over year, giving us 8.7% same-store NOI growth in the second quarter. It is notable that six of our 11 markets experienced NOI growth in excess of 10%. These results are both proof-of-concept and motivation to institutionalize the practices and processes we initiated over the last six months. Drivers of the 3.6% revenue increase continue to be a mixture of other revenue initiatives, increases in occupancy and rents.

Even though we had success in increasing our occupancy during the second quarter, we have seen traffic decrease in September and October due to seasonality, which we do not believe is an adjustment in the market. We continue to be optimistic about our revenue opportunity across our portfolio. Our expense containment initiatives really took shape during the second quarter with a strong focus on year-over-year performance and new variants to budget reporting requirements that have increased accountability for results. Increased discipline on expensive, coupled with effects of our July reduction in force on the operations team, led to eight of our 11 markets having year-over-year expense reductions.

We expect that the results of our value-add projects will also favorably impact our margin initiatives, and we are starting to see initial returns on our first project. We have completed light renovations at 130 units, and we'll be monitoring the renewal and new rents at that asset to ensure our expected premium is achieved. As previously discussed, we have completed 3 LED retrofits and are in the process of implementing 26 more within the portfolio, and we currently have over 700 units identified for renovation and in the final bidding process. Our pipeline of value-add opportunities is growing, and we're closely monitoring our markets, comparable properties and our internal capacity to thoughtfully and successfully execute on our value-add program.

We continue to motivate our team to provide results through innovation, and our team is bolstered by the positive financial results that are stemming from the changes we are implementing. Our initiative to reach every one of our team members in every department across IRET, and I'm grateful for the effort and positivity that our teams bring every day. I'll turn it over to John Kirchmann for a discussion of our overall financial results and balance sheet.

John Kirchmann -- Chief Financial Officer

Thank you, Anne. Last night, we reported core FFO for the second quarter of fiscal year 2019 of $0.09 per share, a decrease of $0.01 from the prior-year period. Core FFO for the year-to-date fiscal 2019 is $0.17 a share, a decrease of $0.03 from the prior year-to-date period. These decreases are primarily due to a reduction in NOI from the sale of noncore assets offset by growth in NOI from our multifamily portfolio as well as a reduction of preferred dividend and interest costs.

Looking at our general and administrative expenses. Total G&A was $3.4 million for the quarter, a $300,000 increase from the prior-year period and a $500,000 decrease from the first quarter of fiscal year '19. The increase from the prior year is primarily due to higher compensation cost related to the expected achievement of certain financial metrics under our short-term incentive compensation plan. The decrease in G&A from the prior quarter is due to our first fiscal quarter, including $510,000 of severance cost related to a realignment and reduction in corporate officers.

G&A for the first six months of fiscal year 2019 was $7.2 million as compared to $7.1 million for the same period in the prior year. We expect G&A to maintain a future run rate of $3.4 million to $3.7 million per quarter. Moving to capital expenditures. As presented in Page S-15 of the supplemental, for the current quarter, same-store CAPEX was $3 million, a $1.6 million decrease from the prior year's quarter.

Same-store CAPEX for the first six months of fiscal year 2019 was $6.4 million, a reduction of $1 million from the same period in the prior year. Lower CAPEX cost are the result of a reassessment and reprioritizing of planned projects due to the addition of a new facility management team. This decrease should be temporary, with future CAPEX cost expected to be closer to our historical levels. Turning to our balance sheet.

We continue to improve our flexibility. As of October 31, we had $195 million in total liquidity, including $177 million available on our corporate revolver. As discussed during our prior call in August, we amended and expanded our unsecured credit facility. Overall, we continue to focus on improving our debt metrics, which we believe position us to be more opportunistic in the future.

Highlights of this improvement include reducing risk to interest rate volatility, with 90% of our debt at a fixed interest rate at quarter-end; improving leverage with core debt-to-EBITDA ratio of 7.6 times; reduce the portion of our debt that is secured to 68% of total debt; and reduced the portion of our portfolio that is recourse to under 6% of total debt. All of these actions continue to improve our balance sheet, increase liquidity and financial flexibility, and further our goal to attain investment grade metrics. Finally, I would like to point out that this is the final fiscal quarter earnings call for IRET. We will be changing to a calendar year end as of December 31, 2018.

This change is a continuation of a transformation initiated 18 months ago, and we believe will increase our transparency and comparability to our industry peers. With that, I will turn over the call to the operator for your questions.

Questions and Answers:

Operator

Thank you. [Operator instructions] The first question today comes from Rob Stevenson with Janney. Please go ahead.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Hi. Good morning, guys. Can you talk a little bit about what you guys have actually done at the properties from a cost savings perspective? I mean, I assume that you're getting some cost savings that feed through the same-store from just having sold a number of smaller assets over the last few quarters, which automatically raises the margins, but what are you -- what's the -- what are the processes under way at the properties? And what's left -- still left to be done there as you try to eke out more margins?

Anne Olson -- Chief Operating Officer

Yes. This is Anne, thanks for the question. We -- the list is long of the things that we're still looking at, but I'd say the main driver of the cost containment has been twofold. One, we've had some lessening in insurance losses, so we've had a really good claims year, which does help us out some.

But our cost containment measures really start with viewing other expenses year over year and giving more rigorous variance reporting and really talking to everyone. We've done a full reassessment of some of our maintenance spending. We really look -- we looked at our staffing, which was part of a reduction in force on July 1 and asked everyone really to take a hard look at the expenses. And it's working, and we're seeing the results pay off.

We do think that there are more expense containment measures to do, and we are planning to try to hold flat on our controllable expenses. We are seeing some increases in taxes and insurance, which I think is true across the industry.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

What's the big -- what's the stuff that's left to be done that still has the biggest capacity to impact you guys?

Anne Olson -- Chief Operating Officer

I'd say our vendor management process and our turn costs. So when we turn an apartment, we have a pretty wide disparity between how much that cost across the portfolio, and a lot of that has to do with how quickly we can do it and the vendors we use to do it. As you know, some of our markets aren't deep in population and so it's a little difficult to find vendors who can act. So we're working hard on the vendor management process to make sure that we have good vendors at good prices and real consistent work that can be done quickly to turn those units.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

OK. And then did you guys repurchase -- and sorry if I missed it, did you guys repurchase any stock in the quarter?

Mark Decker -- President and Chief Executive Officer

No.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

OK. How are you thinking about that, Mark? I mean, in terms of capital deployment with the stock down here around $5, is it the implied cap rate on the existing portfolios is pretty high, it seems like that that's going to give you better returns, but then you have got to also deal with the leverage neutral aspect of doing share repurchase, etc. How is that -- how are you and the board thinking about that these days?

Mark Decker -- President and Chief Executive Officer

Yes. I mean, I -- we have -- as you may have seen, we did -- the board did reauthorize the buyback last week, so still very much on the table as a tool. We do look at it on a leverage neutral basis, and we have bought in some of the OP Units in the last quarter, which I don't think we report on a per se, but you can see it in our cap table. So a couple of hundred thousand shares there and I -- at these levels, I wouldn't be surprised, but we'll report on it next quarter.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

OK. And do you currently have any acquisitions under contract or letter of intent at this point?

Mark Decker -- President and Chief Executive Officer

We do not have anything under a contract.

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

OK. Thanks, guys.

Mark Decker -- President and Chief Executive Officer

Thanks, Rob.

John Kirchmann -- Chief Financial Officer

Thanks, Rob.

Operator

[Operator instructions] The next question comes from Drew Babin with Baird. Please go ahead.

Drew Babin -- Robert W. Baird & Co. -- Analyst

Hey, good morning.

Mark Decker -- President and Chief Executive Officer

Good morning, Drew.

Drew Babin -- Robert W. Baird & Co. -- Analyst

Question on the composition of same-property revenue growth. It looked like the revenue per occupied home grew 3.6%, but rents themselves grew about 1.2%. I was hoping you could talk about the difference between that and whether there's sort of fee-driven elements that might be driving the revenue growth.

Mark Decker -- President and Chief Executive Officer

Yes. There -- and I'll ask Anne to talk about it, but I'd say, generally, yes, and we are trying to maximize revenue per foot. So Anne, why don't you talk more about that?

Anne Olson -- Chief Operating Officer

Yes. I'd say a large portion of our growth is from our other revenue initiatives. And we do -- the list is long on that front too that we're looking at and analyzing for additional revenue growth. Over the quarter, we saw our renewal rents increase about 3.9%.

We did see our new rents decrease a little bit, about 2.7%. We don't think that, that's a, as I said in my prepared remarks, a real comment on the market. But what we do think that is, is we really pushed occupancy through the quarter and we were pushing occupancy going into the slower months. So decrease in traffic, heavy push on occupancy to set us up well for the winter, so we did see a slight decrease in new rents.

Drew Babin -- Robert W. Baird & Co. -- Analyst

OK. And that leads to my second question on just the leasing spreads during the second quarter. So the negative 2.7% new leasing spread, that's down from what in the first quarter? Was that slightly positive, if I remember correctly?

Anne Olson -- Chief Operating Officer

Yes, yes. Slightly positive, yes.

Drew Babin -- Robert W. Baird & Co. -- Analyst

OK. And I guess lastly, with the Williston sale with some of the new balance sheet measures that have been put in place, a decent amount of liquidity here, I guess. What does management view as the current investment capacity right now within certain leverage constraints? And on the transaction market generally, where do you currently see the best opportunities?

Mark Decker -- President and Chief Executive Officer

Yes. I mean, I think at a minimum, we could replace those assets we sold, which are roughly $50 million. And a fair amount of that was funded with leverage, a fair amount of those sales. So leverage neutral at the end of the first quarter would be roughly $50 million.

What we're seeing in a transaction market is, I would say, a little bit of softness in the core market, a lot of enthusiasm in the value-add market, which is probably where we're most focused as a buyer today. So I mean, we're really looking for opportunities where we have some level of edge. We've looked at a few OP Units deals. We're always trying to folks off market.

But I would say, it's really very competitive out there. And we're underwriting a lot and finding that things are a little bit out of reach. Our stock is a pretty good option at this point. But I think we have a lot of interesting things in the pipeline.

I think we have enough capacity to do, call it, $50 million to $100 million. That would be a modest lever up, which is something we have to talk about as a team. But that's what we're looking at right now, but it has to be compelling.

Drew Babin -- Robert W. Baird & Co. -- Analyst

OK, great. That's all for me. Thank you.

Mark Decker -- President and Chief Executive Officer

Thanks, Drew.

Operator

This concludes our question-and-answer session. I will now like to turn the conference back over to Investors Real Estate Trust CEO, Mark Decker Jr. Mr. Decker, please go ahead.

Mark Decker -- President and Chief Executive Officer

Thanks, Nita. Well, thank you, everyone, for your interest in our company, and have a happy holidays.

Operator

[Operator signoff]

Duration: 21 minutes

Call Participants:

Mark Decker -- President and Chief Executive Officer

Anne Olson -- Chief Operating Officer

John Kirchmann -- Chief Financial Officer

Rob Stevenson -- Janney Montgomery Scott LLC -- Analyst

Drew Babin -- Robert W. Baird & Co. -- Analyst

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Contents:

Prepared Remarks:

Questions and Answers:

Call Participants: