The RMR Group Q1 2024 Earnings Call Transcript

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Provided by Quartr
February 8, 2024

There are 7 speakers on the call.

Operator

Good morning, and welcome to the RMR Group Fiscal First Quarter 20 24 Earnings Call. All participants will be in listen only mode. After today's presentation, there will Please note that this event is being recorded. I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations. Please go ahead.

Speaker 1

Good morning, and thank you for joining RMR's Q1 of fiscal 24 conference call. With me on today's call are President and CEO, Adam Portnoy and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and quarterly results, followed by a question and answer session. I would like to note that the recording and retransmission of today's conference is prohibited without the prior written consent of the company. Today's conference call contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws.

Speaker 1

These forward looking statements are based on RMR's beliefs and expectations As of today, February 8, 2024, and actual results may differ materially from those that we project. The company undertakes no obligation to revise or publicly release the results of any revision to the forward looking statements made in today's conference call. Additional information concerning factors that could cause those differences is contained in our filings with the Securities and Exchange Commission, which can be found on our website at www dotrmrgroup.com. Investors are cautioned not to place undue reliance upon any forward looking statements. In addition, we may discuss non GAAP numbers during this call, including adjusted net income, adjusted earnings per share, distributable earnings, Adjusted EBITDA and adjusted EBITDA margin.

Speaker 1

A reconciliation of net income determined in accordance with U. S. Generally accepted accounting principles To adjusted net income, adjusted earnings per share, distributable earnings, adjusted EBITDA and the calculation of adjusted EBITDA margin can be found in our financial results. I will now turn the call over to Adam.

Speaker 2

Thanks, Kevin, and thank you all for joining us this morning. Before providing an update on our Q1 results, Let me first discuss the macro commercial real estate environment. There is no question the commercial real estate has been under pressure since the Federal Reserve began raising interest rates in early 2022. The higher cost of capital has resulted in significant headwinds to property values and the deterioration in capital markets activity. However, as I sit here today, we are currently seeing positive signs as the U.

Speaker 2

S. Economy continues perform well with strong GDP growth, a healthy labor market and declining installation. With anticipated interest rate cuts later this year, We believe we are entering a generally more favorable environment for commercial real estate. Looking across our diversified portfolio, I also see several encouraging trends and we are highly confident in the strength, diversity and durability of our platform and the opportunity for our clients to benefit as the commercial real estate sector normalizes. Turning now to our quarterly results.

Speaker 2

RMR reported a strong first quarter that reflects the continued strength and stability of our operations through all real estate cycles. We delivered sequential growth and adjusted earnings per share that exceeded the high end of our guidance. This quarter, we reported distributable Earnings of $0.53 per share, adjusted EBITDA of $25,300,000 and adjusted EBITDA margin of 52.1%. Our results also continue to demonstrate the strong alignment between RMR and our clients. We remain focused on assisting our clients with the execution of their business plans and expect to capitalize on the significant that exists from a possible recovery and share prices at some of our publicly traded clients.

Speaker 2

To put this into context, all of our managed equity REITs are paying base business management fees on an enterprise value basis. Given the depressed levels of the stock prices, we have a total annualized revenue opportunity of more than $60,000,000 as we work to close the gap between enterprise value and the historical cost in our managed equity REITs. In this end, during the quarter, all of our perpetual capital clients achieved double digit percentage growth in their share prices, supported by recent actions we have taken at RMR, which helped drive this quarter's revenue growth at RMR. In mid December, we successfully closed the Carroll multifamily platform acquisition. The acquisition adds 500 real estate professionals with deep residential market knowledge, value add real estate experience and long term relationships with a number of high quality global institutional partners.

Speaker 2

As of December 31, the Carroll business, which we are now calling RMR Residential consisted of $5,500,000,000 of assets under management at 66 properties with more than 21,000 units largely located across the Sunbelt. As a result of this acquisition, Total AUM at RMR grew more than 15% sequentially this quarter to over $41,000,000,000 And private capital AUM now represents more than $13,000,000,000 or approximately 32% of our total AUM. We are especially proud of these metrics given that private capital assets under management was close to 0 just over 3 years ago. And growing this part of our business has been a strategic objective for the company for the last few years. We believe there is significant long term growth be realized by RMR Residential in the future.

Speaker 2

More specifically, our current general partner fund or Fund 7, which we assume this part of the Carroll acquisition has approximately $200,000,000 in available equity capital remaining, which equates to approximately $3,000,000,000 gross acquisition capabilities in residential properties. In terms of expectations for deployment of this capital, While residential transactions have remained subdued, bid ask spreads are tightening and general market expectations are turning cautiously optimistic for more residential transaction activity as the year progresses. Accordingly, our financial expectations for the residential business are muted in the first half of the calendar year before an expected significant increase in contributions to EBITDA and distributable earnings in the second half of the calendar year. Looking beyond RMR Residential, we ended the quarter with more than $200,000,000 of cash and no corporate debt, giving us the flexibility to continue evaluating growth opportunities that build on our existing capabilities, expand RMR's private capital AUM and create long term value for our shareholders. As a reminder, We are limited as to what we can discuss this quarter regarding our publicly traded clients as we are reporting results in advance of them.

Speaker 2

With that said, I wanted to highlight some public announcements of note across our clients. In December, DHC made significant progress strengthening its financial profile, issuing $941,000,000 of 0 coupon bonds. The notes generate net proceeds of approximately $732,000,000 that was used to repay all of DHC's 2024 debt maturities. Importantly, this financing puts DHC back in compliance with its debt covenants and positions the company to access lower cost GSE financing in the future. With ample liquidity and a fully unencumbered shop DHC is in an excellent position to continue funding the necessary capital and drive the recovery in its senior living communities.

Speaker 2

OPI has also taken significant actions to address its debt maturities and successfully execute new financings. Despite capital market conditions that remain especially challenging for office owners. Last month, OPI closed new secured financing facilities for $425,000,000 with a group of 19 banks, replacing its previous unsecured revolver. Additionally, last night, OPI priced a 5 year $300,000,000 senior secured bond offering and announced the redemption of its $350,000,000 senior unsecured notes maturing this May. These recent successful financings at OPI within a difficult market backdrop for office REITs speaks to the strength of OPI's assets and RMR's management as well as positions OPI well going forward.

Speaker 2

Lastly, our mortgage REIT, Seven Hills Realty Trust has continued to generate outsized returns for its shareholders. During a period when banks have broadly pulled back on commercial real estate lending, 7 Hills has remained active. The strength of its loan book and strong investment returns had contributed to a total shareholder return of more than 60% in 2023. We believe our lending platforms underwriting and asset management capabilities are best in class and something we can ultimately leverage to expand our private capital assets under management in the future. In closing, we are off to a strong start in 2024.

Speaker 2

We are taking meaningful actions to position RMR and our clients for long term growth and deliver increased value for our stakeholders. We look forward to updating you on our ongoing process throughout the year. With that, I'll now turn the call over to Matt Jordan, our Executive Vice President and Chief Financial Officer, who will review our financial results for the quarter. Thanks, Adam,

Speaker 3

and good morning, everyone. For the Q1, we reported adjusted net income of $0.49 per share, adjusted EBITDA of $25,300,000 and distributable earnings of $0.53 per share. Our results exceeded the high end of our guidance, primarily due to construction management fees coming in stronger than expected, as well as improvements in the enterprise values of certain of our managed equity REITs. As Adam highlighted earlier, we closed the Carroll acquisition on December 19. While we remain excited about the long term contributions of the acquisition to our platform, for calendar 2024, We expect earnings accretion from RMR Residential to begin in the back half of the year, given the lack of transaction volume across the residential real estate sector.

Speaker 3

Our residential platform is built to manage far more than its current $5,500,000,000 in AUM, which will result in breakeven results for the 1st 6 of calendar 24. Turning to this quarter's results. Recurring service revenues for the quarter were $46,200,000 which was up almost $900,000 sequentially. This increase exceeded our expectations, primarily due to enterprise value improvements at our managed equity REITs and increases in construction management activity within SVC's hotel portfolio. As it relates to next quarter, Based upon the current enterprise values of our managed equity REITs, projected declines in construction volumes and approximately $5,500,000 RMR Residential revenues, we expect service revenues to be between $48,000,000 $50,000,000 Turning to expenses, cash compensation this quarter was approximately $34,800,000 an increase of $456,000 sequentially Due to annual merit increases that were effective October 1, and $1,500,000 in compensation related to the partial month impact of RMR Residential, partially offset by strategic actions we've undertaken over the last 12 months to streamline our operations.

Speaker 3

Looking ahead to next quarter, we expect cash compensation to increase to approximately $45,000,000 inclusive of RMR Residential. The 1st calendar quarter of each year is always our highest level of compensation as payroll tax and 401 contributions reset each January 1. In the Q1, our cash compensation Our cash compensation reimbursement rate was 48.4 percent. With the addition of RMR Residential, our cash reimbursement rate is expected to increase to approximately 50% next quarter. G and A costs of $9,500,000 were higher than projected due to increases in third party costs to help support the sizable increase in construction activity we experienced this quarter.

Speaker 3

With the inclusion of RMR Residential, G and A should be approximately $10,000,000 next quarter. Aggregating all the assumptions I previously outlined And factoring in $0.04 per share from the adverse impacts of lower interest income and $800,000 of incremental amortization resulting from purchase accounting, next quarter we expect adjusted earnings per share to be approximately $0.40 With the increased levels of non cash impacts to our earnings, we believe adjusted EBITDA and distributable earnings are becoming our most important measures. Next quarter, we expect adjusted EBITDA to range from $21,000,000 to $22,500,000 Finally, as it relates to distributable earnings, Next quarter, we expect it to be closer to historical averages and range from $0.48 to $0.51 per share. That concludes our formal remarks. Operator, would you please open the line to questions?

Operator

The first question comes from Brian Maher with B. Riley Securities. Please go ahead.

Speaker 4

Thank you and good morning Adam and Matt. Maybe to start on a big picture basis, Adam, you touched upon this early in your prepared comments. We read an article last week, I guess it was in Barron's on a large real estate PM runs $80,000,000,000 Talking about how, whereas 2024 still faces challenges, they see recovery in 2025 Seems to be somewhat consistent with what you started off the call with. Can you give us a little bit more color on what kind of green shoots you're seeing out there to give you that positivity?

Speaker 2

Sure. Thank you for that question, Brian. I think that is correct. I think the biggest Positive impact that can happen for real estate is a reduction in interest rates. And then maybe the second biggest positive that can happen for real estate, especially around office and maybe some pockets of retail, Real estate is a unfreezing or a thawing of capital markets and access to capital markets activity.

Speaker 2

I think RMR, we have been very fortunate given the depth of our platform and our experience and relationships throughout The country and Wall Street that we are able to access capital on pretty attractive rates that I think many of our peers would not be able to do, given our expertise in the area. That all being said, I think it's really macro conditions that need to improve. And I think the fact that I think pretty universally believed is that the Fed is not raising rates anymore. I believe there's a pretty robust debate about how fast or when they will reduce interest rates. I think all that is much more positive for commercial real estate.

Speaker 2

And we have seen just the fact that we were able to get 19 banks to participate in a Secured financing at OPI and office REIT. Yes, OPI is a strong has a strong portfolio and is well managed, But it's still in an asset class that gets heightened scrutiny no matter where you are in what part of the capital markets with because it's office. The fact that 19 banks came along for that is also an indication that there is some thawing going on in the capital markets. So I see all those as positive signs. In terms of fundamentals and operations, look, I think Office leasing activity continues to occur.

Speaker 2

And that is probably the biggest and best sign we have as an organization, is that you still see leasing activity occurring and it's happening on a reasonably a comparative basis to what's happened in the past, equal to that, equal to what we saw in past years. So we haven't seen a Big drop off in activity in terms of leasing activity in our portfolio. That being said, obviously, vacancy rates, Generally speaking in office are pretty high, probably the highest they've been in certainly a generation if not longer. And so that While we might have a strong portfolio we're managing, it weighs on the entire market and affects rental rates that you can charge and so on. So the green shoots are really, Brian, the fact that interest rates aren't going up more and they're probably coming down and the fact that capital markets are starting to unfreeze.

Speaker 2

We expect in the second half of this year, especially to see a lot more transaction volume. And we expect to be a significant participant in this transaction volume. We have a tremendous amount of dry powder We can use, especially as we bought at RMR Residential to put to work there. And we also have opportunities to put Capital work in pockets in other parts of the organization as well. So we're pretty much we're looking forward to really the second half of the year and being able to really turn our attention to growth in a much more meaningful way.

Speaker 4

Thanks for that. And just A follow-up on RMR Residential, I mean, this is kind of new to us, maybe a little bit less so to you. How should we think about that back half of the year growth and does that come organically? Does it come from bolt on acquisitions? And what kind of capital might you need to ploy to get that growth?

Speaker 2

So ARMR Residential, as I said in my prepared remarks, We inherited or acquired a fund, what we call Fund 7 that is a it's a general partnership fund and I won't go into the details. But what that means is we have about $100,000,000 of untapped equity there that that fund life time doesn't We have until the end of 'twenty five to deploy that capital. We have a fair amount of runway, 2 years to put that money out. Because it's a GP fund, You bring in LPs and you put leverage on, that's how you get to the $3,000,000,000 of buying power. So that's largely organic.

Speaker 2

And we don't the other areas where I think you could see us grow is in 'twenty four and As we get further into 2025, we are basically setting up really, really well to possibly raise Our first true, what I call private capital commingles closed end funds, however you want to talk about it, vehicles. And I think we're gearing up to do that. I think the two areas that we are going to be best positioned to try to raise a fund around that is going to be in the loan fund or fund that's basically making loans and leverage run. And then perhaps in residential, I think in the residential space, I think we have more we have plenty of runway to put money to work under existing vehicle. And so that's all organic.

Speaker 2

What I just went through, Brian, that's I'm not talking at all about M and A there for acquisitions. And I think on an M and A front, we have $200,000,000 of cash. We have no corporate debt. We will be opportunistic, But we're also very focused at the moment on successfully integrating the RMR Residential platform and getting it to be a significant contributor to our Earnings and EBITDA in the second half of the year, as well as thinking about ways to organically raise funds in strategies that we think will be particularly appealing to investors. Matt, anything else

Speaker 5

you want

Speaker 2

to add?

Speaker 3

Yes, I guess what I would add, Brian, is as we think of the back half of the year, as some of the Thawing plays out that Adam touched on. I can tell you we've engaged with all the partners, the legacy partners. They are committed to continuing to do business with the Carrol team that we've inherited and are really pleased with and the organization can quickly put capital out as that thawing plays out. When we think of their historical run rate, which was part of what attracted to us, they've had they can easily do a 1,000,000,000 a year and 21, the organization, the legacy organization put $3,000,000,000 to work. So once this thawing plays out, We believe the partners are very aligned with the team that we've inherited and are happy with the RMR addition.

Speaker 3

And we think as that line plays out, we can quickly accelerate EBITDA growth at the residential platform.

Operator

The next question comes from Tyler Batory with Oppenheimer. Please go ahead.

Speaker 5

Thank you. Good morning. Just to put a finer point on the RMR Residential commentary there. Can you talk about the EBITDA Contribution from that business this year and longer term, Adam, I think some pretty helpful commentary in terms of With the outlook for second half of this year and certainly 2025 as well, any chance you could be a little bit more specific in terms of putting some numbers around that, and kind of remind us what you're thinking longer term in terms of, the financial impact of really ramping up the residential side of things?

Speaker 2

Sure. So really in our prepared remarks, we talked about the first half, The calendar year, which gets you through June of this year, we expect it to largely be a breakeven business. That's our expectation. We that Just because it's breakeven doesn't mean we're out trying to do stuff. We just think as it ramps up and part of the issue here is we're sort of restarting business that has been kind of dormant unfortunately for about a year and getting its acquisition machine up and running again.

Speaker 2

And then you have the backdrop of Over the last year and the first half of this year, not a lot of transaction activity. When we announced the Carroll acquisition, we put out a presentation, I think we talked about $10,000,000 roughly of EBITDA 11,000,000 to 13,000,000 11,000,000 to 13,000,000 of EBITDA is what we were expecting as a run rate. I think part of our expectations at the time were twofold. 1, we thought we were actually going to close that we did, it took a little longer to close. We didn't close the almost the end of the year.

Speaker 2

We thought we would have done that maybe beginning of the 4th quarter last year and ended up being at the end of the Q4. The other thing that was different than our expectations was the general market conditions continue to stay very muted, meaning there wasn't a lot of transaction volume to look at our activity. So it's actually played out that part of the market cycle is taking longer. We are still bullish that this business will generate over $10,000,000 of EBITDA per year. I think that really starts happening 3rd and really 4th calendar quarter of 2024 is when we think when we are expecting that to really ramp up.

Speaker 2

As we get into 2025, I think we will see possibilities of EBITDA even greater than that $10,000,000 or $11,000,000 to $13,000,000 number. I think it really can ramp up As the business matures, as we raise more cap as we put capital out, as we raise more third party capital there as well. So that's Sort of the finer point, Matt? No, that was everything.

Speaker 5

Okay, great. My follow-up, just a quick one. The construction fees, Why a little bit better than you thought in fiscal Q1? And what are you expecting next quarter and the rest of the year for that line item?

Speaker 3

Yes, the construction estimating construction activity is never an exact science, whether it be permitting, Spend delays supply chain. So it's just a matter of things accelerated as we hit the end of the year and that tends to happen for us and I think many real estate operators, people use up their budget as they approach the end of the calendar year. So it just A number of things fell into play favorably with some hotel renovations that were underway, which was a good thing. And then when you start the year over, It tends to start the hockey stick again as much as we've tried to minimize that over time, people restart their budgets and certain spend slows down. So next quarter we generated about $5,000,000 in construction fees.

Speaker 3

Next quarter we expect that to be about $4,000,000 And then we expect it to ramp back up again as the year plays out. We may not get all the way back to 5.

Operator

Our next question comes from Manavandan with Morgan Stanley. Please go ahead.

Speaker 6

Hey, just going back to Aramar Residential. So the understanding that you're going to be in the market basically the GP is going to be in the market raising for LPs and as that capital gets deployed that's when the EBITDA starts to ramp in the back half of this year and into 2025. And then do I have that correct? And is can you talk about what the because there was an earn out, I think with the announcement. Can you talk about how the earn out sort of factors in what we should be looking at for that?

Speaker 6

Sure.

Speaker 2

Yes. So first off, yes, generally the way you described it is how we're thinking about it as that we will be deploying capital as we get into the second half of the year and that will accelerate more as we get into 2025. The earn out is based on What we refer to as the Fund 7 and deploying that capital and how much of that capital gets deployed by the end of 25,000,000 and there's certain parameters around it?

Speaker 3

Yes, it's probably ratably Ron as the $100,000,000 the first $50,000,000 doesn't count to the earn out, but everything above $50,000,000 starts that $20,000,000 gets earned ratably from $51,000,000 forward. So it aligns everyone here with getting that money out.

Speaker 6

Got it.

Speaker 3

And then on the I guess, Ron, can I just say on the EBITDA and contribution of deployment, I think it's just important to remind folks on the RMR Residential side, how they make money and earn revenue is largely property management and construction management as deals are acquired and they're a manager? But the big hit to revenues is on acquisition fees. So as that money is deployed and new deals are made, The residential business under the current construct of their GP fund, they're getting about 65 basis points on each acquisition from an acquisition fee. So ramping this business up and putting money out, will immediately generate sizable impact to revenue.

Speaker 6

Got it. And my second question is a 2 parter, but it's kind of unrelated. But so Part 1 is really just on, I think you talked about sort of sovereign wealth funds sort of interest and some of the assets. Just curious from your like how are those conversations going with the sovereign wealth funds in terms of some of your assets and are there more opportunities to do JVs? And part 2, which is unrelated, is just so the EBITDA guidance for The second fiscal quarter, it's I guess it's $21,000,000 to $22,000,000 or $23,000,000 Is it dipping all because of

Speaker 4

the G and A or

Speaker 6

is there anything else we should

Speaker 3

I'll take the second part. It's dipping because of the revenue hit. I think This quarter's results speak to the flow through and the power of this platform because we revenues grew so rapidly, We saw almost a direct bottom line benefit and now the inverse is happening next quarter. We have a certain infrastructure, Construction revenue construction fees are down. The REITs enterprise values are stable, but not increasing and that has a direct flow through Adversely to EBITDA, which is driving the decrease.

Speaker 3

There's a little bit of cost headwinds, but it's really at the revenue line, which is dipping pretty sizably.

Speaker 2

With regards to the sovereign wealth fund relationships the company has, the existing ones, Those are largely in what I would call core, core plus vehicles, which have are generating core, core plus type returns, sovereign wealth funds and our relationships. And I think generally, given the current environment and sort of the lack of capital in the marketplace, Their return expectations have increased and they're now increasingly looking for what I'd call closer to value add type returns. So call it mid teens or low teen returns, which are historically different than what you would normally receive in a core core plus vehicle. So saying all that, our existing vehicles are fine. Those relationships are fine there.

Speaker 2

We expect to continue to manage them for some time. But we don't think there's going to be a lot of growth in today's environment in those existing joint ventures just because the return hurdles that the sovereign wealth funds that are in our that our relationships are with are just higher. And I also think that's generally speaking for Sovereign Wealth Funds is a blanket statement and sort of institutional capital that we've been interacting with is the return expectations are higher. And that sort of ties back to what I've said a couple of times, I think during the call, which is the areas where we're trying to organically grow are areas where we think we can raise private capital around the debt fund I mentioned and maybe on a residential The residential discretionary fund, which will probably come later in the year or into 2025. But Those are all types the funds I'm talking about generate those type of returns that we call it mid teens or low teen returns on a sort of a value add basis or type returns.

Speaker 2

And so that's why we're focused on that because That's also what the market is looking for in the sovereign wealth funds that we have relationships as well as ones that We just talked to those are the sort of the return criteria they're looking for. I would tell you broadly speaking, sovereign wealth funds today are looking at more debt strategies as I think Most people that are putting money to work in real estate, if they are putting money to work or looking at private credit strategies or debt funds, which is why we're focused on that part of our business as well.

Speaker 6

Helpful. Thanks so much.

Operator

This concludes our question and answer session. I would now like to turn the conference back over to Adam Portnoy, President and Chief Executive Officer for any closing remarks.

Speaker 2

Thank you all for joining us today. Operator, that concludes our call.

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Key Takeaways

  • Favorable Market Outlook: RMR sees improving conditions as the U.S. economy continues strong, with expectations of Federal Reserve rate cuts later this year creating a more positive environment for commercial real estate.
  • Strong Q1 Performance: The company beat the high end of guidance, delivering distributable earnings of $0.53 per share, adjusted EBITDA of $25.3 million (52.1% margin), and sequential growth in adjusted EPS.
  • Carroll Acquisition and RMR Residential: Closed the $5.5 billion AUM multifamily platform acquisition, boosting total AUM to $41 billion (32% private capital) and positioning RMR Residential for significant EBITDA contributions in H2 2024 and beyond.
  • Client Financial Strengthening: Managed-reit clients took key actions—DHC issued $941 million zero-coupon bonds to refinance debt, OPI secured $425 million in new bank facilities and issued a $300 million bond, and Seven Hills Realty Trust delivered a 60% total shareholder return in 2023.
  • Q2 Guidance: For Q2 2024 RMR expects service revenues of $48–$50 million, adjusted EPS of ~$0.40, adjusted EBITDA of $21–$22.5 million, and distributable earnings of $0.48–$0.51 per share as construction volumes and REIT enterprise values normalize.
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