The RMR Group Q2 2024 Earnings Call Transcript

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Provided by Quartr
May 8, 2024

There are 7 speakers on the call.

Operator

After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations.

Operator

Please go ahead.

Speaker 1

Good afternoon and thank you for joining RMR's Q2 of fiscal 2024 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. First, I would like to note that management will not be answering questions about the debt exchange offer that its client Office Properties Income Trust announced last week as the offering period is currently open. I would also like note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the company.

Speaker 1

Today's conference call contains forward looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. These forward looking statements are based on RMR's beliefs and expectations as of today, May 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.rmrgroup.com. Investors are cautioned not to place undue reliance upon any forward looking statements.

Speaker 1

In addition, we may discuss non GAAP numbers during this call, including adjusted net income, adjusted earnings per share, distributable earnings and adjusted EBITDA. A reconciliation of net income determined in accordance with U. S. Generally accepted accounting principles to these non GAAP figures 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 today. Since our last earnings call, we have continued to advance our business and support our clients through the current headwinds facing many aspects of commercial real estate. Overall real estate transaction volumes have remained subdued for over a year, largely a result of an increase in interest rates, persistent inflation and uncertainty regarding whether the Federal Reserve will cut interest rates later this year. While interest rates may remain higher for longer, we do remain cautiously optimistic about an improving market environment later this year and into 2025. The resiliency and strength of the RMR platform over many years and through numerous business cycles gives us a solid foundation to continue creating long term value for all our stakeholders.

Speaker 2

Last night, we reported 2nd quarter results that reflect both revenue growth driven by our recent residential platform acquisition and investments we are making to ensure RMR remains well positioned to take advantage of growth opportunities in the future. This quarter, we generated distributable earnings per share of $0.51 and adjusted EBITDA of $22,700,000 With nearly $200,000,000 of cash and no corporate debt, we have ample flexibility to continue making the necessary investments to further our strategic objectives. The strength of our balance sheet and the durability of our cash flows also led to our recent announcement regarding an increase to our recurring dividend by 12.5 percent to $0.45 per quarter, which remains well covered in a 64% payout ratio. We ended the quarter with AUM of over $41,000,000,000 broadly diversified across all major commercial real estate sectors. While perpetual capital accounts for approximately 68% of our AUM, over the past 4 years, we have strategically focused on increasing our private capital AUM from essentially 0 to more than $13,000,000,000 today.

Speaker 2

Our fiscal second quarter marks the Q1 of RMR Residential's results being incorporated, and we remain optimistic about the future of this business. Despite a recent leveling off in multifamily rent growth in the Sunbelt region, which is largely the result of absorbing new supply, the long term multifamily fundamentals in the Sunbelt are supported by favorable long term trends, including continued population in migration, a strong labor market, declining construction starts, and the cost differential between owning a home and renting. While multifamily deal volume has been muted, we have recently seen a considerable uptick in new transaction marketing activity, which we believe bodes well for deployment of our residential dry powder in the back half of calendar twenty twenty four. Our residential acquisitions team is currently tracking close to 100 deals across various Sunbelt markets, including a number of potential off market transaction. Beyond our residential platform, we are continually evaluating strategic growth opportunities that leverage our existing capabilities.

Speaker 2

To this end, we are in the initial stages of creating a private debt vehicle that capitalizes on the attractive risk adjusted returns private credit is currently generating and leverages the experience and expertise of our lending platform Tremont Realty Capital. Tremont has demonstrated a successful track record originating commercial mortgages that have generated substantial shareholder returns at our public mortgage REIT, Seven Hills Realty Trust. Since it began managing Seven Hills, Tremont has made approximately 50 value add and light transitional investments totaling $1,300,000,000 resulting in a weighted average gross IRR of 14.5% on its realized investments. With constrained bank lending for commercial real estate, together with nearly $2,000,000,000,000 of commercial real estate debt maturing by the end of 2026, we see a meaningful opportunity to increase loan volume for both public and private capital investors. To launch this new strategic initiative, we plan to amass a seed portfolio of up to $100,000,000 in loans over the coming months using our own balance sheet, which would in turn help expediate capital raising for this vehicle.

Speaker 2

These loans will be levered through a bank repurchase facility resulting in RMR's net equity or cash commitment to be minimal. Based on market feedback, we believe raising private capital via a seated venture will garner greater success than attempting to raise a blind pool of capital. As 3rd party investors are identified for this Tremont managed vehicle, a substantial majority of the equity investment we are making is expected to be repaid and the investments to move off balance sheet at RMR. In support of this strategic initiative, last month, we accepted an application from a prospective borrower for a floating rate mortgage loan secured by a hotel in Massachusetts for a gross commitment of $40,000,000 In the coming months, we plan to make additional commitments for similar type loans, and we look forward to updating you on the progress of this strategic initiative in the future. Turning to noteworthy highlights at our perpetual capital clients.

Speaker 2

During the quarter, we remain focused on assisting our clients with the execution of their strategic and financial priorities. We arranged over 3,000,000 square feet of leases on behalf of our clients with an 8 weighted average roll up in rent of 17%. More than 60% of this quarter's leasing activity was executed at ILPT, highlighting continued strong demand for the company's industrial and logistics properties. ILPT's quarterly earnings once again demonstrated solid operating results. Occupancy increased to 99%.

Speaker 2

Cash leasing spreads grew 25% or the strongest in 6 quarters. And same property cash basis NOI was up 2 30 basis points. With no final debt maturities until 2027, ILPT has the flexibility to be patient until the financing environment improves. DHC continues to advance key initiatives focused on improving its operating results and further strengthening its capital and liquidity profile. First quarter financial results reflect continued improvement in DHC's SHOP segment with same property cash basis NOI increasing almost 10% year over year and continued roll ups in rent within their medical office and life sciences segment.

Speaker 2

DHT has also outlined targeted strategies for capital deployment and operator transitions within the SHOPS portfolio to continue improving performance. OPI has made considerable progress since the beginning of the year addressing its debt maturities and continues to execute on its financing strategies amid a challenging and lending environment for the office sector. The company recently launched an offer to exchange certain of its outstanding unsecured senior notes for new senior secured notes. Additional information about this exchange offer can be found in OPI's press release, which was issued last week. Lastly, at SVC, overall hotel performance during the quarter reflected softer seasonal trends as well as the impact of ongoing renovations across the portfolio.

Speaker 2

SVC remains intensely focused on improving hotel operating trends and enhancing the quality of its hotel portfolio to best position its operators for long term growth. To that end, the company is currently executing a twofold strategy aimed at investing in its hotel renovation program and advancing plans to dispose of lower performing assets that have been a drag on profitability. In addition, the near term challenges within SVC's lodging portfolio is somewhat offset by the stability of SVC's net lease portfolio. With that, I'll now turn the call over to Matt Jordan, Executive Vice President and our Chief Financial Officer.

Speaker 3

Thanks, Adam. Good afternoon, everyone. For the Q2, we reported adjusted net income of $0.39 per share, adjusted EBITDA of $22,700,000 and distributable earnings of $0.51 per share. This quarter's results were in line with our guidance and reflect the balance of cost containment and necessary platform level investments to support long term growth. This quarter, we continued the integration of the RMR Residential platform and remain on track to identify the synergies outlined at the time we announced the acquisition.

Speaker 3

The realization of the synergies and the related impact on our financials will occur in varying periods over the next 2 years. Given the expectations around multifamily capital markets activity that Adam highlighted earlier, we expect RMR Residential to remain largely breakeven through at least next quarter. Turning to this quarter's results. Recurring service revenues were $49,600,000 an increase of $3,400,000 sequentially and in line with our expectations. The sequential increase reflects the full quarter impact of RMR Residential, partially offset by declines in construction management fees as a result of slowing construction spend at our clients.

Speaker 3

Next quarter, we expect recurring service revenues to remain relatively flat at an expected range of $48,000,000 to $50,000,000 This estimated range assumes enterprise values that our managed equity REITs stay at their current levels, normal seasonal improvements in Sonesta related management fees and consistent levels of construction spend. Cash compensation was approximately $44,000,000 which includes the full quarter impact of RMR Residential as well as the adverse impacts of payroll tax and 401 ks contributions resetting 12 months. Looking ahead to next quarter, we expect cash compensation to remain at these same levels and our cash reimbursement rate to be approximately 50%. G and A expenses this quarter were $11,600,000 which includes $600,000 of annual director share grants and $200,000 of technology transformation costs. The remaining $10,800,000 of recurring G and A expenses reflects increased levels of 3rd party construction costs and higher than anticipated expenses related to RMR Residential.

Speaker 3

As it relates to RMR Residential, the bulk of those costs are from marketing and technology expenses, the majority of which are passed through to managed properties and are included in our service revenues. Next quarter, we expect recurring G and A to remain at approximately $11,000,000 Aggregating these collective assumptions, next quarter we expect adjusted earnings per share to be between $0.37 $0.39 per share, adjusted EBITDA to range from $21,000,000 to $22,000,000 and distributable earnings to range from $0.46 to $0.48 per share. As it relates to our balance sheet, we ended the quarter with almost $200,000,000 in cash and no corporate debt, providing us ample flexibility to continue investing in platform and leaves us well positioned to capitalize on strategic opportunities as they arise. Before we begin the question and answer portion of the call, I would like to first acknowledge the publication of our annual sustainability report. RMR remains committed to reducing greenhouse gas emissions at assets we have operational control over by 50% by 2029 and to attain net zero emissions by 2,050.

Speaker 3

Through calendar 2023, we are well on our way, having achieved a 35% reduction in greenhouse gas emissions through energy efficiency measures, sustainable procurement and renewable energy programs. Lastly, as Kevin highlighted earlier, we cannot address questions regarding LPI's current debt exchange offer. That concludes our formal remarks. Operator, would you please open the line to questions?

Operator

We will now begin the question and answer Our first question is from Bryan Maher with B. Riley Securities. Please go ahead.

Speaker 4

Thank you and good afternoon, Adam and Matt. Just 2 for me today. I was hoping you could elaborate a little bit more on what you were talking about as it relates to the residential and the uptick in deals that you're seeing and how specifically that feeds through and will benefit RMR over the next couple of years?

Speaker 2

Well, I'll talk about it generally and I'll let Matt maybe get a little bit more details on how it can affect the financials. But generally speaking, generally over the last, I'd say, 2 to 3 months, there's been an uptick in what say marketing activities in terms of transaction or deals coming to market, especially that's actually happened across the board, but most pronounced in the residential area or multifamily space, and specifically in the markets that we're targeting throughout the Sunbelt region. There's a lot of reasons maybe for why that's happening. There hasn't been a lot of deal activity for several quarters now. I think there's I think buyers and sellers are starting to converge on pricing.

Speaker 2

I think sellers are getting a lot of pressure from let's say what's going on in the lending market. Broadly speaking, I think buyers are getting some pressure. There's a lot of money on the sidelines and some buyers are anxious to put that money to work before their investment period ends. So I think they're starting to be a convergence on pricing. And we do expect to see more transaction volume to occur.

Speaker 2

And we expect we will actually engage in transactions throughout the calendar year. I'll let Matt talk about what that could mean for the company's financials.

Speaker 3

Yes. And Brian, getting deals done are really the stimulus we need to get residential beyond breakeven. It is a platform built to handle much more AUM than the $5,500,000,000 it's currently managing. So in terms of the way the business is structured today, every deal should generate an acquisition fee of about 62 to 65 basis points. So just getting a deal done has a very sizable impact to RMR's P and L because we'll recognize those acquisition fees immediately.

Speaker 3

And then obviously there's property management that comes with that new deal. The way I like to think about it between property management and construction, every $1,000,000,000 of new AUM in the residential platform should equal about $1,000,000 of new property management and construction management fees per quarter. So deal volume is really the thing we need to start to see come through, and a lot of that will flow to the bottom line. And I think what Adam highlighted, we hope by the back half of this year, we'll see some of that come through because we've clearly made the investments in people, getting the right acquisitions professionals in place and have a cost structure to support that growth when it starts occurring.

Speaker 4

That's really helpful. And the second question for me and understanding fully that you can't comment on the OPI deal, but you do see a lot of transactions and financing activity. Can you speak broadly as to what you're seeing in a commercial real estate financing market currently kind of across categories and how that can positively impact your managed REITs over the next years and maybe specifically touch upon CMBS?

Speaker 2

Sure. So I'll start with CMBS. I would say the secured market, and especially CMBS market, broadly speaking for well leased assets, cross segments is open. It's open to do to conduits where you can do one off transactions. You can also do large single issuer transactions as well.

Speaker 2

So generally markets are open. They're more expensive than typically what people have been paying on their debts. So if they're refinancing debt, you're paying more for it, but the market is definitely open. Generally speaking, what you see in the capital markets in terms of debt availability and financing largely trends overall sentiment, people more open to financing apartments, multifamily, industrial, and then there's pockets of other sort of niche assets around that, life science buildings, medical office buildings, hotels, believe it or not, are very much somewhat in favor in the investment community. Probably the toughest market or toughest segment to find financing is in and around general multi tenant office buildings.

Speaker 2

But even there, if it's the right asset, newer building, well located, well leased, there is financing available. It's expensive, but it's available. So markets are open. Everything, in general, it just costs more.

Operator

The next question is from Mitch Germain with Citizens JMP. Please go ahead.

Speaker 5

Thank you for taking the question. Matt, I appreciate the comments on residential and profitability or AUM growth and acquisition fees. I guess I'm trying to gain insight. The near term profitability of residential is driven by additional synergies and acquisition fees, meaning the recurring income is already recognized in the numbers today, if you don't get any more AUM growth? Is that the way to think about it?

Speaker 3

Yes. The way I would think about it, it, the AUM we have today pays for the business, but that's about it. And the way their business works, as value add deals season, they ultimately do get sold. So it is critical the acquisitions activity pick back up later this year.

Speaker 5

Got you. And Adam, we've been I guess you've got a full quarter of the team in the RMR platform. I'd love to get some initial thoughts about kind of where things are versus the original expectations?

Speaker 2

So I think we're very pleased with the integration of the folks from RMR Residential into the broader RMR platform. And I think we're very pleased with many of the synergies that we planned on realizing and acquiring the business. We are clearly behind on the revenue side. Matt's alluding to it in terms of we need more transaction volume. I think everyone's acutely focused on it.

Speaker 2

And I think unfortunately, it's a little bit or maybe materially impacted by just market environment. We are working really hard and the acquisitions team that's focused on residential is working really hard at finding deals and sourcing them. I am optimistic that we will be able to close on transactions in the second half of this year. But so overall, I'm pretty pleased. But yes, there's no question from a revenue side, we're behind where we'd want to be.

Speaker 2

But on the cost side, I think we're right where we thought we'd be. And I think from an integration just generally, social issues, I think, are great. I mean, I think we're well integrated. I think the team is working well. Teams are working well and integrated well.

Speaker 2

So that's how I'm looking at it and I feel good about the business going forward.

Speaker 5

Great. Last for me. I recall about had must have been like probably 2017, 2018. Adam, you tried to incubate a similar type of vehicle for the office sector, given your capability and the fact that you had some office assets that were held outside of the Managed REITs. I'm curious how this is a little bit different and how you're approaching this new debt vehicle differently?

Speaker 2

Yes. So at the time, you're right, you have a good memory, Mitch, in terms of we tried something like this. It's similar. 2 different 1, different asset class, obviously, different time. 2nd, we have we're working with a very reputable placement agent on this capital raise that we're engaged in right now.

Speaker 2

We've also learned a lot, including from that exercise that you're mentioning from 6, 7 years ago about how is the best way to organically create a fund. And I think we've learned from all those experiments and all those twists and turns, especially what we did several years ago that you're referencing. I feel very good about our ability to be able to raise this capital. There was also the biggest maybe the biggest difference is the return profile. We were trying to raise at the time a core office fund, core meaning high single digit return IRRs.

Speaker 2

Here what we're talking about on a levered basis, we're talking about mid teens IRRs. And so it's a different investment profile, different return expectation, which is partly based on what we've learned and talking to the market. I feel very good about our ability to execute on this. Timing, how long it's going to take, that's a little bit of a wildcard. I can't could it be 1 quarter, could it take 4 quarters?

Speaker 2

I don't know, till we actually get all the money in. But I'm confident we will raise money is the best way to say it. And I wouldn't be putting the RMR balance sheet or at use here unless I had some pretty strong conviction that we were able to use it to start one of these funds.

Speaker 5

Thank you.

Operator

The next question is from Ronald Kamdem with Morgan Stanley. Please go ahead.

Speaker 6

Great. Just a couple of quick ones for me. Just staying with the sort of capital raising for Tremont, you talked about sort of $100,000,000 Just trying to get a sense of what the opportunity set, what the pipeline is and what is there sort of a target? Is this something that could be 200, 300? What sort of the thought of how this was going to evolve over time?

Speaker 2

Sure. So just to be clear, we talked about up to $100,000,000 gross investment that will use our balance sheet. And it's a little confusing when I say that. We're going to that's inclusive of leverage. We're going to use leverage on these loans.

Speaker 2

So let's just use the round number, dollars 100,000,000 of our gross investments, dollars 70,000,000 of which will be debt, dollars 30,000,000 of which will be equity in the loan or use of our cash. That is to seed a portfolio or a fund that is not the total fund itself. We expect that the fund itself from an equity perspective will be $200,000,000 to $400,000,000 in equity. Use leverage on that and you're talking about total investments of $1,000,000,000 give or take. So that I just want to be clear that's what we're trying to do with the balance sheet to seed the portfolio.

Speaker 2

But the ultimate size in this first fundraise I should point out is about $1,000,000,000 In terms of the pipeline, again, we feel very good about the pipeline. Yes, there is less transaction volume going on in the marketplace today. As a result of less transaction volume, there are less loans being originated. Fully half of what you used to see in originations of loans was new acquisition financing. Well, here there's not a lot of new acquisition financing.

Speaker 2

There is some, but not much. It's a lot of refinancings that we're underwriting. But from a risk return perspective, we're making 1st lien secured mortgages against performing real estate that's going to go through a value add or a light value add repositioning. And it doesn't really matter what type of real estate because we'll lend them we'll lend against almost anything. And that type of investment reduces mid teen returns.

Speaker 2

The pipeline is very strong. A and we also think we differentiate ourselves in the marketplace. Look, there's a lot of folks that are talking about private credit and private credit real estate. What really differentiates us from in the marketplace is we are a real estate operating platform. So we have a perhaps a more robust underwriting of the loan itself.

Speaker 2

But also we are able given our scale to be much more middle market focused. So our average loan size could be $20,000,000 $30,000,000 versus many of the larger players are focused on, let's say, dollars 100,000,000 larger loans. So when we play in what we call that middle market tier, there's a tremendous amount of transaction volume and not as many players. So we don't have as much competition and actually leads to a little bit higher returns for the investors. So yes, we feel good about the pipeline.

Speaker 2

We feel good about the investment opportunity we're presenting to potential LPs.

Speaker 6

Great. And then my second one was just going back to RMR Residential. I think you made some comments about dry powder, potentially sort of opportunities in the second half of the year and tracking 100 deals. Just can you talk a little bit about sort of the return profiles of those deals? And is there any sort of thematics across those 100 deals and the type of properties you're looking at?

Speaker 2

Thanks. Sure. So we're targeting again sort of value add turnaround or light turnaround properties in the multifamily space or apartment buildings in the Sunbelt region where we currently operate. The return hurdle when I when we referenced that 100 deals in the pipeline, we're talking about that type of characteristic deal that is going to hopefully produce a mid to high teen IRR for the investor. So that's a general outline of the type of deals we're looking at.

Speaker 2

And when I said 100, they sort of all in mixed fashion meet those criteria in some way.

Speaker 6

Great. Thanks so much.

Operator

This concludes our question and answer session. I would like to turn the conference back over to Adam Portnoy for any closing remarks.

Speaker 2

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

Operator

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

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Key Takeaways

  • Generated distributable earnings of $0.51 per share and adjusted EBITDA of $22.7 M in Q2, supporting a 12.5% dividend increase to $0.45 per quarter (64% payout ratio).
  • Integrated RMR Residential platform delivering initial results with AUM growing to $5.5 B, tracking ~100 multifamily deals in Sunbelt markets to drive acquisition fees and future property management revenue.
  • Announced a new private debt vehicle through Tremont Realty Capital, planning to seed up to $100 M in loans on the balance sheet to catalyze a $200 M–$400 M equity fund targeting ~ $1 B of total assets at mid-teens IRRs.
  • Maintained a strong balance sheet with nearly $200 M of cash and no corporate debt, providing flexibility for platform investments and strategic growth initiatives.
  • Published its annual sustainability report highlighting a 35% greenhouse gas reduction to date, on track for a 50% cut by 2029 and net zero by 2050.
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Earnings Conference Call
The RMR Group Q2 2024
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