Camden Property Trust (NYSE:CPT) Q4 2017 Results Earnings Conference Call February 2, 2018 8:00 AM ET
Kim Callahan – SVP, IR
Ric Campo – Chairman and CEO
Keith Oden – President
Alex Jessett – CFO
Nick Joseph – Citi
Juan Sanabria – Bank of America Merrill Lynch
Austin Wurschmidt – KeyBanc Capital Markets
John Kim – BMO Capital Markets
Alexander Goldfarb – Sandler O’Neill
Rob Stevenson – Janney
John Pawlowski – Green Street Advisors
Drew Babin – Robert W. Baird
Dennis McGill – Zelman & Associates
Good morning and welcome to the Camden Property Trust Fourth Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Kim Callahan, Senior Vice President of Investor Relations. Please go ahead.
Good morning and thank you for joining Camden’s fourth quarter 2017 earnings conference call. Before we begin our prepared remarks, I would like to advise everyone that we will be making forward-looking statements based on our current expectations and beliefs. These statements are not guarantees of future performance and involve risks and uncertainties that could cause actual results to differ materially from expectations. Further information about these risks can be found in our filings with the SEC and we encourage you to review them. 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 because of subsequent events.
As a reminder, Camden’s complete fourth quarter 2017 earnings release is available in the Investors section of our website at camdenliving.com and it includes reconciliations to non-GAAP financial measures which will be discussed on this call.
Joining me today are Ric Campo, Camden’s Chairman and Chief Executive Officer; Keith Oden, President; and Alex Jessett, Chief Financial Officer. We will be brief in our prepared remarks and try to complete the call within one hour. We ask that you limit your questions to two, then rejoin the queue if you have additional items to discuss. If we are unable to speak with everyone in the queue today, we’d be happy to respond to additional questions by phone or email after the call concludes.
At this time, I’ll turn the call over to Ric Campo.
Good morning. By now, you understand today is Groundhog Day. And this day always reminds me of the classic Bill Murray movie in which he relives Groundhog Day over and over and over again. For the thousands of our Houston area neighbors whose homes were flooded by Harvey and have not yet moved back into their homes, every day feels like Groundhog Day. So much progress has been made and yet so much work remains to be done in the Houston area. Fortunately, for 98% of the people that live in the area that were not flooded, life has returned to normal within a few days of the flood. All Camden’s communities are as good as new including Camden Spring Creek which had homes flooded.
The recent uptick in oil prices and the Astros’ great win in the World Series have lifted Houston’s spirits and economic activity. Harvey’s initial positive impact on the multifamily business has carried over into 2018, as Keith will share with you in his market-by-market report card. Houston’s rating improved from last year’s D and declining to these year’s B and improving, amazing what a year will do to the market rating sometimes.
I want to thank our Camden team members that stepped up and really showed what neighbors helping neighbors really meant for the Hurricane Harvey and Irma relief efforts that we did as a Company.
During 2018 will mark Camden’s 25th year as a public company. Few high points of where we have come from I think are in order. We started in three Texas cities and now are in 15 diversified growing markets throughout the country. We began providing 6,000 homes to customers and now provide 56,000 homes to customers, improving the lives of our customers, one experience at a time. We began with a $194 million market cap and have grown to over $11 billion, providing shareholders with solid returns, growing dividends and increasing stock prices from the beginning.
In the beginning, the multifamily industry was really a slow adapter to technology. Today, we embrace cutting edge technologies to help our employees, perform better and take care of our customers better, and also have provided customers with cutting edge technologies that they really appreciate. And more importantly, we started a workforce that started out at about 250 people and provided jobs and now provide jobs to nearly 2,000 fulltime employees and 5,000 construction workers, creating an amazing customer and shareholder focused culture that has been recognized in consecutive years on the Fortune 100 best companies to work for list with six top-10 finishes. We look forward to the next 25 years and really embrace the opportunity to continue improving the lives of our employees, our customers and our shareholders one experience at a time.
I’ll turn the call over to Keith for his market-to-market update now, thanks.
Thanks, Ric. Consistent with our prior years, I’m going to use my time on today’s call to review the market conditions that we expect to encounter in Camden’s markets during 2018. I’ll address the markets in the order of best to worst by assigning a letter grade to each one, as well as our view on whether we believe the market is likely to be improving, stable or declining in the year ahead. Following the market overview, I’ll provide additional details on our fourth quarter operations and our 2018 same property guidance.
We anticipate same property revenue growth will be between 2 and 5% this year in majority of our markets with the weighted average growth rate of 3% at the midpoint of our guidance range. The markets budgeted in the 2% to 5% growth range represent nearly 90% of our same property pool and 11, of our 13 markets received the letter grade of B or higher this year. Our top ranking for 2018 goes to Southern California, which we rate as an A with a stable outlook. Our Southern California portfolio has been a strong performer, averaging 5.5% annual same property revenue growth over the last three years. Approximately 25,000 new apartments are expected to open this year with 120,000 new jobs created, putting the jobs-to-completions ratio at a manageable 4.8 times.
Denver also earned an A rating but with the declining outlook. Denver has been one of our top markets for the past several years and we expect another strong year there in 2018. Approximately 40,000 new jobs are expected during 2018. But supply will remain elevated with 13,000 new units schedule for delivery this year, likely tempering the pace of revenue growth from the 5.3% level we achieved last year.
Raleigh, Orlando and Phoenix each get an A minus rating with stable outlooks. All of these markets face healthy operating conditions with balanced supply and demand metrics. In Raleigh, new developments have been coming on line steadily over the past few years with 5,000 to 6,000 new units delivered each year. Job growth has been stable and 22,000 new jobs are projected for 2018. Orlando is expected to have over 40,000 new jobs in 2018 with only 7,000 completions and estimates in Phoenix call for 50,000 jobs with 9,500 new units coming on line this year.
Up next are Atlanta and Tampa, both receiving B plus ratings with stable outlooks. Job growth has been strong in Atlanta and 55,000 new jobs are projected in 2018. Completions also remain steady with another 11,000 to 12,000 new apartments scheduled for delivery this year. In Tampa, supply and demand metrics for 2018 look very similar to last year with 30,000 new job versus 5,500 or so new apartments being completed.
Jumping up five spots in the rankings this year is Houston, which improved from a rating of D and declining in 2017 to a B and improving this year. After back-to-back years with negative same property results, our Houston portfolio is expected to achieve 3% revenue growth for 2018. Job growth went from under 20,000 in 2016 to around 50,000 last year and is currently projected to be at 80,000 for 2018. New supply has been heavy the last couple of years with an average of 20,000 new units delivered. 2018 should bring a significant drop off in supply with less than 3,000 completions expected this year.
Washington DC receives a B rating again this year with a stable outlook. Revenue growth for our DC portfolio averaged less than 1% from 2014 to 2016, then rebounded to 3.2% last year. We expect 2018 to look a lot like 2017 in the DC area with regards to same property growth. Supply and demand metrics should also remain consistent with another 10,000 to 12,000 completions this year and 40,000 new jobs projected.
Dallas earns a B as well but with a declining outlook, given the continued wave of new supply being delivered in that market. Job growth has been solid with nearly 70,000 jobs created last year and a similar amount expected to be created in 2018. But with over 20,000 completions last year and another 20,000 units coming on line this year, the Dallas apartment market will remain challenging in 2018 and our pricing power may be limited.
We gave Austin a B rating with a declining outlook this year. A level of new supply in the Austin market should finally start to come down in 2018 but only slightly with 8,000 new units anticipated this year versus 9,000 last year. Job growth was mediocre in 2017 with around 30,000 new jobs created and estimates call for a slightly weaker year in 2018 with employment growth of 22,000. Given the current supply and demand metrics, our 2018 outlook for Austin is below average with revenue growth of 1% to 2% expected for our portfolio this year.
Conditions in Charlotte seem to have firmed up a bit and are currently at B — were at a B minus with an improving outlook. New supply has been persistent in Charlotte with 6,000 to 7,000 units delivered in both ‘16 and ‘17 and a similar amount anticipated this year. Job growth should accelerate in 2018 with over 30,000 new jobs projected. So, we expect our portfolio’s revenue growth will be slightly higher than the 1.9% we achieved last year.
And our last market, South Florida, ranks as a C plus with a stable outlook. We began to see weakness in our South Florida portfolio during 2017 and the economic outlook for 2018 calls for deceleration in job growth this year. Deliveries of new apartments should remain steady but our communities will continue to compete with additional supply from for-sale and rental condominiums. As a result, we expect limited revenue growth for our South Florida portfolio this year with a range of 1% to 2%.
Overall, our portfolio rating is a B plus this year, up slightly from last year’s B rating, primarily due to the improvement we’ve seen recently in Houston after hurricane Harvey. As I mentioned earlier, the majority of our markets should achieve 2% to 5% revenue growth this year with the outliers being South Florida and Austin, both in the 1% to 2% range. As a result, we expect our 2018 total portfolio same property revenue growth to be 3% at the midpoint of our guidance range, and this compares to our actual revenue growth last year of 2.9% with again most of the year-over-year improvement driven by Houston.
Now, few details on our 2017 operating results. Same property revenue growth was 3% for the fourth quarter and 2.9% for full year 2017. We saw strong performance during the fourth quarter ‘17 with most of our markets recording 3% to 6% revenue growth. Our top performers for the quarter were Tampa at 5.6%, Orlando at 5.4%, Raleigh at 4.6%, and Atlanta, Phoenix, San Diego — and the San Diego/Inland Empire each 4.4%.
Rental rate trends for the fourth quarter were as expected with new leases down one tenth of a percent, and renewals up 4.9% for a blended rate of 2.3% growth, and our preliminary January results are in a similar range. February and March renewals are being sent out at just over 5%. Occupancy averaged 95.7% during the fourth quarter compared to 94.8% last year. January occupancy has averaged 95.4% compared to 94.7% in January of 2017. Annual net turnover for 2017 was 200 basis points lower than 2016 at 46% versus 48%, and that’s always good to see. Move-outs to purchase homes were 15 — were at 15.8% for the fourth quarter of 2017 and 15.2% for the year, down slightly from 2016 levels.
At this point, I’ll turn the call over to Alex Jessett, Camden’s Chief Financial Officer.
Before I move on to our financial results and guidance, I’ll provide a brief update on our recent real estate activities.
During the fourth quarter, we reached stabilization at Camden Lincoln Station, a $56 million development in Denver, and began construction on Camden Downtown Phase I, a $132 million development in Downtown Houston. Additionally, late in the quarter, we completed the $78 million disposition of our only student housing community Camden Miramar, which is located in Corpus Christi, Texas. We built and owned Camden Miramar since 1994. And over the past 23 years, this was a very successful investment for Camden and our shareholders, generating a 16.5% unleveraged internal rate of return. We made the strategic decision to sell this asset given its age, use, and its location on a ground lease with just over 20 years remaining. At the sale’s price, this disposition represents an AFFO yield of 8.5% and an FFO yield of 10.5%. This disposition FFO yield was driven in large part by the short remaining duration of the ground lease and the capital-intensive nature of this asset due to its age, use and location directly on the Gulf Coast.
Subsequent to quarter-end, we purchased Camden Pier District in St. Petersburg, Florida, for approximately $127 million. This newly constructed 358-unit 18-storey concrete building was purchased at a year one yield of just under 5%.
We ended the quarter with no balances outstanding on our unsecured line of credit, $370 million of cash on hand and no debt maturing until October of 2018. Our current cash balance after purchasing Camden Pier District, the January 2018 payment of our fourth quarter dividend and the payment of property taxes which are disproportionally due in January, is approximately $160 million.
Moving on to financial results. Last night, we reported funds from operations for the fourth quarter of 2017 of a $114.6 million or $1.18 per share, in line with the midpoint of our prior guidance range of a $1.16 to a $1.20 per share. Contained within the $1.18 per share of FFO was approximately $0.005 in higher same store insurance expense as result of estimated freeze damages at our Georgia, North Carolina and DC area communities, offset by approximately $0.005 in higher non-same store net operating income, driven by the slightly delayed sale of our Camden Miramar student housing community. This sale occurred on December the 12th as compared to our forecast for December the 1st.
Moving on to 2018 earnings guidance. You can refer to page 26 of our fourth quarter supplemental package for details on the key assumptions driving our 2018 financial outlook. We expect our 2018 FFO per diluted share to be within the range of $4.62 to $4.82 with a midpoint of $4.72 representing a $0.19 per share increase from our 2017 results.
The major assumptions and components of this $0.19 per share increase in FFO at the midpoint of our guidance range are as follows. An approximate $0.13 per share increase in FFO related to the performance of a 41,968 unit same store portfolio. We are expecting same store net operating income growth of 1.5% to 3.5% driven by revenue growth of 2.5% to 3.5% and expense growth of 3.5% to 4.5%. Each 1% increase in same store NOI is approximately $0.05 per share in FFO. An approximate $0.15 per share increase in FFO related to net operating income from our non-same store properties resulting primarily from the incremental contribution from our development communities and lease-up during 2017 and 2018, the four development communities which stabilized in 2017, and our one stabilized acquisition completed in June of 2017. An approximate $0.06 per share increase in FFO related to the net operating income from our January 2018 acquisition of Camden Pier District, an approximately $0.08 per share increase in FFO due to assumed additional $380 million of pro forma acquisitions spread throughout the year, and an assumed year one yield of 4.5% and an approximately $0.05 per share increase in FFO due to the nonrecurring nature of our 2017 hurricane related charges.
This $0.47 cumulative increase in FFO per share is partially offset by an approximate $0.16 per share reduction in FFO, resulting from additional shares outstanding as a result of our September 2017 equity offering, an approximate $0.08 per share decrease in FFO related to loss NOI from the disposition of our Camden Miramar community, an approximate for $0.04 per share decrease in FFO resulting from the combination of lower third-party construction fees, lower interest income resulting from lower cash balances, and higher corporate depreciation and amortization due to the implementation of a new back office system expected to come on line in the third quarter 2018.
We are anticipating overhead expenses to be flat in 2018, resulting from a combination of general cost control measures and the impact of a construction-related settlement in which we will receive a reimbursement of legal fees expense in prior periods. We’re also anticipating interest expense to be flat in 2018 as the repayment of debt in 2017 is offset by 2018 higher borrowings under our unsecured line of credit combined with lower amounts of capitalized interest resulting from the completion of construction of three developments in 2017 and three developments in 2018.
The interest rate for our line of credit floats at LIBOR plus 85 basis points and we anticipate draws under our line of credit beginning in June. Additionally, we anticipate repayment maturity, $175 million of secured floating rate debt with an anticipated interest rate of 2.3% in the second half of the year, and we anticipate repaying at $205 million of secured fixed rate debt with an interest rate of approximately 5.7% late in 2018. Our current guidance does not anticipate any early debt prepayments and any resulting penalties.
We currently anticipate issuing $400 million of unsecured debt late in 2018 at an all-in rate of approximately 3.75%. In anticipation of this offering, we have entered into $200 million of forward starting swaps, partially locking in the 10-year treasury at 2.34%.
On the same store — our same store expense growth range of 3.5% to 4.5% for 2018 is primarily due to increases in salaries and benefits and taxes. Salaries and benefits represent 20% of our total operating expenses and are anticipated to increase by 6.5%. This increase is a result of two factors. First, our benefit related expenses in 2017 were unusually low, trading at tough comparison. In 2017, we experienced unusually low amounts of self-insured healthcare expenses resulting in our 2017 increase in salaries and benefits to be less than 1%. I’ve discussed this trend on past calls and said at the time that I did not believe this trend could continue. And second, we are being responsive to the effects of general labor tightening and are making market-driven wage adjustments where appropriate. The two-year average increase in salaries and benefits averaging 2017 and 2018 is 3.7%.
Property taxes represent a third of our total operating expenses and are projected to be up just over 4% in 2018. 3.5% of the expected growth is core, the result of anticipated increases in assessment for our properties. The remaining increase is due to a year-over-year reduction in anticipated refunds from prior year tax protests. We had success in 2017 with our prior year tax protests and current year appeals. As a result 2017’s full year property tax expense increased by 4.1% as compared to our original budget of 5.5%. Although we do anticipate further tax refunds in 2018, we do not anticipate reaching the levels received in 2017. Excluding salaries and benefits and taxes, the remainder of our property level expenses are anticipated to increase at less than 3% in the aggregate.
Page 26 of our supplemental package also details other assumptions I’ve not previously mentioned. We’re anticipating at the midpoint $100 million in dispositions late in the year with no significant impact to our guidance, and we’re anticipating $100 million to $300 million of on-balance sheet development starts spread throughout the year.
Last night, we also provided earnings guidance for the first quarter of 2018. We expect FFO per share for the first quarter to be within the range of $1.11 to $1.15. The midpoint of $1.13 represents a $0.05 per share decrease from the fourth quarter of 2017, which is primarily the result of an approximate $0.035 decrease in sequential same-store net operating income. Of this amount, $0.02 is due to sequential increases in property taxes, resulting from both higher fourth quarter 2017 tax refunds and the reset of our annual property tax accrual on January the 1st of each year. The remaining $0.015 of the sequential decrease in same-store NOI is due to other expense increases, primarily attributable to typical seasonal trends including the timing of onsite salary increases. These increases in same-store operating expenses are partially offset by slight increase in same-store operating revenues, an approximate $0.025 per share decrease in FFO due to disposition of our previously mentioned student housing community. As a reminder, occupancy and NOI at this community were strong during the school term but declined significantly during the summer months and an approximate $0.01 per share decrease in FFO due to a combination of lower third-party construction fees and lower interest income resulting from lower cash balances.
This $0.07 aggregate decrease in FFO is anticipated to be partially offset by an approximate $0.015 per share increase in acquisition NOI, and an approximate $0.005 decrease in combined overhead expenses, resulting from the previously mentioned reimbursement of legal fees, expense in prior periods, partially offset by the normal beginning of the year compensation increases and the timing of certain corporate events.
And finally, our balance sheet is strong with net debt to EBITDA at 3.5 times and fixed charge expense coverage ratio at 5.5 times, secured debt to gross real assets at 11%, 80% of our assets unencumbered, and 92% of our debt at fixed rates. We have $736 million of developments coming under construction or in lease-up with $280 million left to fund.
At this time, we’ll open the call up to questions.
We’ll now begin the question-and-answer session. [Operator Instructions] Our first question comes from Nick Joseph with Citi. Please go ahead.
Thanks. Maybe just starting with Houston. Could you give us the underlying assumptions for that 3% revenue growth in terms of new and renewal pricing and occupancy? And then, just generally, how dependent are you on kind of that 80,000 job growth assumption number, just given that you’re coming into the year with such high occupancy?
Yes. We’re still running at 97%, little better than that occupancy in Houston. And obviously, in our plan, we do expect that to moderate over the course of the year. So, we would expect to end the year at something closer to what would look like normal in Houston, 94 to 95%. So, definitely, we do believe that it will come down over time as the people who were displaced from their homes, who still are in a rental apartment kind of slog through the long process of getting their primary residence back in order. And one of the things we talked about in our last call and we were very cautious in terms of giving people guidance that were coming in and inquiring about three-month lease terms, very short-term lease terms as we felt like the magnitude of this event was going to be such that three months was just a — it was really not doable in most cases, and that’s turned out to be true.
I think what’s actually — what we’re going to actually see is that we thought was not three but probably six, in many cases, it’s going to turn into as many as nine months to a year, unfortunately, for a lot of folks. So, we’ve tried to anticipate when that shift will happen but we’re in pretty uncharted waters here in terms of a market, the size of Houston with the degree of impact that — and displacement that we’ve seen. But, we did our best to try to put a fence around it. So, we think we’ll trend back down closer to 94.5 to 95%.
In terms of the overall lease and renewals, right now, we’re doing new leases at basically flat and then we’re doing renewals at somewhere around 4% for Houston. So, that’s 2%. We think, we’ll stay somewhere in that range throughout the year. I think, our guesstimate for Houston same store revenue growth next year is in the 3% range for the full year. So that’s where we think we’re going to end up. But I will tell you that it was one of the more challenging revenue forecasting tasks that our teams have ever been faced with just trying to anticipate all the moving parts.
As far as dependency on the 80,000 jobs, I mean, clearly, we’re probably less exposed to a little bit — to the variability in that number than we have been in the past, primarily because we’ve got a lot of the overhang and supply has been taken care of currently. We think again some of that’s going to unwind over time. But, the good news for Houston is that in 2018 we expect to see only about 7,000 apartments completed and delivered and that compares to roughly 20,000, 22,000 we’ve had for each of the last three years.
So, a lot of relief on the supply front, a lot more optimism about the 80,000 jobs. Those forecasts that we’ve seen were before even the most recent uptick in the price of oil, and there just seems to be a lot more vibrancy and optimism in the overall Houston economy. So, I think overall, we’ve got a good plan for Houston for 2018.
Thanks. And then, just, what was the final impact of the tech package rollout on 2017’s same store revenue expense and NOI, and then, what’s assumed the impact in 2018?
Sure. So, for 2017, numbers came in, revenue was about 65 basis points, expenses was right around 130; and NOI was right around 20. For 2018 revenue is right around 10 basis points, expenses is actually — it’s a positive 20 basis points because we have redone some of our contracts, and that gets us to an NOI positive about 20 basis points.
Our next question is from Juan Sanabria with Bank of America Merrill Lynch. Please go ahead.
Just hoping you could talk a little bit about the acquisition environment, kind of the pipeline you have today. I think, you said you expect the acquisition to be evenly spread out. But, any color on what you’re seeing? You guys raised equity in the fall and it’s been slow to allocate that. But, just what you are seeing in the pricing and what markets you are looking at?
Sure. The acquisition market is very competitive, continues to be very competitive. We just got back from the National Multi Housing Council meeting in Orlando and it was the biggest meeting they’ve ever had . When I was Chairman of NMHC, we I think peaked at like 2,600 people; and there were 5,800 people in Orlando in the multifamily space. So, I mean, there is a — it’s a very interesting time because you have — there is still a lot of capital that is investing in multifamily that’s significant. The really interesting part of it however is that the capital because of slowing rent growth around the country and slowing NOIs in most markets, the capital has, in the last sort of year or so have been focused on value add. And the idea of buying older property and fixing it up and then creating that value add proposition, it’s been value add driven primarily because of the lower cap rates on core and then slowing growth rates on core has been tough for people to hit their sort of unlevered IRR numbers.
I think that you are going to have a continued competitive environment this year. We have looked at lots and lots of properties. The challenge that we have is that we’re not just going to go out and acquire properties because we have capital. We want to make sure that they fit into our strategy. And our strategy has been buying below replacement cost in lease-up scenarios, like in ST. Pete property we bought, and the one we bought last year in Atlanta where we could buy it below replacement cost, come in at a lower yield because there are generally embedded concessions, they are now fully leased up yet. And then, once we go and finish the lease-up, start bringing the concessions off and then putting some Camden sort of customer focus, we move those lower cap rates up to where we are more comfortable.
I think, what’s happening now is that people are positioning in terms of sale assets and sort of investors are all kind of queuing up to see what happens to the sale market. We think, there’s going to be probably 15% to 20% more assets in the market this year to sell than there was last year given where we are in the cycle. So, we will get our fair share. The markets we want to be in or markets where we are underrepresented where we think long-term the growth prospects for the regions are good, and most of our markets fit that category. And so, we are really agnostic about where we buy within our markets as well as we can hit that sort of sweet spot of below replacement cost, lease-up and then driving the yields up higher over the next 12 to 24 months.
And then, just on — in Dallas and Atlanta, I was hoping you could talk about kind of the trajectory you expect for same-store revenues across those markets and what you’re seeing on the new leases kind of recently in those two markets as well?
So, I’m sorry, Juan. Was it Dallas and Atlanta?
Okay. So, we have Dallas on our rating as B and declining, and that’s just strictly a result of the new supplier that’s going to be delivered this year, going to see another really strong year of employment growth but there’s just too many apartments that need to be absorbed. So, we ended last year, revenue growth in Dallas, at about 4.4% and we’ll be around 3% this year. So, still overall a good year for Dallas, just certainly, we think it’s decelerating from the strength that we’ve seen in the last two years. Atlanta, we have as a B plus and a stable market. And again, if you’re just comparing to last year, Atlanta was — revenue almost 5% for the full year, and we’ve got that a little bit over between 3% and 3.5% for 2018. So, again, good year, solid, a little bit of biased towards too many apartments relative to the 5 to 1 ratio long-term, but still okay in terms of the overall results in both those markets.
The next question is from Austin Wurschmidt with KeyBanc Capital Markets. Please go ahead.
Just curious in terms of how you’re thinking about returns today given the recent move in the base rate. And then, you also mentioned you’re focused on market share underrepresented. Can you share what markets those are? Not sure if I missed anything there.
Sure. If you look at our biggest markets we have, we have high concentrations in Washington DC and in Houston. But, if you look at markets like Tampa, Orlando where we’ve like 4% or 5% of our NOI comes out of those markets; Phoenix, we’re under represented in. If you just look at the supplement and you see the percentage of NOIs, it’s just — we just try to kind of fill in where we have little less market exposure. And, first part of your question was?
Just how you’re thinking about returns today with the recent move in the base rate?
Sure. The thing that’s really interesting is that people I think make a mistake when they think that the 10-year treasury is what drives cap rates. The 10-year treasury is probably the fourth most important thing that drives cap rates; it’s not the number one. And because a lot of people are funding with floating rate debt anyway, so they think about the treasure — the 10-year, and even though fairly the curve is flattening which increasing the cost of floating rate debt as well. But, when you think about cap rates, cap rates remain very sticky, and the reason they do is because the number one driver of price of any asset is the liquidity in the marketplace that is there to be able to fund that asset, that acquisition. And today, the market is very deep in liquidity, there’s still — you’ve got still lots of financial institutions who want to make loans on apartments, Freddie Mac and Fannie Mae including life companies. And life companies now are actually cheaper on a financing side than Freddie and Fannie. And you have a wall of equity capital that continues to need to make investment. So, it’s liquidity in the marketplace that drives cap rates. The next thing is supply and demand fundamentals.
And we know that even though we’re in the latter part of this cycle, since we’ve been going now eight years into the recovery cycle, you still have reasonable supply and demand economics. You don’t have markets that are all trending negative and you’re not in a recessionary environment. So, supply and demand looks reasonably well. And if you look out into ‘19 and ‘20, lots of folks believe that you’re going to have a reduction in new development because of the pressure on land prices and costs and what have you. So, there’s that hope that and I think view that supply is going to be going down over the next few years and demand continues to look really good with millennials, with — when you look at every cohort of group, whether it be millennials or baby boomers, we have an increase in propensity to rent apartments across the board.
As a matter of fact, between 2014 to today, the increase in demand for people 55 and older for market rate apartments is about the same in terms of market share as for millennials. And you have this really interesting thing going on which is, millennials have very high propensity to rent, the 55 and olders have a lower propensity but there’s a whole lot of those. So, if you have an uptick in how — in capture rate for those, which we’ve been having for the last 10 or 15 years, having an increase in propensity to rent for those people, you have this really nice increase in demand model that you can really look forward to the next three or four years. So supply and demand are good.
The next big issue is inflation, inflation that drives cap rates. And what’s driving the 10-year today is incredibly low unemployment and wage pressure which we’re feeling and all of our competitors are feeling. And so, I think people are not thinking it’s deflationary, I think they’re thinking that we’re maybe getting back to an inflationary environment, which supports short-term leases and the ability to raise rents on those short-term leases. So, then, you hit the 10-year, right, which is the last piece of the equation, the 10-year even at what it is today is still very low relative to long-term interest rate. So, I don’t think pricing is going to change at all. If anything, it’s going to get more competitive because when you start putting the inflation equation on the table for investors, they’re like well, maybe I should go to an inflation protected asset like a multifamily asset. So, all that said, I don’t see price — I don’t see cap rates moving much given the 10-year tenure and it’s going to be a competitive environment unless something dramatically changes on the supply and demand side or something that we don’t know is out there from an economic shock perspective.
I appreciate the detailed response there. And to the first point, as a follow-up, given depths, I guess — the liquidity in the market today, the fact that we’re through the wall of CMBS maturities, do you think there’s a potential we see more portfolio deals this year and is that something that you’d be interested in?
I think, we’re interested in portfolio deals and one-offs. The challenge you have with portfolio deals generally is that there’s always a — you have to sort of take the whole thing and often times you have to choose whether you want everything, and sometimes that’s not ideal. But, on the other hand, we’re looking at all these different activities.
I think that — I think, there is definitely going to be an increase in sales this year because when we think about the merchant builder model which is how properties get built, the merchant builders are having trouble reloading their balance sheets because they are holding assets longer than usually do. And primarily, because it took longer to build and you have had — had a sort of feathering in of the inventory, which is serving good on the market side because you haven’t flooded the market as fast as it could have been, given the delay in construction that everybody has had across the country because of lack of labor. So, with that said though, merchant builders are full. In order for them to reload to do their next few deals, they do have to sell. And you also have the equity side of that equation that is in play, which they have equity in there and they have funds, and the funds are unwinding with other properties, what have you. And so, they don’t want to hold assets too long too because their sort of levered IRR start going down, longer they hold, assuming that prices are sort of not going dramatically up.
And so, I think that’s driving the market to more sales, probably more portfolio sales, and we are going to look at it all.
Our next question is from John Kim with BMO Capital Markets. Please go ahead.
Your average monthly rental rent increased this quarter sequentially and that goes against the grain of pretty much all of your peers. Can you just explain that dynamic? Did you purposely focus on pushing the rates versus occupancy?
So, John, the biggest change in our portfolio was just the flip-flopping what was going on in Houston from third to fourth quarter. We were — even as late as the second quarter call, we were still thinking that Houston could be down 4% for the year on rental revenues. And obviously, we had a reversal of that in the third quarter and a pretty decent sequential increase in Houston and it’s 12% of our footprint. So, it’s always enough to move the needle when we get that kind of a shift. That’s the only market that I can point to where other than sort of what’s normal things that happen seasonally in our portfolio in some of our markets, Phoenix et cetera that do benefit from the fourth quarter generally over the third. But, everything else looks kind of what you would typically see in our portfolio with the exception in Houston, and that was a big shift.
It seems like it was pretty strong across the board but you’re basically saying you didn’t change anything as far as the rate versus occupancy trade this quarter?
No, we didn’t. Again, look at the occupancy rates across the board in our platform, and we normally try to operate somewhere around 95% occupied, and we have got a — most of our markets are operating north of that. And in that environment, you still from a revenue management standpoint, the model is still going to want to push rents.
Okay. And the second question is on your redevelopment guidance, which seemed like it was new this year of about $30 million. Can you just remind us how this compares to 2017 because it’s not on your CapEx schedule?
Yes, absolutely. So, the redevelopments are new. So, in the past, we have been doing repositions. Redevelopments is a new concept, introduced in 2018. What we are going to do is combine a traditional reposition program with extensive exterior upgrades, and we are taking assets that will be redeveloped out of same-store. And we currently have three assets that are in that bucket, two in South Florida and one in Arlington. And total spend for those for 2018 is going to be somewhere around $25 million to $30 million.
The redevelopments you are taking out of same store pool, repositions and revenue enhancing are kept in the same store?
Our next question is from Alexander Goldfarb with Sandler O’Neill. Please go ahead.
Two market questions for you. First, just going back to Houston, Keith, in your response to one of the earlier questions, I didn’t know if you were saying that you expected Houston to end at 94% versus the 97% now. So, I didn’t know if I misunderstood that. And then, second is, when do you think that we’ll see a return of development in Houston, just given the dramatic drop off that we’ve had north to 60%? How long do you guys think before people start putting 2 by 4s in the ground again and we get supply coming back?
Alex, I think, I said 94 to 95, which is what I was trying to be specific on that, other than just say back to a more normal situation. Obviously, 97.5% occupied is just not normal. It’s not normal for Houston, it’s not normal for any of our markets. I expect to get back to normal but in so doing, we’re going to have to — at some point, we’ll be bleeding off 250 basis points of occupancy, which I expect to happen over the course of 2018.
In terms of new construction, I think that you’re — you’ve got people right now that are just sort of — got bailed out in some cases of their last round of new developments by the Harvey effect. There’s discussion, there’s always conversations about potential new starts. But, I think, the reality of the world that we live in today with how long it takes to get through the planning and permitting process even in Houston, it’s just — restarting of the development pipeline, meaningful — to have a meaningful impact in 2019 and 2020 I just think is not likely to happen. We obviously started our Downtown community in the fourth quarter at the end of last year. That’s a community that we bought land on years ago, it’s been part of our legacy land portfolio. We just did that opportunistically, because we look out on the horizon, 7,000 completions this year in 2018; I don’t have — let’s see, in terms of completions or projected completions in Houston for 2019, about 5,000 apartments are projected to be completions in the entire Houston metropolitan area, which is an extraordinarily low number. Our building Downtown is the type 1 high rise construction, and we won’t even be delivering units there until probably the first part of — or late ‘19, early 2020. So, I think…
I think, the other thing that’s really interesting that’s going on when we talk about Harvey, I was at Urban Land Institute event this week in Houston, and one of the engineers who is working on the city’s new response to detention, mitigation and raising the elevations of new construction, there’s a major move that could significantly negatively impact the ability of people to build as a result of these new rules. And these new rules actually are coming into play. Harris County put in new rules just recently and it just makes it more expensive, takes up more land, takes — requires more infill dirt [ph] and what have you. So, the cost side equation is being driven up by new Harvey regulations. And it’s classic government though when you think about it, to a certain extent because they’re pushing the new developers to spend a whole lot more money and creating — making it more difficult, which is sort of good for the incumbents, right? And the city I think in mid February has a very restrictive program that actually takes the — requires developers to go above the 500-year floodplain by I think 12 inches or something like that. And that — all those things are kind of impediments that heretofore were never really impediments in Houston. So, you’re having a little bit more regulatory constraint that’s going to constrain people.
The other thing is also, lenders are not rushing back into Houston to make loans there at this point. They’re sort of waiting, and there’s a lot of wait and see. So, the equity capital and the debt capital are not like blasting in there saying let’s go build, and you still have in markets like — in pockets that didn’t get flooded, fair amount of concessions that are still going on in those lease-ups.
Okay. And then, the second one is on Orlando, which for Axiometrics seems to be benefiting from the Caribbean influx. So, could you just give a little more detail what you expect for Orlando, both rent — your occupancy there is it 97, so obviously what you expect there, and then as far as the supply picture as we look out into ‘18?
Yes. Sure, Alex. We have Orlando as an A minus and stable. I mean, we expect it to be one of our best performers this year. We’re going to be probably in the 3 to 3.5 to 4% on top line revenue growth, which is down from last year, but last year it was in the top 3 or 4 in our entire portfolio. And yes, it is true that there has been a very significant influx. People from Puerto Rico that are — we’ve done a lot of homework on this and it is true that the port of entry or the place of destination of a lot of the people from Puerto Rico is Orlando. So, they’re going to get the normal job growth that we would have seen in Orlando but we’re also going to see a big influx of other potential residents. So, Orlando, we have it as the third or fourth best market in our portfolio this year, so looking for another really good strong year in Orlando.
Orlando, just to give you a sense of this Puerto Rican connection. So, the number one city in America with Puerto Rican heritage is New York City, number two is Orlando. And so, we’re getting at least 5 to 10 Puerto Rico sort of effects in our properties there. Right now, it’s sort of anecdotal but as long as Puerto Rico continues to be challenged, more people are flowing out.
The next question is from Rob Stevenson with Janney. Please go ahead.
Good morning, guys. What’s the expected stabilized yield on the current development pipeline? And what have you guys been achieving on the stuff that’s completed and are stabilized in the last year or so?
So, our overall portfolio yield’s around 6.25, 6.5 something like that. The high rises are lower and the mid rises are higher. And the trend on development yields is down unfortunately, obviously because you’re later in the cycle and comps are higher, and it takes longer to build today. Our yields sort of on the last maybe batch of — that were fully stabilized were probably in the 7 range and now we’re down into the low-6 kind of zone at this point.
And for the stuff that you guys expect to start in ‘18, where are you on that, are you basically cherry picking the best returns, are you sort of targeting specific markets on that?
We are obviously — we are absolutely driven by long-term, unlevered IRRs that have a spread against our long-term weighted average cost of capital. So, while we — markets are important for — in terms of driving the decision, the key is making sure that the numbers work going in. And a good example would be, we’ve owned land in South Florida that we’ve been trying to figure out how to build on for a long time and we just hadn’t been able to make the numbers work. I remember our Boca deal, I think we owned the land maybe eight years before it started working. And then, we — and it made sense, and it’s a right yield now. So, it’s more driven by return that we can — long-term unlevered IRRs that we can earn, not necessary markets. We do developments today because of land cost and construction cost. You can’t look at — you look at a market like Charlotte for example and we’ve built three properties in Charlotte. And the construction cost from those three properties is probably on average up 30% today for what we booked them for in the last three years. And the rents are not 30% obviously. So, you know what that does to yields.
Alex, what do you guys renew on your insurance and what are you expecting there, and you guys plan to do more self insurances if rates go up meaningfully?
Yes, absolutely. So, we are actually in the market right now working on a renewal. It’s with the May 1st effective date. What we’re being told on the property side is to expect premiums up 10% to 20%, and that’s what we have rolling through. But when you actually take property and you combine it with general liability and all of other insurance lines, and then pull in our self-insured retention component, we’ve got property insurance for calendar year 2018 that’s about 5%. And there’s no doubt this is going to be a very tough renewal process.
Our next question is from John Pawlowski with Green Street Advisors. Please go ahead.
I just want to follow up on Rob’s question there. So, on the 2018 starts, what is the stabilized yield and spread to prevailing cap rate assumptions?
So, the yields, assuming that we get these yields because we haven’t started them obviously, are going to be in the sort of low sixes, and the spread to cap rates in those markets today is probably 150 basis points.
So, Ric or Keith, you were able to raise equity at what in hindsight is a pretty attractive price, given the selloff here in REITs. And so, five months later, you are left with a different opportunity set, and deploying that capital, to your comments, acquisition and developments are really getting more competitive. So, you can buy stabilized yields at mid to high 4, you could build at a 6, which carries some risk. But now suddenly you can buy the stock back at a mid 5 and implied yield with no risk. So, has this discount probably you’ll reevaluate your plan at all? If not, what discount will it take for you to change your plans?
So, obviously the stock price selloff for all the multifamily companies is obviously new in a sense it’s about, what, a three or four-week deal. And we put together our plans through the end of the year. And I think, you always have to reevaluate where you are based on current market conditions. And we have been — we haven’t been in this period long enough to sort of abandon our program for this year and say okay, let’s go buy the stock back at this point. Just historically, we’ve always said that — obviously buying your stock back at a significant discount is an opportunity that doesn’t happen that often. And when we bought back 16% of our Company at roughly at 20% discount during the sort of tech days in 1998, ‘99 and 2000, we had a persistent discount. And we were able to then sell an asset and buy the stock back and it was very methodical and perfunctory at the time to do it and it was the right thing to do. And if the stock stays at a significant discount and we have a — as persistent we’re able to get size in the buyback, then we do it. So, we’re evaluating that now and we’ll continue to evaluate it.
If you look at the last maybe four or five years, I mean, it’s been really interesting. The volatility of these stocks has been huge. I mean, starting back when — I think we were trading at maybe 15% to 16% discount at the beginning of 2014 or maybe 2013 and we had lots of conversations around the — our senior management table and our Board table saying, you know what, this is silly, we’ve got to go buy the stock. And then, the stock is up $20 a share in a month. And so, we didn’t have the opportunity to buy at that point. So, it has to be persistent and it has to be — and it has to be a significant discount for us to sort of change our long-term strategy of owning and operating apartments and driving cash flow.
So, at today’s current levels, obviously nothing stays static but at current levels, if it doesn’t make you — if it persisted today, it would make you reconsider?
Well, I think the key is, if you think about what we did the last time, it was 20% discount and it was persistent. I mean, the challenge you have in terms of trying to buy the stock back is that to make a difference in your — in getting sized, it’s hard to do, it takes a while to do it. And so, we’re going to evaluate it. And we’re just going to put the capital allocation priorities on the table and say alright, here’s what you get from development, here’s what you get from acquisitions, here’s what you get from buying stock, how can you do this and how can you do something that makes sense, in the short term, knowing that this is a long-term business. So, we’re going to look at it, obviously. And if we get an opportunity to create a lot of value that drives cash flow and drives cash flow per share growth and we can do that with little execution risk, then, we’re going to do it.
Our next question is from Drew Babin with Robert W. Baird. Please go ahead.
Question on Washington DC, kind of your forgotten largest market. Going out to 2018, it seems like outside of maybe defense, government and government related employment should be pretty weak, combining that with new supply. I guess, I am just curious, how you view your relative portfolio positioning in the market? And whether — is there any kind of new strategy for this year in terms of managing for occupancy versus rate or anything like that that you’re doing that’s proactive.
Well, first, the thing to me that your comment that it’s driven by government workers, I would disagree with that. It’s — definitely, government is significant part of the economy. But, if you think about the DC metro area, one of the highest education profiles for MBAs and master degrees, one of the richest, highest paid workforces, lots of technology, very economically driven by the overall economy. And I would say given the tax cuts and given the sort of kind of animal spirits perhaps that the administration is kind of creating on the business side, you could pick up additional economy growth that would help DC. I’m not worried so much about the government and what their workers are doing.
So, just from the standpoint of where the numbers shake out, I mean, our DC portfolio, we have a very different footprint than a lot of our competitors do. It’s not heavily oriented towards DC proper. But last year, on total revenue, DC produced top line revenue growth of about 3.2%. I think, we’re looking at something closer to 3%, so a slight decline from the prior year but 2018 to me, unless you get any external shocks and government shutdowns and other madness that comes and goes from time to time in DC, it just seems like almost a repeat of 2017. We’re going to get probably another 10,000 apartments delivered in 2018, but we should get about 40,000 new jobs. And that’s okay, that’s enough to keep us kind of in a steady state at about 3% top line revenue growth.
Would it be fair to say that on supply side, I mean, the vast majority of the supply that’s going to impact the MSA is kind of located down, maybe in the ballpark area Southwest DC, maybe few other pockets. I guess, are there any pockets in Camden’s portfolio where there might just be kind of an outsized impact from anything delivering in ‘18?
So, in 2018, it was like — I’ve mentioned 10,000 completions. I don’t think — I think the two — the area down by the ballpark that you mentioned is definitely going to be — there’s a competitive set there that’s going to impact us. Outside of that, we’ve been pretty fortunate with our footprint in the DC area to have missed a good portion of this cycle of new development, and I think that probably — and that certainly has been baked into our 3% growth plan for next year.
Our next question is from Dennis McGill with Zelman & Associates. Please go ahead.
First question just has to do with the storm-impacted markets, which I guess really are considered to be Houston, Orlando and Tampa all collectively. If we think about 2017, the final revenue number came in 2.9 I think versus the 2.8 midpoint that you started the year. Any sense how much the storms benefited that number and assuming that’s material where were the offsets relative to initial expectations?
Yes. So, in Houston, the impact would be meaningful. I mean, it’s pretty easy to do the math. We had a top line revenue decline that was factored in for the year of 4% for the full year and I think we ended up at about 2% for the full year; it’s 12% of our income, so it was 48 basis points in over half a year. It was a meaningful impact from Houston on the overall portfolio. Orlando and Tampa, I would say, it’s approaching zero. I mean, literally, we’ve got very fortunate on the path of the storm and other than a few nicks and bruises and down trees in those two markets, we really didn’t see any impact, either on the operating expense side of things, outside of the just some normal cleanup or on the rental side of things. Just to put it in perspective, we had in Houston, from Harvey, we had about 53 employees who were impacted to one degree — to some degree from the storm, about 23 of which got literally displaced from their homes by the flood. We did not have a single employee in our Florida footprint, in Miami or South Florida, Tampa or in Orlando who got displaced by the storm event in Florida. So, I would say, it is zero, approaches zero in Florida and was probably pretty meaningful in Houston.
I wasn’t thinking of existing residence in Florida but as you talked about earlier, the inflow of demand from outside of Florida.
Yes. That really didn’t start until almost towards the end of the year where people sort of started throwing up their hands and saying this is way longer of an event than anybody thought it was going to be in Puerto Rico. Maybe we will have some impact in 2018 and that could be helping us with our occupancy rate in Orlando right now, but we will just have to see how that plays out.
And then, second question, as you look at the guidance this year, the 3% revenue midpoint. Can you break that down into rent and occupancy? And then, beyond the modest benefit from the cable package that you still expect in ‘18, is there any other ancillary income that would impact that number?
I would say no on ancillary income. We are 95.7% occupied right now. Our plan for the year would be at about 95 — little bit north of 95 for the full year. So, very slight impact from occupancy decline, maybe call it 20, 30 basis points. And then, on the rental side, so that would be slightly more than what the three would imply. So, maybe 20 basis points on rent versus the giveback on occupancy.
And then, last question, just bigger picture. You talked a lot about wall of capital coming at the space and some of the demographic factors that you would look as being very positive as you look at a couple of years, and a story that’s very similar to what’s driven a lot of the development in the space for the last couple of years. So, trying to just square that with why supply would pull back if those in the industry have those two pillars to stand on and have some optimism for the next couple of years, especially if the belief is other people are pulling back, then would now be a good time to start and so it becomes a little bit self-fulfilling.
Sure. Well, if developers can get capital, they will start period, right? And because — and that’s a merchant builder mantra. And so, what’s causing the developers not to start are that rising land costs, rising construction costs, labor shortages in every market have driven construction costs and or just total project costs up higher than rental rate growth. And therefore, the returns that the private equity wants to get on their equity and has just been really hard to get, and so those numbers are — that’s what’s really driving the slowdown. It’s not that they don’t — people look at the market and say yes, demand looks good over the next couple of years. And that doesn’t mean you are not going to have construction start on any units but it’s just not going to be at peak levels, it’s going to drop dramatically because you have a lot of deals you just won’t pencil today, and the capital — if you can’t convince the capital that you are going to make your numbers, then the capital is not going to play.
If you look at banks and just the lending environment, it continues to fall in terms of lenders’ appetite to finance multifamily and finance real estate in general. They sort of think it’s late in the cycle. And because of the Basel agreements, I think it’s Basel III or IV that creates this, the category of highly volatile commercial real estate, the lenders have all pulled back. And so, the capital stack for the merchant builders has changed pretty dramatically. In early cycle timeframe, you’re able to get 70% construction loan, recourse burns off after you deliver, and then you do 30% equity and maybe even get higher than 70%. Today, it’s 50%, 55% underlying construction loan, developers are having to go out and put mezz pieces in between the sort of 50%, 55%, 60% if you’re — best case, and then they put a mezz piece on top of that and then equity on top of that. And so, their cost of capital has gone up in addition to the cost of everything else. And rents have moderated having going up enough to make the numbers work. So, that’s why supply is going down, not that they don’t want to do it, they just aren’t able to make the numbers work.
That’s a helpful perspective. So, maybe, one way to think of it is, it’s a wall of capital that won’t get placed?
Well, the wall of capital that I was talking about is acquisitions, because when you look at acquisitions, that’s a different animal, right? Because most of that acquisition is going at the same way going — wait a minute now, construction costs are going to go up, 5% to 10 — 5%, let’s just on average 5% a year for the next five years. And I am a institutional investor and I look out there and say, rents are moderating but they’re still good, there’s still positive NOI and get 2.5%, 3% NOI growth. And if I buy an asset today, no one is going to build against me in the future if it’s going to cost 25% more to build that asset. So, I am going to buy my — I am going to buy today and knowing that — or having the belief that I have a growing cash flow that’s inflation-protected in theory and some sort of replacement cost protection, if you will, in the future as well. So, I think that capital gets placed and that’s the sort of the toughest part of the equation is, is competing with that wall of capital. Now in terms of wall of — there’s not a wall of capital for development because it’s just not as easy of a sale, right, Oh, I have really high…
If the wall of capital — sorry. If the wall of capital drives down, for the acquisitions and drives down cap rate, doesn’t that lower the required return necessary on the development side?
No, because the problem is, is that — I don’t think cap rates are going to be driven down, actually, they’re going to stay in the kind of low to mid-4s. And when you start looking at — the challenge you’re having — when we’re looking at a project, for example, we just priced in Charlotte, I mean, we can’t get it out of the high-4s from a yield perspective, when it stabilized. And that’s assuming that rents continue to rise in Charlotte at 2% to 3%, and it’s because construction costs went up 30%. So, if I can’t even get my pro forma to get into a 5, then, how do I make that work even if the cap rates today are 4.5 or 4.25 in Charlotte, and I am building to a 4.75, I don’t have enough spread and a merchant builder is not going to get that deal financed. I am not going to do it, even though I don’t have the same capital constraints that they do.
This concludes our question-and-answer session. I would like to turn the conference back over to Ric Campo for any closing remarks.
I appreciate your time today. And we look forward to having more detailed discussions when we start the meeting cycle in March. So, take care and thank you.
The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.
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