Q2 2024 RMR Group Inc Earnings Call

Participants

Kevin Barry; Senior Director, IR; RMR Group Inc

Adam Portnoy; President, Chief Executive Officer, Managing Director, Director; RMR Group LLC

Matthew Jordan; Chief Financial Officer, Executive Vice President, Treasurer; RMR Group LLC

Bryan Maher; Analyst; B. Riley Securities

Mitch Germain; Analyst; JMP & Securities

Ronald Kamdem; Analyst; Morgan Stanley

Presentation

Operator

Good afternoon and welcome to the RMR Group fiscal second quarter 2024 earnings conference call. (Operator Instructions) Please note this event is being recorded.
I would now like to turn the conference over to Kevin Barry, Senior Director of Investor Relations. Please go ahead.

Kevin Barry

Good afternoon, and thank you for joining RMR's second quarter of fiscal 2024 conference call. With me on today's call are President and CEO, Adam Portnoy; 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, but its client office properties, Income Trust announced last week as the offering period is currently open. I would also like to note that the recording and retransmission of today's conference call is prohibited without the prior written consent of the Company.
Today's conference call contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and other securities laws. 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 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.

Adam Portnoy

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 the 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 proving 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.
Last night, we reported second 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 $22.7 million with nearly $200 million 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% to $0.45 per quarter, which remains well covered, a 64% payout ratio.
We ended the quarter with AUM of over $41 billion, broadly diversified across all major commercial real estate sectors, while perpetual capital accounts for approximately 68% of our AUM. Over the past four years, we have strategically focused on increasing our private capital AUM from essentially zero to more than $13 billion today.
Our fiscal second quarter marks the first quarter 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 long-term multifamily fundamentals in the Sunbelt, supported by favorable long-term trends, including continued population 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 2024. Our residential acquisitions team is currently tracking close to 100 deals across various Sunbelt markets, including a number of potential off-market transactions beyond our residential platform, we are continually evaluating strategic growth opportunities and leverage our existing capabilities.
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.
Toromont Realty Capital trend loan has demonstrated a successful track record of originating commercial mortgages that have generated substantial shareholder returns at a public mortgage REIT Seven Hills Realty Trust since it began managing Seven Hills, Toromont has made approximately 50 value add and light transitional investments totaling $1.3 billion, 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 trillion 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 million in loans over the coming months using our own balance sheet, which would in turn help Expedia capital raising for this vehicle.
These loans will be leveraged 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 VA ceded venture will garner greater success than attempting to raise a blind pool of capital as third party investors are identified for this Tramont 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 million 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 of our perpetual capital clients. During the quarter, we remained focused on assisting our clients with the execution of their strategic and financial priorities. We arranged over 3 million square feet of leases on behalf of our clients, with a weighted average rollup 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.
Iret's quarterly earnings once again demonstrated solid operating results occupancy increased to 99%. Cash leasing leasing spreads grew 25% were the strongest in six quarters and same-property cash basis NOI was up 230 basis points with no final debt maturities until 2027. ILDT. 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-up of roll-ups in rent within the medical office and life sciences segments. Jt 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 news 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. 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 SBC's lodging portfolio is somewhat offset by the stability of SV. C's net lease portfolio.
With that, I'll now turn the call over to Matt Jordan, Executive Vice Vice President and our Chief Financial Officer.

Matthew Jordan

Thanks, Adam, and good afternoon, everyone. For the second quarter, we reported adjusted net income of $0.39 per share, adjusted EBITDA of $22.7 million 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. The realization of the synergies and the related impact on our financials will occur in varying periods over the next two 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 $49.6 million, an increase of $3.4 million 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 next quarter, we expect recurring service revenues to remain relatively flat at an expected range of $48 million to $50 million.
This estimated range assumes enterprise values that our managed equity rates stay at their current levels. Normal seasonal improvements in semester related management fees and consistent levels of construction spend. Cash compensation was approximately $44 million, which includes the full quarter impact of ARMOUR Residential as well as the adverse impacts of payroll tax and four one k. contributions resetting on January first, both of which were partially offset by strategic restructuring act actions taken over the last 12 months.
Looking ahead to next quarter, we expect cash compensation to remain at the same levels and our cash reimbursement rate to be approximately 50%.
G&A expenses this quarter were $11.6 million which includes $600,000 of annual directors' share grants and $200,000 of technology transformation costs. The remaining $10.8 million of recurring G&A expenses reflects increased levels of third party construction costs and higher than anticipated expenses related to arm our residential as it relates to arm our 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&A to remain at approximately $11 million, aggregating these collective assumptions next quarter, we expect adjusted earnings per share to be between $0.37 and $0.39 per share, adjusted EBITDA to range from $21 million to $22 million 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 million in cash and no corporate debt, providing us ample flexibility to continue investing in our 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 2050 through calendar 2023. We are well on our way having achieved that 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 LTAs. Current debt exchange offer that concludes our formal remarks.
Operator, would you please open the line to questions?

Question and Answer Session

Operator

Bryan Maher, B. Riley Securities.

Bryan Maher

Thank you, and good afternoon, Adam and Matt. And just two 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?

Adam Portnoy

So I'll talk about it generally, and I'll let Matt maybe get a little bit more details and how it can affect the financials. But generally speaking and generally over the last, I'd say two to three months, there's been an uptick in what I would say marketing activities in terms of transactions 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.
And 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 a I think buyers and sellers are starting to converge on pricing. I think sellers are getting a lot of pressure from, let's say, what's going on the lending market. Broadly speaking, I think buyers are getting some pressure.
There's a lot of money on the sidelines and some buyers, our interest to put that money to work before the investment period ends. So I think there's starting to be a converging a convergence on pricing, and we do expect to see some more transaction volume to occur. We expect we will actually engage in transactions and throughout the calendar year. I'll let Matt talk about what that could mean for the Company's financials.

Matthew Jordan

Yes. And Bryan, getting deals done or really the stimulus we need to get residential beyond breakeven. It is a platform built to handle much more AUM than the $5.5 billion is currently managing. So in terms of the way, the business is structured today, every deal should generate an acquisition fee about 62 basis points to 65 basis points. So just getting a deal done has a very sizable impact to RMR's P&L because we'll recognize those acquisition fees immediately.
And then obviously this property management that comes with that new deal. On the way I like to think about it between property management construction, every billion of new AUM and the residential platform should equal about $1 million 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.

Bryan Maher

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 the commercial real estate financing market currently kind of across categories and how that can positively impact your managed rates over the next years and maybe specifically touch upon CMBS?

Adam Portnoy

Sure. So I'll start with CMBS. I would say the secured market in especially the CMBS market broadly speaking for well leased assets, cross segments is open. It's open to do it through conduits where you can do one-off transactions. You can also do large single issuer transactions as well so generally, markets are open.
They're more expensive than typically what people have been paying on their debts. So if the refinancing debt, you're paying more for it, but the market is definitely open on generally speaking what you see in the capital markets in terms of debt availability and financing, largely trends, you know, overall sentiment, you know, people are 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 and probably the toughest market were tough.
The segment to find financing is in and around general multi-tenant office buildings. But even there, if it's the right asset, a 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 cost more.

Bryan Maher

Okay.

Operator

(Operator Instructions)
Mitch Germain, Citizen's JMP.

Mitch Germain

Thank you for taking the question. Matt, I appreciate the comments on residential and profitability, I guess or for some AUM growth in 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.

Matthew Jordan

Yes, the way I would think about it. The AUM we have today pays for the business, but that's about it 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.

Mitch Germain

Yes. Yes. 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 their original expectation?

Adam Portnoy

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, and I think everyone's acutely focused on it. 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 and finding deals and sourcing them. I am optimistic that we will be able to it closed on transactions in the second half of this year on. 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.
But on the cost side, I think we're right. We're right where we thought we'd be. And I think from an integration just generally, you know, social issues, I think are great. I mean, I think we're well integrated. I think come the team is working well. The teams are working well in integrated well. So that's how I that's I'm looking at it and I feel good about the business going forward.

Mitch Germain

Great. And last for me, I recall about half must have been like probably 2017, 18, 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 management. I'm curious how this is a little bit Chrysalin and how you're approaching. So this new debt vehicle?

Adam Portnoy

Definitely, yes. So at the time you're right. You have a good memory, Mitch, in terms of we tried something like this similar to different one different asset class, obviously different time. So second, we have we're working with a very reputable placement agent on this train on this capital raise that we're engaged in right now. We've also learned a lot, including from that exercise that you're mentioning from seven six, seven years ago about how is the best way to organically create a fund on.
And I think we've learned from all those, you know, experiments and all those twists and turns, especially that we did several years ago that you're referencing, I feel very good about our ability to be able to raise this capital. There is 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 here, what we're talking about on a levered basis on a levered basis, we're talking about mid 10s IRRs.
And so it's a different investment profile, different return expectation, which is partly based on what we learned in 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 wildcard. I can't or could it be one quarter or could it take four quarters.
I don't know till we actually get all the money and you on, 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 use here unless I had some pretty strong conviction that we are able to use it to start one of these funds.

Mitch Germain

Thank you.

Operator

Ronald Kamdem, Morgan Stanley.

Ronald Kamdem

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

Adam Portnoy

Sure. So just to be clear, we talked about up to $100 million gross investment that will use our balance sheet. And you know, it's a little confusing when I say that we're going to be that's inclusive of leverage. We're going to use leverage on these on these loans. So let's just use the round number $100 million of our gross investments, $70 million of which will be debt, $30 million of which will be equity in the loan or use of our cash.
That is to see the portfolio or a fund. That is not the total fund itself. We expect that the fund itself from an equity perspective will be to noon to $400 million in equity use leverage on that and you're talking about total investments of around, call it $1 billion, 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. But the ultimate size in this first fund raise I should point out is about $1 billion.
In terms of the pipeline, again, we feel very good about the pipeline. And 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 used to see in originations of loans was on new acquisition financing.
Well, here there's not a lot of new acquisition financing. 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 first-lien secured mortgages against a 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 number or lend against almost anything.
And that type of investment reduces, you know, mid-teen returns, the pipeline's very strong 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 the marketplaces. We are real estate operating platform. So we have perhaps a more robust underwriting of the loan itself.
But also we are able given our scale to be much more middle market focused. So our average loan size could be $20 million, $30 million versus many of the larger players are focused on, let's say, $100 million larger loans. And so where 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 plus the pipeline. We feel good about the investment opportunity. We're presenting to potential LPs.

Ronald Kamdem

Great. And then my second one was just going back to RMR residential. I think you made some comments about dry powder and potentially sort of opportunity second half of the year and tracking 100 deals. 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 there are?

Adam Portnoy

So we are targeting again sort of value, add a turnaround or a light turnaround properties in the multi-family space or apartment buildings in the Sunbelt region where we currently operate the return hurdle. When I was meant to reference 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 and when I said 100, they are all in mixed fashion meet those criteria in some way.

Ronald Kamdem

Okay, thanks so much.

Operator

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

Adam Portnoy

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

Operator

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