Mark Decker - President and CEO John Kirchmann - CFO Anne Olson - COO

Jim Lykins - D.A. Davidson Drew Babin - Baird

Good morning and welcome to the Investors Real Estate Trust First Quarter 2019 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 today’s event is being recorded. I would now like to turn the conference over to Mark Decker Jr., President and CEO. Please go ahead sir.

Thank you and good morning. IRET’s Form 10-Q for the first quarter of our fiscal year 2019 was filed with the SEC yesterday after the market closed. Additionally, our earnings release and supplemental disclosure package have been posted on our website at iretapartments.com and filed yesterday on Form 8-K. Before we begin our remarks this morning, I need to remind you that during the call we will discuss our business outlook and we’ll be making certain forward-looking statements about future events based on current expectations and assumptions. These statements are subject to risks and uncertainties discussed in our release and Form 10-Q and in other recent filings with the SEC. With respect to non-GAAP measures we use on this call, including pro forma measures, please refer to our earnings supplement for a reconciliation to GAAP, the reasons management uses these non-GAAP measures and the assumptions used with respect to any pro forma measures and their inherent limitations. Any forward-looking statement made on today’s call represent management’s current opinions and the Company assumes no obligation to update or supplement these statements that become untrue due to subsequent events. With me today are John Kirchmann, our Chief Financial Officer; and Anne Olson, our Chief Operating Officer. Okay, let's dive in. In the last 90 days, we’ve continued to make great strides as an organization that is focused on operations, capital allocation and balance sheet strength. Let me hit a few highlights. As reported, our same-store portfolio NOI grew 2.8% year-over-year on strong revenue growth and expense growth that was within our expectations. This represents our third consecutive quarter of same-store NOI gains demonstrating our capacity to generate internal growth. In July, we exited the Williston, North Dakota market and I’d like to amplify the positive impact this had on our company. Selling the homes in Williston furthered several important objectives. First, the Williston market is not consistent with our strategy based on size and demand drivers. We sold the assets at a sub 5% cap on our forward and trailing numbers. It is our view that Williston will require a sizable risk premium in the future and we were very happy with the execution. In addition with this sale, IRET eliminates three third-party joint venture properties, cutting our exposures to JVs by half, eliminates $29 million of recourse debt. And lastly, by recognizing the investment loss that we already booked on our balance sheet in the form of an impairment in September of 2016, we were able to offset the remaining $30 million capital gain from our fiscal year 2018 medical office building sale. Each of these individual improvements is worthwhile accomplishing them all in one [fell swoop] was outstanding for our shareholders and our team. Just a few weeks ago, subsequent to quarter end, we amended our revolving line of credit improving our terms, flexibility and adding a new seven year unsecured term loan. This recast represents a meaningful rerating of our portfolio from the lending community. The rerate occurs in the loan documents where we define how asset values are calculated. In summary, when we embark down the unsecured path two years ago, our business was mixed and our apartment portfolio quality was not as high as it is today. As a result, the multifamily cap rates required to calculate total asset value were 6.5 to 8.25. Today, the cap rates are 6 to 7.25, a big improvement in terms that has real money behind it. Also worth noting on this quality of income point, 12 months ago, our multifamily portfolio was less than 70% of NOI for the first quarter and today it’s greater than 95%. As we’ve said, we are building a balance sheet that gives us capacity to be opportunistic in support of our strategic objectives and this is continued movement forward in that regard. Most importantly, last quarter we made significant changes to our operations team, flattening our organization and lowering G&A going forward. And while we’re moving quickly to alter how we do many things operationally, these changes will advance the speed at which we can harness the full earnings power of our business. This is the biggest and most exciting thing we’re working on and this further illustrates the support our highly respected Board has provided in helping me put a team in place to capture the opportunity. Our operational changes further our focus on one of our main goals, expanding our profit margin across our portfolio. We call this initiative Rise By 5 and we’ve challenged all of our people to improve the margins by 5%. Let’s put some math around why we’re still excited. In this most recent quarter, we reported same-store NOI of $20.6 million on $36.7 million of revenues, rising by 5% will take us to a NOI of $22 million, a $1.4 million NOI improvement that all else equals drops to the bottom-line $0.01 of FFO. $0.01 on the $0.09 we just reported is greater than 10% growth. This math is particularly compelling given that we control the bulk of this opportunity within our four walls. And at this point in the economic cycle that’s growth you can match. The result of this initiative will not happen overnight, but we make progress every day. Turning to our markets. As mentioned last quarter, we have traded North Dakota for Minnesota as our largest economic base and entered Denver approximately one year ago. Focusing on Minneapolis and Denver, two top 25 markets differentiates us from our public competitors and we believe provides great promise for cash flow growth and operational efficiencies over the long-term. We commented on Denver and Minneapolis more specifically last quarter. But taking a moment to look at recent near-term activities in these markets, they continue to inspire confidence. Denver’s job growth and unemployment continues to outpace national averages and the city announced a big win in August when VF Corporation, parent company of North Face, JanSport and Timberland announced they were relocating from North Carolina to Denver, bringing 800 high paying jobs and Denver’s 11th Fortune 500 Company. There has been a lot of talk about Denver recently among the REIT investors. If you like Denver, IRET is the way to play it, making up 10% of NOI versus 6% for the next highest competitor. In Minneapolis, the market has generally kept pace with national job growth metrics while unemployment is the lowest in the nation among large metros. Minneapolis realized 2.9% effective rent growth in the second quarter of ‘18 outpacing 2.5% as a national average, and market-wide occupancy sits at 96.8% ranking 8th among top 120 apartment markets. These performance indicators along with historical performance solidify our belief in Minneapolis and inform our view of the long-term market strength. Looking at our secondary markets, we continue seeing unemployment comparing favorably to national averages, favorable relative incomes and occupancy levels and have recently seen strength in rent growth results. However, a few markets in particular are showing softness due to supply such as Rochester and across North Dakota and we are monitoring these closely. So, as we sit here today, we’re fortunate to be in good markets and a good economy with improving operations and a sound balance sheet. These are the ingredients for a good business. If we can take these ingredients and put our customers at the center of everything we do, we will have a great business. With that, Anne, why don't you talk a little bit more about our operations?

Thank you, Mark. And good morning, everyone. We continue to see improving -- improved operating performance with strong revenue growth and we’re making progress on continuing expense growth. While our same-store weighted average occupancy dipped 1.4% from fourth quarter of fiscal year 2018, we did experience revenue growth of 70 basis points quarter-over-quarter. With 10 of our 11 markets experiencing year-over-year revenue growth, our same-store revenue year-over-year increased 3%. The primary driver of this increase was rent growth. We experienced a 2.4% rental increase year-over-year. This is positive news and we also recognize that there is additional opportunity to increase revenue through occupancy gains. Our same-store weighted average occupancy for the quarter was 93.5% and we ended the quarter at 91.9% as we experienced approximately 45% of our portfolio expire in May through July. We’re focused on increasing occupancy over the course of the second quarter, so we can carry that through our lower expiration winter month. The variances in our occupancy are results of efforts to optimize revenues and manage our lease expirations. We’ve previously talked about the need to shift our lease expiration timing and we will continue to refine both the number of expirations in each month and the timing of our expirations within the month. Looking at our expenses, the same-store expenses increased 3.3%. Minneapolis had uniquely high expense increases as we saw an increase of a $150,000 in operating expenses and $80,000 in real estate tax expenses due to recent development stabilizing at the end of fiscal year 2017 that had lower operating expenses through the first quarter of fiscal ‘18. These increases compared with the severance cost of a $110,000 associated with the staffing reduction at our site, make up the majority of our overall expense increases year-over-year. As Mark mentioned, we continue to focus on our margin and a large part of that is management of expenses. We’re focused on smoothing the historical volatility we’ve experienced quarter-to-quarter and year-over-year. We have and continue to implement changes in our operating platform and best practices that we believe will assist us in the management of expense growth. Some examples of this are the reorganization of our site staffing in July, which we believe will reduce our rate of expense growth beginning in the second quarter and we’ve been closely monitoring utility costs, tenant buildbacks and have completed an LED retrofit at three properties consisting of 414 unit with the goal of reducing our utility expenses and improving sustainability in our communities. Our margin expansion efforts are also focused on ensuring we're capturing market rent growth and other revenue opportunities. We looked across the portfolio at our other revenue categories: administrative fees, exclusive amenities charges, pet rent, garage rent, storage rent and we adjusted them all to market. Year-over-year, our same-store other revenue has increased 14%. We expect that the results of our value add projects will also favorably impact our margin. We have several projects underway and our pipeline continuing to grow. We anticipate that we will begin seeing the results of our initial investments in value-add in the third quarter of this year. Mark mentioned the sale of our Williston portfolio. We also continue to complete sales of our commercial assets, selling two commercial properties and one parcel of vacant land in this quarter. Since quarter end, we sold an additional lands parcel. These sales allow us to continue to shift our focus to our multifamily operations and new investments. We’re getting better and more efficient every day and grateful for how hard our team is working to identify and execute on opportunities to be innovative for our customers, to pull together as a team and to provide good results for our investors. I’ll turn it over to John Kirchmann for a discussion of overall financial results.

Thank you, Anne. Last night, we reported core FFO for the first quarter of fiscal year 2019 of $0.09 per share, a decrease of $0.01 from the prior year. The decrease is primarily due to a reduction in NOI from the sale of non-core assets, partially offset by reduced interest costs from redeploying a portion of the proceeds to pare down debt. Looking at our general and administrative expenses, total G&A was $3.9 million for the quarter, a $100,000 decrease from the prior year and a $200,000 decrease from the fourth quarter of fiscal year 2018. The current quarter includes $510,000 of severance cost related to a re-alignment and reduction of corporate officers. As mentioned in our prior quarters call, we continue to experience elevated legal cost associated with our pursuit of a recovery under our construction defect claim. Moving to capital expenditures as presented on Page S-14 of the supplemental. For the current quarter, same-store CapEx was $3.5 million, a $600,000 increase from the prior year’s quarter, higher capital expenditures are mostly due to timing, including expenditures originally planned for the fourth quarter of fiscal year 2018, which were postponed due to April’s unusually high snowfall. Turning to our balance sheet, we continue to improve our flexibility. As of July 31st we had $190 million in total liquidity including $170 million available on our corporate revolver. As discussed earlier on the call, debt proceeds from the Williston disposition were in part utilized to further reduce our recourse debt. As of July 31, our recourse debt totaled $37 million or just 6% of total debt versus $173 million and 21% from a year ago. As mentioned earlier by Mark, in August we’ve recast and expanded our unsecured credit facility including reducing the pricing spread by approximately 25 to 35 basis points, increasing the overall commitment from $370 million to $395 million, reallocating a portion of the line balance to a $75 million term loan maturing in 2025, extending the current $70 million term loan to 2024, reallocating the current revolver capacity from $300 million to $250 million while extending it to 2022, and maintaining the $200 million accordion option to expand the revolver. Concurrent with the recast, we synthetically fixed both term loans further full duration further decreasing our floating rate debt exposure. The effective of swaps and the recast of the credit facility increases our weighted average maturity from 4.2 years to 4.9 years and takes our fixed rate debt as a percent of total debt from 80% to 92%. All of these actions continue to improve our balance sheet, increase liquidity and financial flexibility, and further our goal to obtain investment grade metrics. With that, I will turn the call over to the operator for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Today’s first question comes from Jim Lykins of D.A. Davidson. Please go ahead.

Morning everyone. And just a few from me. First of all, can you give us a little bit more color on the Rise By 5 initiative? And Mark you mentioned, how that could add a $0.01 to FFO? I know you said not overnight. But any sense for how quickly that could begin to positively impact margins and we might be able to see that incremental $0.01?

Good morning, Jim. Well, we can’t give you the amount and the timing. We can only give you one. Listen, there are a number of items that are pretty low hanging fruit, and then there are some items that require more investment such as some of our back of house systems that would enable us to -- I mean really what we’re really trying to do is put our team members in a position to spend more time with the customer and less time filling out TPS reports as I like to joke. But there are a number of items, I mean the first one is occupancy, as you can see this quarter we really have been working to optimize revenues and we had a lot of volume. I think in the past calls we’ve talked about our lease curve and how we shifted it, we may have over done it and shifted a lot into this quarter. So, we had as Anne said almost 45% plus leases in the last three months and we made a decision to stay on rent instead of pushing occupancy. But so occupancy is the first one listed on the portfolio at full and with good pricing power. And then after that there are a bunch of little things. I think realistically it’s a three to four year timeline to get all of it done. John and Anne would like me to say 3 to 5. I’d like to say 12 months. But in truth, it will take some time. Our hope is that we can kind of check in every quarter with some progress. And in our shop it's that something we’re spending a lot of time on communicating with the team and so forth.

And you also said with the value add program there are several units underway. Can you give us and I know you said results won't -- or you won't expect seeing results until the third quarter, but can you tell us how many units you anticipate being this part of the program at that point? And how you see that trending for the remainder of this fiscal year?

Yes. I’m going to ask Anne to answer that one. Go ahead Anne.

Yes. So, as we stated I think last quarter, we have about a 1,000 units that are, I would call underway whether they are small renovations or full unit renovations or buildings that we put into test where I’d say we’ve done three full unit renovations just to test and make sure their underwriting is sound. And of those 1,000 units probably 240 of them are really close to coming online with smaller than full unit renovations where we add just a few amenities or backsplashes, UBS ports, things like that. Those -- some of them are close to coming online, so as I’ve said in the third quarter we’re going to start being able to reports results on those. And then some of our full unit renovations, these just take a little bit longer time to ramp up and then run through the portfolio. We’re not going to be -- as Mark mentioned, we’re pushing on occupancy right now. And so, we’re not going to be giving out occupancy emptying out large blocks to renovate. We’re doing the renovations on the turn. And we want to be careful and make sure that we’re getting the rent and the premiums that we expect in meeting underwriting. So, we’re taking a pretty methodical approach, but a lot of the value add that we see in the pipeline is also common area renovations and those take a little bit longer to get underway as well.

Okay. And one last one for me, can you just give us any color on how rents and occupancy are trending so far into Q2?

Yes. Anne, you want to take that?

Yes. So, as we have mentioned we have about 45% of our leases expire in the first quarter and we’re looking at about 30% of our portfolio expiring in the second quarter. So, with this big bunch of expirations, we really wanted to push rent, we gave up a little bit on occupancy and now we’re pushing occupancy on those. The gains that we saw in rent were really volume driven. So, while we have an opportunity to gain revenue by pushing occupancy, we may see some softness in the rental increases as we do push forward on occupancy.

Yes. I'd just add to that Jim. It’s a 10 months to 12 months revenue optimization cycle that we’re on and if you think about our company and this team sort of in the fullness of time, we’ve only been under LRO for a couple of years. This full team has only been kind at the helm for a year and a half. And so we’re going to -- it will probably take a few years to get it completely optimized the way we like it.

[Operator Instructions]. Today’s next question comes from Drew Babin from Baird. Please go ahead.

A question on the first quarter recent performance and sort of early in the second quarter with heavy expirations going on. I guess we obviously see the decline in occupancy sequentially which sounds like a lot of that was strategic. But can you talk it all about kind of realized renewal and releasing spreads experienced during the first quarter and early second quarter? And how that will eventually have a lag in benefit to revenue?

Yes. I mean I think on our leasing spreads, our new leases we’re seeing about a 2.5% increase on our renewal rates, we’re seeing about a 3.5% increase. As I mentioned in response to Jim’s question, I think we may see some pressure on rental rates as we try to drive occupancy. But, I think we feel good about the rental increases that we got in the first quarter and we haven’t seen them drop significantly so far this quarter.

Yes. I mean, this is a bit not on your question, but I just wanted to add one of the comments that we read last night not from you actually Drew was or may was you, was about Minnesota, Minnesota weakening and …

Not me …

From our perspective that’s not what we saw, we really -- we actually saw rents grow on a sequential basis in Minnesota. So, the revenue fall up was occupancy related, it wasn’t you Drew sorry. But sorry, did you have any other questions?

Yes. Sure. Just talking about that decline in occupancy sequentially and I guess 731, I think Anne you mentioned that was 91.1%. Is that surprising? Was that a little more occupancy decline than was expected once you kind of began to push rate more on a decreasing seasons or is this kind of fully consistent with the strategy?

Yes. Go ahead. Ann, you start.

Yes. It was purposeful. I don’t think we’re surprised by it, but we do need to focus on it in the second quarter. And this was a part of the strategy, we’re not going to get an opportunity again to have nor do we necessarily want opportunity again to have 45% of our leases expiring in one quarter. And what we want to do is really push the rate so that we can hold that rent through the next 10 to 12 months. And if we can now drive occupancy in the second quarter, we're going to have -- we’re going to be really in a good position as leasing season ends and we go into our low exploration month, which are the month we typically see less traffic during the winter.

Yes. And just to clarify, so the lower occupancy wasn’t from us pushing rent, it’s we sat around we saw this bubble coming up and we decided we wanted to hold the rents as opposed to using pricing and sticking on course with occupancy. And as Anne said, it’s a big piece of that is with 45% of our leases expiring we weren’t going to get a lot of opportunity the rest of the year to be able to get rent growth.

Yes. So, I think Drew in the future we won't -- we are seeking and we will be altering our expiration schedule to not be quite as thick through these three months. So, when you say was it on purpose, I mean I would say, it wasn’t on accident, but we are going to change our lease curve overtime.

Okay. That all make sense. And one more questions on North Dakota you mentioned there is some supply popping up in some markets. And I know that some of the markets saw lot of supply maybe 2, 3 years ago and then somewhat of a drop-off. And I guess where you’re seeing it comeback and specifically. And I guess, are there any markets where you worry the barriers to entry just be might be a little too well?

Yes. I think we all, we always worrying about the barriers around our property. I think we are seeing some supply for example in Grant Fort, there is 400 units going up right across the street from one of our properties and the builder there is giving away some pretty spectacular concessions $2,000 gift cards. So I mean these are the things that are tough to compete with. So, this is a paradox of small markets, I mean in Rochester as an example there is a about 400 units coming this year, there is 800 coming next year that doesn’t sound like a lot but that’s one, that’s 2% to 3% given the size of the market. So, one project can certainly affect things when the markets are this small. And the economic drivers that an investment group may be focused on keeping its construction crew busy or building on piece of land they don't particularly. They just, sometimes our competitors don’t cost things the way we do. And then I’d say in a couple of spots we aren’t seeing necessarily supply, but we are seeing just a fall off in demand.

Yes. So, a good example would be Minot. And in Williston, there is even though the Bakken is now taking off, and there is actually some jobs going in there. There is nothing like there was before and it doesn’t look like there is going to be and there is already supply -- our infrastructure and supply being delivered. So even Minot which in the last cycle got some residual bump from that is not going to get that or is not giving that at this point. And so, we’re seeing struggle there not from supply Minot, but from supply coming in Williston.

And ladies and gentlemen, this concludes our question-and-answer session. I would like to turn the conference back to the management team for any closing remarks.

Thanks, Rocco. We appreciate everyone’s time and interest. And we’ll talk to you next quarter. Thanks very much.

And thank you, sir. Today’s conference is now concluded. And we thank you all for attending today’s presentation. You may now disconnect your lines. And have a wonderful day.