RMR Group Inc

NASDAQ:RMR

Earnings Call Transcript 2024-Q2

[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, executive]

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; and Chief Financial Officer, Matt Jordan. In just a moment, they will provide details about our business and quarterly results, followed by a question-and-answer session.

First, I would like to note that management will not be answering questions about the debt exchange offer that its client, Office Properties Income Trust, announced last week as the offering period is currently open. I would also like 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, executive]

Thanks, Kevin, and thank you all for joining us today. Since our last earnings call, we have continued to advance our business and support our clients through the current headwinds facing many aspects of commercial real estate. Overall real estate transaction volumes have remained subdued for over a year, largely a result of an increase in interest rates, persistent inflation and uncertainty regarding whether the Federal Reserve will cut interest rates later this year.

While interest rates may remain higher for longer, we do remain cautiously optimistic about an improving market environment later this year and into 2025. The resiliency and strength of the RMR platform over many years and through numerous business cycles, gives us a solid foundation to continue creating long-term value for all our stakeholders. 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 in 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 4 years, we have strategically focused on increasing our private capital AUM from essentially 0 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 our recent leveling off in multifamily rent growth in the Sun Belt region, which is largely the result of absorbing new supply, the long-term multifamily fundamentals in the Sun Belt are supported by favorable long-term trends, including continued population in migration, a strong labor market, declining construction starts and the cost differential between owning 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 Sun Belt markets, including a number of potential off-market transactions. Beyond our residential platform, we are continually evaluating strategic growth opportunities to 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, Tremont Realty Capital. Tremont has demonstrated a successful track record, originating commercial mortgages that have generated substantial shareholder returns at our public mortgage REIT, Seven Hills Realty Trust.

Since it began managing Seven Hills, Tremont has made approximately 50 value-add and light transitional investments totaling $1.3 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 expediate capital raising for this vehicle.

These loans will be levered through a bank repurchase facility, resulting in RMR's net equity or cash commitment to be minimal. Based on market feedback, we believe raising private capital via a seeded venture would garner greater success than attempting to raise a blind pool of capital. As third-party investors are identified for this Tremont managed vehicle, a substantial majority of the equity investment we are making is expected to be repaid and the investments to move off balance sheet at RMR.

In support of this strategic initiative, last month, we accepted an application from a prospective borrower for a floating rate mortgage loan secured by a hotel in Massachusetts for a gross commitment of $40 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 in our perpetual capital clients. During the quarter, we remain 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 roll-up in rent of 17%. More than 60% of this quarter's leasing activity was executed at ILPT, highlighting continued strong demand for the company's industrial and logistics properties. ILPT's quarterly earnings once again demonstrated solid operating results. Occupancy increased to 99%. Cash leasing spreads grew 25% were the strongest in 6 quarters. In same-property cash basis, NOI was up 230 basis points. With no final debt maturities until 2027, ILPT has the flexibility to be patient until the financing environment improves. DHC continues to advance key initiatives focused on improving its operating results and further strengthening its capital and liquidity profile.

First quarter financial results reflect continued improvement in DHC's SHOP segment. The same property cash basis NOI increasing almost 10% year-over-year and continued roll-ups in rent within their medical office and life sciences segment. DHC has also outlined targeted strategies for capital deployment and operator transitions within the SHOP's portfolio to continue improving performance.

OPI has made considerable progress since the beginning of the year addressing its debt maturities and continues to execute on its financing strategies amid a challenging and lending environment for the office sector. The company recently launched an offer to exchange certain of its outstanding unsecured senior notes for new senior secured notes.

Additional information about this exchange offer can be found on 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 from 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, near-term challenges within SVC's lodging portfolio is somewhat offset by the stability of SVC's net lease portfolio.

With that, I'll now turn the call over to Matt Jordan, Executive Vice President and our Chief Financial Officer.

[Matthew Jordan, executive]

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 2 years.

Given the expectations around multifamily capital markets activity that Adam highlighted earlier, we expect RMR Residential to remain largely breakeven through at least next quarter.

Turning to this quarter's results. Recurring service revenues were $49.6 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 at our managed equity REITs stay at their current levels, normal seasonal improvements in Sonesta related management fees and consistent levels of construction spend. Cash compensation was approximately $44 million, which includes the full quarter impact of RMR Residential as well as the adverse impacts of payroll tax and 401(k) contributions resetting on January 1. Both of which were partially offset by strategic restructuring 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 director 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 RMR Residential. As it relates to RMR Residential, the bulk of those costs are from marketing and technology expenses, the majority of which are passed through to managed properties and are included in our service revenues.

Next quarter, we expect recurring G&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 and assets we have operational control over by 50% by 2029 and to attain net 0 emissions by 2050. Through calendar 2023, we are well on our way, having achieved a 35% reduction in greenhouse gas emissions through energy efficiency measures, sustainable procurement and renewable energy programs.

Lastly, as Kevin highlighted earlier, we cannot address questions regarding OPI's current debt exchange offer. That concludes our formal remarks. Operator, would you please open the line to questions.

[Operator]

[Operator Instructions]

Our first question is from Bryan Maher with B. Riley Securities.

[Bryan Maher, analyst]

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, executive]

I'll talk about it generally, and I'll let Matt maybe get a little bit more details on how it can affect the financials. But generally speaking, generally over the last, I'd say, 2 to 3 months, it has been an uptick in, what I would say, marketing activities in terms of transaction or deals coming to market, especially -- that's actually happened across the board, but most pronounced in the residential area or multifamily space and specifically in the markets that we're targeting throughout the Sun Belt region. There's a lot of reasons maybe for why that's happening.

There hasn't been a lot of deal activity for several quarters now. I think there's -- I think, buyers and sellers are starting to converge on pricing. I think sellers are getting a lot of pressure from, let's say, what's going on in the lending market. Broadly speaking, I think buyers are getting some pressure. There's a lot of money on the sidelines and some buyers are anxious to put that money to work before their investment period ends.

So I think they're starting to be a convergence on pricing. We do expect to see more transaction volume to occur. We expect we will actually engage in transactions throughout the calendar year. I'll let Matt talk about what that could mean for the company's financials.

[Matthew Jordan, executive]

Yes. And Bryan, getting deals done are really the stimulus we need to get residential beyond breakeven. It is a platform built to handle much more AUM than the $5.5 billion it's currently managing. So in terms of the way the business is structured today, every deal should generate an acquisition fee of about 62 to 65 basis points. So just getting a deal done has a very sizable impact to RMR's P&L because we'll recognize those acquisition fees immediately.

And then obviously, this property management that comes with that new deal, the way I like to think about it between property management and construction, every $1 billion of new AUM in 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, analyst]

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 REITs over the next years? And maybe specifically touch upon CMBS.

[Adam Portnoy, executive]

Sure. So I'll start with CMBS. I would say the secured market in especially CMBS market, broadly speaking, for well-leased assets across segments is open. It's open to do 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 debt. So if they're refinancing debt, you're paying more for it, but the market is definitely open.

Generally speaking, what you see in the capital markets in terms of debt availability and financing largely trends overall sentiment, people 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.

Probably the toughest market or toughest segment defined financing is in and around general multi-tenant office buildings. But even there, if it's the right asset, newer building, well-located, well-leased, there is financing available. It's expensive, but it's available. So markets are open. Everything in general, it just costs more.

[Operator]

[Operator Instructions]

The next question is from Mitch Germain with Citizens JMP.

[Mitch Germain, analyst]

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

[Matthew Jordan, executive]

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

[Mitch Germain, analyst]

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

[Adam Portnoy, executive]

So I think we're very pleased with the integration of the folks from RMR Residential into the broader RMR platform. And I think we're very pleased with many of the synergies that we planned on realizing and acquiring the business, we are clearly behind on the revenue side, Matt's alluding to it in terms of we need more transaction volume. I think everyone is 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 at finding deals and sourcing them. I am optimistic that we will be able to close on transactions in the second half of this year.

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 where we thought we'd be. And I think from an integration, just generally, social issues, I think, are great. I mean I think we're well integrated. I think the team is working well -- the teams are working well and integrated well. So that's how -- that's how I'm looking at it, and I feel good about the business going forward.

[Mitch Germain, analyst]

Great. Last for me. I recall about -- 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 managed REITs. I'm curious how this is a little bit different and how you're approaching this new debt vehicle differently?

[Adam Portnoy, executive]

Yes. So at the time, you're right, you have a good memory, Mitch, in terms of we tried something like this. It's similar, 2 different -- 1 different asset class, obviously, different time. Second, we have -- we're working with a very reputable placement agent 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 6, 7 years ago about how is the best way to organically create a fund and I think we've learned from all those experiments and all those twists and turns, especially what we did several years ago that you're referencing. I feel very good about our ability to be able to raise this capital. There was also the biggest -- maybe the biggest difference is the return profile.

We were trying to raise, at the time, a core office fund, core, meaning high single-digit return IRRs. Here, what we're talking about on a levered base -- on a levered basis, we're talking about mid-teens IRRs. And so it's a different investment profile, different return expectation, which is partly based on what we 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 a wildcard. I can't -- could it be one quarter, could it take 4 quarters? I don't know until we actually get all the money in, but I'm confident we will raise money, is the best way to say it. And I wouldn't be putting the RMR balance sheet at use here unless I have some pretty strong conviction that we were able to use it to start one of these funds.

[Operator]

The next question is from Ronald Kamdem with Morgan Stanley.

[Ronald Kamdem, analyst]

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

[Adam Portnoy, executive]

Sure. So just to be clear, we talked about up to $100 million gross investment that will use our balance sheet. It's a little confusing when I say that, we're going to -- that's inclusive of leverage. We're going to use leverage on these loans. 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 seed the portfolio or a fund that is not the total fund itself. We expect that the fund itself from an equity perspective will be $200 million 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 see the portfolio, but the ultimate size in this first fundraise, I should point out, is about $1 billion. In terms of the pipeline, again, we feel very good about the pipeline. Yes, there is less transaction volume going on in the marketplace today. As a result of less transaction volume, there are less loans being originated. Fully half of what you used to see in originations of loans was new acquisition financing. Well, here, there's not a lot of new acquisition financing. 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 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 against almost anything and that type of investment introduces mid-teen returns. The pipeline is very strong. It's -- 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 in the marketplace is we are a 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. So when we play in what we call that middle market tier, there's a tremendous amount of transaction volume and not as many players. So we don't have as much competition and actually leads to a little bit higher returns for the investors. So yes, we feel good about the pipeline, we feel good about the investment opportunity we're presenting to potential LPs.

[Ronald Kamdem, analyst]

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

[Adam Portnoy, executive]

Sure. So we're targeting, again, sort of value-add turnaround or like turnaround properties in the multifamily space, so apartment buildings in the Sun Belt region where we currently operate. The return hurdle -- when I -- when we referenced that 100 deals in the pipeline, we're talking about that type of characteristic deal that is going to hopefully produce a mid- to high-teen IRR for the investor. So that's a general outline of the type of deals we're looking at. And when I said 100, they serve all in mixed fashion meet those criteria in some way.

[Operator]

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

[Adam Portnoy, executive]

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.