RMR Group Inc

NASDAQ:RMR

Earnings Call Transcript 2024-Q4

[Operator]

Good morning, and welcome to the RMR Group Fiscal Fourth 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 morning, and thank you for joining RMR's Fourth Quarter 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. 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, November 12, 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 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 this morning. Yesterday, we reported fourth quarter results that were generally in line with our expectations, which included adjusted net income per share of $0.34, distributable earnings per share of $0.51 and adjusted EBITDA of $21.8 million.

Over the past year, we have continued to invest time and resources into growing our private capital business, while simultaneously supporting our public clients through a challenging commercial real estate environment. This past quarter, we have seen increased signs that we are entering a more favorable market environment. More specifically, we are seeing an increase in transaction activity and as a result, a more energized fundraising environment. In fact, we're seeing increased interest from our legacy institutional partners as well as greater success in engaging with potential new capital partners.

While there are many reasons for optimism, it is important to note that the industry continues to experience an elongated fundraising cycle. We are confident that the scale and diversity of real estate sectors, our platform encompasses will position us to capture opportunities as the commercial real estate market improves. We have a robust and growing pipeline, and are advancing discussions with new and existing partners across a number of sectors, some of which we have previously discussed and others we expect to discuss in the future.

Turning to our previously announced strategic initiatives. The fundraising process is progressing for our private debt vehicle, which we intend to seed with $100 million in middle market and transitional bridge loans. To date, our real estate lending platform, Tremont Realty Capital, has originated $67 million in aggregate commitments for this vehicle, and these loans are expected to generate returns in the mid-teens.

As part of the credit vehicle, in September, we entered into a $200 million master repurchase agreement with UBS, which allows us to effectively leverage our loans up to 80%. After using the UBS facility, our net cash outlay was approximately $15 million for these loans.

Expanding the RMR Residential platform also remains a priority. As we previously announced, we closed on our first multifamily investment in July, acquiring a 240-unit garden-style community in Denver. While it is still in the early stages of the business plan for this property, we are already seeing increased rental rates as leases roll.

In addition to this transaction, we are seeing increased activity in our residential acquisitions pipeline, and I'm optimistic that our residential AUM and its related EBITDA contribution will increase in 2025. In addition to our growing pipeline, my optimism is based on our continued belief that the U.S. multifamily market is positioned for significant long-term growth as the shortage of housing and high cost of home ownership continues.

Beyond our strategic initiatives, we remain focused on assisting our managed equity REITs with the execution of their operational and financial strategies. During the quarter, we arranged 5.2 million square feet of leasing on behalf of our clients, highlighted by the early renewal of Vertex Pharmaceuticals for 1.1 million square feet in Boston Seaport District, and the lease renewal of more than 2 million square feet with FedEx.

Turning to a few brief highlights across our public clients. SVC's third quarter performance reflected the continued slow recovery of its hotel portfolio, combined with the impact of its ongoing renovation program. Notably, SVC is taking significant actions to improve liquidity and reduce leverage, including a reduction in its quarterly dividend, and plans to sell 114 Sonesta hotels, targeting approximately $1 billion in proceeds. We are confident that the rationalization of its hotel portfolio, stable cash flows from its triple-net lease assets and continued prudent capital management will improve performance and drive long-term value for SVC shareholders.

OPI continues to advance its process to address its upcoming debt maturities and strengthen its balance sheet. In the first half of the year, OPI completed $1.3 billion in secured financings, and has since reduced its 2025 debt maturity by nearly $200 million. We are in active negotiations with OPI bondholders, and we continue to work with OPI's outside advisers to evaluate all possible strategies to address OPI's upcoming maturities.

Lastly, DHC continues to progress on its initiatives to evolve its portfolio, increase occupancy and advance its SHOP turnaround. The company is conducting a comprehensive portfolio analysis to transform its asset mix to focus on properties in key markets with the highest upside opportunities.

DHC currently has LOIs or agreements to sell 28 properties for estimated proceeds of $348 million and recently expanded its SHOP disposition program to include a total of 32 communities, which are in various stages of the disposition process. We are confident that the optimization of the portfolio, combined with the strategic operator transitions and capital investments will position DHC to capitalize on market tailwinds and drive sustainable profitable growth.

In closing, RMR delivered a solid finish to fiscal 2024 and we are confident we are heading into fiscal 2025 in a strong position to capitalize on the growth opportunities we see ahead as markets improve. The business continues to have stable recurring revenues, a diversified client roster and a solid balance sheet. We are actively taking measures to position our clients for long-term success, while advancing our private capital initiatives to drive future growth and create long-term value for RMR and its shareholders.

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 morning, everyone. For the fourth quarter, we reported adjusted earnings per share of $0.34, adjusted EBITDA of $21.8 million and distributable earnings of $0.51 per share. The majority of these measures were in line with our expectations, though adjusted earnings per share were adversely impacted by depreciation and amortization costs from our Denver multifamily acquisition and year-end true-ups to our annual tax rate.

Recurring service revenues were $48 million this quarter, a decrease of approximately $900,000 sequentially. This decrease was in line with our expectations, and primarily driven by our Managed Equity REIT share prices and declines in construction supervision fees. Next quarter, assuming enterprise values at our Managed Equity REITs remain static, we expect service revenues to remain at these levels.

As Adam highlighted earlier, this quarter, we executed on strategic investments within our credit and residential platforms. Our financial results presentation provides detailed insights on these investments. But in summary while these investments are wholly owned by RMR, we expect them to have the following financial impacts.

The mortgage loans that we closed in July contributed approximately $1.3 million in adjusted EBITDA this quarter. It's important to note that these loans were not levered via our new UBS repurchase facility until late September. And accordingly, the $1.3 million in net investment income does not reflect a full quarter of interest expense. Going forward, on a quarterly basis, we expect these loans to contribute approximately $500,000 in adjusted EBITDA.

As it relates to the Denver multifamily investment, this quarter, it generated approximately $900,000 of net operating income. Going forward, we expect this asset to contribute approximately $1.1 million of net operating income and approximately $600,000 of interest expense on a quarterly basis.

Turning to expenses. Recurring cash compensation was $44 million, which excludes approximately $2.2 million in annual bonus true-ups this quarter. Recurring cash compensation this quarter declined approximately $1 million sequentially, which reflects the head count actions we discussed on last quarter's call. Looking ahead to next quarter, we expect recurring cash compensation to remain at approximately $44 million, with our cash reimbursement rate at approximately 49% going forward.

Recurring G&A expenses this quarter were $10.2 million after the exclusion of noncash loan loss reserves of $600,000 and $300,000 of technology transformation costs. With construction volumes expected to improve next quarter, we estimate recurring G&A will increase to approximately $11 million due to increased levels of third-party construction oversight costs.

This quarter's income tax rate of 18.9% reflects year-end tax provision true-ups primarily related to limitations on tax deductible compensation. We expect our tax rate next quarter to normalize at approximately 15%.

Aggregating these collective assumptions, next quarter, we expect adjusted earnings per share to range from $0.34 to $0.36 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.

That concludes our prepared remarks. Operator, please open the line for questions.

[Operator]

[Operator Instructions] The first question today comes from Bryan Maher from B. Riley.

[Bryan Maher, analyst]

Adam, Matt, just a couple for me today. When we look at your cash position, I think it's $130-something million, what percentage of that do you think you'll end up deploying in RMR Residential and the other private capital AUM initiatives? And maybe asked a different way, how much do you think you need to retain just to kind of run RMR ops from day to day? .

[Adam Portnoy, executive]

Sure. Bryan, good to talk with you. I think a good amount of that money is open for investment in different initiatives. We're very much focused on sort of pivoting the platform and seeding new investments. We've talked about it for a long time, but I would say, over the last several months, it's really accelerated, and you've seen that in the acquisitions, which we think are really good acquisitions in around the credit investments as well as the RMR Residential investment. I expect you'll see investments like that, maybe in those sectors as well as other sectors going forward.

As to how much we really sort of need to hold on to for just general operations, I'll let Matt answer that.

[Matthew Jordan, executive]

Yes, Bryan, that's probably $5 million to $10 million. And I guess I would also highlight, we're still a business that's generating $90 million or so of adjusted EBITDA, and about $20 million of that is really growth capital after taxes and dividends. So I would say no more than $5 million to $10 million. .

[Bryan Maher, analyst]

And then when we think about syndicating out equity stakes like in RMR Residential example being the Denver acquisition, what's been the receptivity of that to date? And what percentage equity stake do you think you retain in each of these investments? .

[Adam Portnoy, executive]

Sure. So as I talked about in my prepared remarks, we don't have anything to announce today in terms of syndicating the equity. But what we can talk about is there's been sort of, I would say, over the last 3 months really when the Fed started reducing rates, sort of a little bit of a sea change in the market environment where we have a lot more active conversations happening with potential partners. And so I feel -- we feel optimistic that we will be able to eventually syndicate either the equity or get those funds off the ground.

Timing is a very difficult thing to predict precisely. I can say, generally, and again, I said this in my prepared remarks, it is elongated. Investors, LPs are taking a longer time to make decisions. They have advantages in their court because there's not a lot of money going out and those that are putting money out can be very judicious around it. And so they're taking their time in terms of making evaluations and making decisions. And I don't think this is unique to us. This is across the sector.

In terms of what our retention will be in these vehicles, our equity, I don't believe it will be more than 20%. I expect it will likely be on average, less than 20%. But I don't -- I think the upper limit would be 20%.

[Bryan Maher, analyst]

And just last for me. When we look at the public managed REITs and kind of the shrinking AUM there through the asset sales, which basically will lower your base management fees there, how do you think about that relative to the potential upside from incentive management fees in the next 1, 2, 3 years from -- for lack of a better phrase, doing the right thing by these public entities and sacrificing in the near term, potentially making it up in the incentive fee side. How do you think through that process?

[Adam Portnoy, executive]

Sure. So I think we're primarily focused on doing what is in the best interest of those public vehicles. And generally speaking, as a theme across all of the public vehicles, public equity REITs, for example, I think the theme is deleveraging and reducing leverage and rightsizing the balance sheet. That's a general theme across all the equity REITs. And that's our primary objective.

And our view is, as you delever those vehicles, that you should get rewarded in the stock price. Generally speaking, lower levered equity REITs trade at a better -- trade better than highly leveraged equity REITs, and that's a general statement. So our hope is that over time, that's a way to increase stock price performance, and we'll pick that up hopefully over time as we deleverage these REITs, that we'll pick that up both in the base management fee.

As you know, Bryan, we get our fee base, not just -- AUM is the lower of enterprise value or gross investments in assets. So even though the gross investments in assets is going down, all of our equity REITs are being paid on the lower of enterprise value. And so there's the potential, and our hope is that any reduction in, let's say, AUM, will be more than made up or, let's say, real estate AUM will be more than made up than hopefully, stock price performance. And eventually, that will drive the increase in both base management fee and incentive fee.

It's going to take time. We have to execute on these strategies with our equity reach, and we understand that. So a little bit of what you said is true. We are taking some short-term paying at RMR, but it's the right thing to do for these equity REITs, and that's primarily what we're focused on is doing the right thing and making those recommendations to the Boards of those equity REITs in terms of what's the best thing and best course of actions with those businesses.

[Operator]

[Operator Instructions] The next question comes from Ronald Kamdem with Morgan Stanley.

[Ronald Kamdem, analyst]

Just 2 quick ones. Just going back to the pipeline for RMR Residential as well as the private lending vehicle. Maybe can you just talk a little bit through sort of the opportunities that you're looking at? Should we expect anything to close by sort of year-end? Or is it all sort of a 2025 story now at this point? .

[Adam Portnoy, executive]

On the lending vehicle itself, the credit vehicle, it's probably more of a 2025 story in terms of bringing in partners there. That being said, again, as I said in my prepared remarks, we are, I would say, picking up traction there. It's obviously an attractive investment sector for many investors if they're focused on investing in real estate, commercial real estate. And we have a very strong performance track record there, and we also have a seed portfolio that we think position us very well to attract investors into that vehicle. So I do think it's a 2025 event more than it is likely a 2024 event. .

[Matthew Jordan, executive]

And then on the Residential, I think it's fair to say that is also an early '25 event, but the momentum is far accelerating now that started in late summer with the interest rate cuts and now the elections behind us, we've definitely seen our legacy partners and, frankly, new partners come back to the table. So we're feeling good heading into '25 on the Residential front, too.

[Ronald Kamdem, analyst]

Just -- and my second question was just on the cash balance. Obviously, it goes down as you're sort of investing, but then you could sort of lever up things and so forth. Just curious where you would expect cash to end sort of at the end of this year? Any sort of high-level comments for next year in terms of what cash is going to go out and what's going to come in?

[Matthew Jordan, executive]

Yes. Longer term, it's going to be a function of what strategic investments start to get executed upon as I look at where we're going to land at December 31, frankly, I'm expecting our cash to increase to approximately $150 million just because we don't expect anything significant on the strategic front to close in the next -- in this upcoming quarter, but expect that to accelerate into calendar '25. And I think you'll start to see us draw down some of that cash to execute on strategic actions. .

[Operator]

The next question comes from Mitch Germain with Citizens JMP.

[Mitch Germain, analyst]

Are there additional loan and multifamily investments that you're targeting? I mean, 2 in loan and 1 in multifamily, is that enough to attract investors to think about setting up a larger venture?

[Adam Portnoy, executive]

So on those 2 specific strategies, I think we originally said anywhere from 2 to 4 credit -- loans in the credit vehicle. So we could do more in the credit vehicle over the coming months that you could see on our balance sheet to step that up. I think we're probably at the higher -- on the upper end would be 4 loans. And maybe it would be a little more than $100 million that we've targeted, but it wouldn't be much more than $100 million more that we've targeted.

On the Residential side, there's also a possibility that there could be -- I'm picking a number here, 1 or 2 more investments that could happen that we put on our balance sheet. But again, that's an area where we talked about on our -- both in the prepared remarks. Matt mentioned it too before.

We are seeing significant interest in and around Residential. And while we may put more money out to work in that strategy, there's an opportunity that we won't have to put it on our balance sheet. In other words, we'll be able to syndicate the equity before closing as we move forward with those sort of acquisitions. And so I expect we'll be making more acquisitions there, but it's less likely we're going to have to put it on our balance sheet. I don't rule it off the table. We may still put 1 or 2 more investments there.

I will also -- you didn't ask this, Mitch, but I'll tell you, there are other strategies we are pursuing, and I sort of hinted at it in my prepared remarks, we spent a lot of time talking about the credit vehicle and the residential vehicle. There are other strategies we're pursuing where we may put the asset on our balance sheet to help seed those investments.

And to sort of go there without anyone asking, I'll say, generally speaking, it's sort of in the areas that, if you were paying attention to commercial real estate, which all of you are, in the areas that are most favorable to folks, things like industrial parts of retail, some development activities that have high returns that gives you a flavor for some of the other things that we're looking at that may also go on our balance sheet in the coming months. So that's a little more than you asked, Mitch, but it gives you a feel.

[Mitch Germain, analyst]

Well, you actually answered my second question. There you go, Adam.

Maybe shifting over to Matt. Just in thinking about base management fees, obviously, you still have a little time before this quarter is over. But we saw a drop in price of one of the managed REITs. We saw some increases in the other. You've got some planned asset sales. So obviously, what are the different machinations that you're paying attention to with regards to thinking about what they'll equal kind of quarter-over-quarter?

[Matthew Jordan, executive]

Yes, we're guiding to flat because I think, to your point, the puts and takes tend to all wash, whether it's construction volumes, given calendar fourth quarter is always our strongest as people execute on utilizing their capital budgets or some of the sales impacting enterprise value from a debt perspective and seasonality in our operators. But net-net, the expectation is it will all wash to get us back to a flat answer for next quarter. .

[Mitch Germain, analyst]

That's super helpful. And then maybe last one for me and maybe just kind of moves over to Adam. In terms of how should we be thinking about the sustainability of revenues associated with OPI? Obviously, it's very early stages in terms of how that process could play out as you near the refinancing date. But I think given how things are structured, it seems like business as usual for RMR at least initially, is that how we should think about it? .

[Adam Portnoy, executive]

Yes. I think if you -- it's a broader question about what's going on with OPI. All I can really -- it's not exactly what you asked, Mitch, but I'll just say it anyways. As OPI said on its earnings call, it is engaged in discussions with its bondholders. Those conversations are constructive. That being said, we continue to plan that we will be operating and managing OPI for the foreseeable future. That is the way RMR is -- the way we are planning it, and it's the way we are thinking about the business. .

[Operator]

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

[Adam Portnoy, executive]

Thank you all for joining us this morning. Have a good day.

[Operator]

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