Centerspace: Rental Growth Will Fuel Growth In 2023 And Beyond

Centerspace (NYSE:CSR) demonstrated a strong Q1 2023 performance, focusing its robust apartment portfolio on key areas such as Minneapolis and Denver. Amid leadership changes and economic challenges, the company signals potential growth and financial stability, guided by strategic diversification and effective cost controls. Due to the stock price decline during the first quarter, the company could be an attractive choice for REIT income investors.

Property Portfolio

Centerspace owns 84 apartment communities consisting of 15,065 homes located in Colorado, Minnesota, Montana, Nebraska, North Dakota, and South Dakota. Approximately one-third of its NOI comes from Minneapolis, about a quarter comes from Denver, and the rest is spread among the other five states it operates in. The company restructured its property portfolio in the last 5 years, focusing heavily on Minneapolis and Denver. In addition, they could increase the rental rates by an average of 3.9% in the first quarter compared to Q4 2022. The occupancy rates are also around 95% with approximately 20-30% expirations per quarter on average.

First Quarter Earnings Results

Centerspace's management team reported a strong performance for the first quarter of 2023, with an increase in core Funds From Operations growth of 9% YoY. The company also experienced a significant (10.5%) increase in same-store revenue, largely driven by an increase in scheduled rents. This led to a rise in Net Operating Income by 11% over the prior year's corresponding quarter. Furthermore, Centerspace effectively managed its expenses, which were reported to be flat in Q1 2023 compared to Q4 2022, indicating an easing of inflationary pressure and the successful implementation of cost control measures. I believe that this trend will continue for the rest of 2023 and the operating expenses will likely stay flat or even decrease momentarily. Encouraging leasing trends were noted, with a 2.5% increase in same-store new lease trade-outs and a 5.8% increase in same-store renewals. The company further reported the strategic disposal of nine communities, which improved portfolio construction and quality, and led to a favorable 6% cap rate. The transition of CEO Mark Decker out of his role also took place during this period, with Anne Olson stepping up as the new leader. Despite one-time expenses related to this transition, the company continued to optimize its balance sheet, repaying a $100 million term loan, reducing floating rate exposure, and repurchasing its stock.

In terms of the path forward for the company, I expect no major changes. Anne Olson, the new CEO of the company, conveyed during her first earnings call that while there might be subtle shifts in the company's strategic focus under her leadership, it is largely a continuation of the vision established by her predecessor, Mark.

And so we're not expecting a lot of huge changes…So it might feel a little bit different, but it's all kind of part of the same plan and vision." - Anne Olson - CEO

Anne's expectations for 2023

The management team of Centerspace anticipates a positive performance for the rest of 2023. They expect continued growth in revenue driven by increasing rents, which were up by 10.5% in Q1, leading to an 11% increase in NOI over the same period in 2022. Expense pressures experienced in 2022 are leveling off, indicating effective cost control measures and easing inflation. The rental rates are going to increase by 2-3% on average per quarter in my opinion and the renewal percentage will likely stay high. This is due to value-add renovations and value-add opportunities to maximize rental growth. In addition, in 2 years (2020-2022) the company could increase its rental rates in these apartments by almost 20%. With a successful CEO transition leading to a reduction in G&A expenses, they reiterate their guidance for the year. The NOI 2023 guidance is 7-9% while the FFO figure is $4.03-$4.56. Blended rent increases in April indicate continued strength across markets. The team is also confident about its recent portfolio diversification and stock repurchase strategies. However, the team remains cautious due to potential challenges in acquisition opportunities and competition in certain markets. As I see it, new acquisitions will be hard to make due to the lasting high interest rate environment so I do not expect any major acquisition for the year.

The new CEO is prioritizing technological enhancements and investments to improve execution standards and accountability. They're also planning to cautiously manage the company's balance sheet, with an emphasis on potential dispositions to reduce debt and reserve capital for any emerging opportunities. This is reflected in the management's 2023 expenses guidance which is between 4.75%-6.25% compared to the first quarter's 9.9% figure. On the topic of repurchasing shares, the approach will be conservative to avoid unnecessary leverage increases or reductions in scale. The company is observing higher-than-expected growth in market rent, although the larger chunk of lease expirations are still to come. The company has an ongoing focus on property renovation and upgrades, investing in value-add programs like smart home technology installations, with around $25 million planned for this year. The company has also managed to stabilize bad debt trends, reducing them to about 25 basis points, in line with historical averages. Finally, after selling nine properties, the company expects its remaining portfolio to need about $1,150 per door in annual recurring CapEx, having already factored this into their projections. The main risk factor for the company are the high-interest rates staying longer than expected. In addition, a mild recession could decrease the renewal rate and with an average 20% expiration per quarter, this could significantly decrease the FFO.

Valuation and Dividend

The company is trading at attractive valuation levels. It is trading at 1.3x its book value which might seem high but compared to the last 10 years it is among the lowest figures. The dividend yield supports the undervalued theory; CSR is yielding almost 5%. The rent growth projections for the rest of the year are also strong however the price per AFFO ratio is 20% higher than the sector median, currently standing at 15.66.

The company has been paying dividends for more than 25 years so we can safely say that they will very likely continue this trend (also because they need to maintain their REIT status). Analysts estimate small dividend increases in the next 2 years and I agree with the analysis due to rental growth, lower expenses, and a better balance sheet than in the previous years. The former CEO was also confident about the dividend for the upcoming years. I believe that CSR might be a good choice for REIT income investors for the next 2-3 years.

And in my mind, the dividend is at no risk. I think we have 50 assets that have about 25% leverage on them if you looked at sort of our unencumbered base versus our unsecured debt. So we've got lots of financial security, in my view, and that's how I look at it." - Mark Decker - former CEO

Summary

Centerspace in Q1 2023 showed robust performance, enhancing its apartment community portfolio across six states, with a focus on Minneapolis and Denver. A 3.9% increase in rental rates and 95% occupancy rates signal sustained growth. The company's restructuring efforts were rewarded with a 9% YoY core FFO increase and a 10.5% rise in same-store revenue. Despite changes in leadership and challenging macroeconomic conditions, Centerspace shows promise, with the new CEO projecting continued positive growth for 2023, strategic diversifications, and effective cost management. The dividend is stable and the valuation is attractive so I rate the company a Buy.