Creative Media & Community Trust - Q1 2024

Transcript

Operator (participant)

Good day, and welcome to the Creative Media & Community Trust Corporation's First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the Star key, followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press Star, then one on a touchtone phone. If you need to withdraw your question, please press Star, then two. Please note, this event is being recorded. And now, I would like to turn the conference over to Steve Altebrando. Please go ahead.

Steve Altebrando (Portfolio Oversight)

Hello, everyone, and thank you for joining us. My name is Steve Altebrando, the Portfolio Oversight for CMCT. Also on the call today are David Thompson, our Chief Executive Officer, and Barry Berlin, our Chief Financial Officer. This call is being webcast and will be temporarily archived on the Investor Relations section of our website, where you can also find our earnings release. Our earnings release includes a reconciliation of non-GAAP financial measures discussed during today's call. During this call, we will make forward-looking statements. These forward-looking statements are based on the beliefs of, assumptions made by, and an information currently available to us. Our actual results will be affected by known and unknown risks, trends, uncertainties, and other factors that are beyond our control or ability to predict.

Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will prove to be incorrect. Therefore, our actual future results can be expected to differ from our expectations, and those differences may be material. For a more detailed description of potential risks, please refer to our SEC filings, which can be found in the Investor Relations section of our website. With that, I'll turn the call over to David Thompson.

David Thompson (CEO)

Thanks, Steve, and thank you everyone for joining our call today. Following our last call 7 weeks ago, where we gave some insights into our intra-quarter occupancy and development activity, we are pleased to report our first quarter 2024 results. Overall, we saw an improvement from the fourth quarter of 2023, which was primarily due to higher net operating income in our office and hotel segments, the latter of which was largely due to seasonality. Even with the improvement from last quarter, our cash flow continues to be impacted by elevated short-term interest rates. We are evaluating ways to strengthen our balance sheet and improve our cash flow, including potentially selling assets and reducing our debt. In addition, we expect to eventually benefit from lower SOFR on our floating rate debt and lower preferred dividends as the Fed Funds Rate is expected to come down over time.

As a reminder, our Series A-1 preferred dividend is the greater of 6% or Fed Funds +2.5%. As for our results in the quarter, our same-store office NOI increased 9% year-over-year to $7.4 million, primarily due to improved NOI at our Beverly Hills property, driven by the commencing of our 20-year lease with the Rolls-Royce dealership. We're working on the build-out for the lease and anticipate the grand opening toward the end of this year or early next. Overall, our office lease percentage remained stable in the quarter at 84%, and we executed approximately 37,000 sq ft of office leases in the quarter. While our fourth quarter hotel segment NOI increased quarter-over-quarter, largely a result of seasonality, it was a consistent $4.1 million for both Q1 2024 and Q1 2023.

Hotel trends are still strong, and we anticipate starting our long-planned renovation on our hotel asset in the second half of this year. We believe this renovation will significantly benefit the asset as our hotel is one of two hotels located directly across the street from Sacramento's Convention Center, which itself underwent a major renovation and expansion in 2021. Our lending segment NOI decreased year-over-year, primarily due to what we have previously described on these calls, the impact of the securitization completed a year ago, which increased interest expense attributable to that segment, but also generated significant proceeds for CMCT. Our multifamily segment generated $900,000 of NOI in the quarter. Our occupancy improved significantly to 86.2% at the end of the first quarter from 79.3% at the end of 2023.

Although the rental rate at our two largest properties, Channel House and 1150 Clay, located in Oakland, has been below our expectations. Turning to our development pipeline, we don't have much new to report since we just recently spoke. However, we do continue to be on track to deliver two new multifamily assets in Los Angeles, one later this year at 4750 Wilshire and one in mid-2025 at 1915 Park Avenue. Between our acquired properties and development activity, we're trying to grow the multifamily side of our portfolio and achieve more balance between creative office and multifamily assets. With that, I will turn it over to Steve to provide a further update on the portfolio.

Steve Altebrando (Portfolio Oversight)

Thanks, David. I would like to provide an update on our operating assets, starting with multifamily. As David mentioned, on a consolidated basis at quarter end, our multifamily segment was 86.2% occupied, compared to 79.3% at the end of the fourth quarter. In Echo Park, Los Angeles, at our multifamily asset at 1902 Park, occupancy increased to 90.7% at the end of the quarter, up 140 basis points from the 2023 year end. We have been executing new leases for new tenants at substantially higher rates than our in-place rents. Monthly rent per occupied unit was about $1,800 as of the end of the first quarter.

This represents a 29% increase from a year ago, and our rate for new tenants generally exceeds $2,200 per month, more than a 20% increase from our in-place rents. In Oakland, we continue to make significant progress in improving occupancy. But as David referenced, our rental rate at Channel House and 1150 Clay have been below expectations. As we have previously discussed, there was significant supply growth in the Oakland market from 2018 through 2022. The market continues to absorb this excess supply, and we're encouraged by our ability to secure leases at these properties. It's important to note that we believe local rents would need to increase dramatically before it is economical to see no new multifamily construction. So we expect minimal new supply for the foreseeable future.

The pipeline for development in East Bay is well below the average for the top 25 U.S. markets. Turning to our office segment, we leased approximately 37,000 sq ft in the first quarter. Our occupancy rate at the end of the first quarter was 83.4%, compared to 83.8% at the end of 2023, and our lease percentage was 84%, down about 40 basis points from the end of 2023. With that, I'll turn it over to Barry.

Barry Berlin (CFO)

Moving on to financial highlights. Let's start with our segment NOI, which was $13.6 million for the first quarter of 2024, compared to $13 million in the prior year comparable period. This increased NOI of around $600,000 was driven by increases of $1.1 million in our office segment and $240,000 in our multifamily segment, which were partially offset by a decrease of $570,000 from our lending segment. Our office segment NOI increased to $7.9 million from $6.8 million in the prior year comparable period.

The decrease of $1.1 million was primarily driven by higher rental revenues at an office property in Beverly Hills, California, and an office property in Los Angeles, California, due to increased occupancy, in addition to higher income from an unconsolidated office entity in Echo Park, Los Angeles, during the quarter. Our hotel segment NOI remained consistent at $4.1 million for the first quarter of 2024 and 2023. For our lending division, NOI decreased to $800,000 from $1.4 million in the prior year comparable period, primarily due to the increased interest expense. We issued debt through a securitization transaction last year in March, with the interest relating to the securitization being directly expensed at the lending segment level.

Lastly, we began reporting multifamily segment NOI in the first quarter of 2023, after we acquired two multifamily properties in Oakland in late January and late March, as well as invested in another multifamily property in Los Angeles through a 50/50 joint venture investment. During the first quarter of 2024, we reported multifamily segment NOI of approximately $900,000, compared to approximately $680,000 for the prior year comparable period. The operations of the Oakland properties provided around $1.4 million of NOI compared to breakeven during the first quarter of 2023, largely due to multifamily segment not having an entire quarter of operations during the first quarter of 2023, due to the acquisition of the properties occurring during the quarter.

This net increase in NOI was partially offset by a $1.3 million swing in equity pickup from our investment in the JV, from NOI of approximately $800,000 during the first quarter of 2023, to a loss of $400,000 during the first quarter of 2024. For our non-segment expenses, we had a decrease in depreciation and amortization expense of $3 million, which was primarily due to a decrease in acquired in-place lease and tangible assets amortization for our multifamily properties in Oakland, which had been fully amortized prior to the first quarter of 2024. We also had a decrease in transaction-related costs of around $2.7 million, which had been elevated in the first quarter of 2023 as a result of the Oakland multifamily property acquisitions during that period.

Partially offsetting these non-segment expense decreases was an increase in non-segment allocated interest expense, which increased by around $2.1 million. The increase was primarily due to market interest rate rises and the assumption of mortgages in connection with the acquisition of our two multifamily properties in Oakland and borrowing on our revolver in connection with the acquisitions. Our FFO was -$0.26 per diluted share, compared to -$0.21 in the prior year comparable period, and our core FFO was -$0.19 per diluted share, compared to +$0.06 per share in the prior year period. These reductions were primarily driven by the increase in interest expense, as well as an increase in our redeemable preferred stock dividends of approximately $2.4 million.

Finally, regarding liquidity during the quarter, we raised an additional $19.1 million in net proceeds from the sale of our Series A-1 preferred stock. As David mentioned, although our Core FFO improved from last quarter, our cash flow continues to be impacted by elevated short-term interest rates. It is important to note that we are evaluating ways to strengthen our balance sheet and improve our cash flow, including potentially selling assets and reducing our debt. With that, our host can now turn the call over for questions.

Operator (participant)

Thank you, and we will now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you're using a speakerphone, please pick up the handset before pressing the key. And if at any time your question has been addressed and you would like to withdraw your question, please press star, then two. And we'll start with a question from Brendan McCarthy from Sidoti. Brendan, you may proceed.

Stephen Gill (Equity Research Analyst)

Hi, good afternoon. This is [Stephen Gill] on for Brendan McCarthy. How are you guys doing?

David Thompson (CEO)

Good. Good. Thanks for calling.

Steve Altebrando (Portfolio Oversight)

How are you?

Stephen Gill (Equity Research Analyst)

Good. First question I have is, regarding potential asset sales. How would you describe the deal flow now, and are any sales dependent on lower rate environment?

David Thompson (CEO)

Yeah, let me take that. I think when you look at our portfolio of assets, I mean, we've you know, we view that we've got a pretty desirable portfolio. The assets that we have, we think will still trade at pretty low cap rates. But obviously we're living in an environment today with higher short-term interest rates, so, you know, asset sales are accretive to our cash flow. And that's really our goal here, is to improve the cash flow that'll allow us to be in a better position to participate in what we expect to be a real estate recovery and potential opportunities that we'll see down the road. In terms of what assets we would potentially sell, we're really in the process of evaluating that right now, and-

Stephen Gill (Equity Research Analyst)

All right, thank you for the call there. Can you also talk about rent spreads in the office portfolio and how renewals have progressed?

Steve Altebrando (Portfolio Oversight)

Yeah, sure, I can take that. So I think for... They're about unchanged for the first quarter. We did about 33,000 sq ft of leasing, which is, you know, not a large sample size, but, you know, nothing unusual on the spread side.

Stephen Gill (Equity Research Analyst)

Got it. I guess the last one for me. With recent occupancy gains in the office portfolio, is it fair to say, like, office net operating income has a positive outlook now?

Steve Altebrando (Portfolio Oversight)

I think we'll see. I mean, we did see office NOI pick up quite a bit this quarter. Off the fourth quarter is an easier comp. But, you know, we still do have some expirations coming our way, so, yeah, I think we still have some wood to chop in terms of renewals.

Stephen Gill (Equity Research Analyst)

All right. Thank you so much for taking my questions.

David Thompson (CEO)

Thank you.

Operator (participant)

Our next question comes from John Massocca from B. Riley. John, please go ahead.

John Massocca (Senior Research Analyst)

Good morning out there.

David Thompson (CEO)

Morning.

John Massocca (Senior Research Analyst)

Maybe going back to dispositions. I mean, is there any specific property types or maybe strategic elements to the disposition activity you might be considering?

David Thompson (CEO)

Again, I think we're really in the process of evaluating that right now. I mean, obviously. If you look at our portfolio, the largest part of it still would remain the office product that we have. So that's probably, you know, likely to be a key place that we'll start and look at. You know, we've talked about historically trying to get this, and I mentioned on the call as well, getting more balance between the multifamily and the creative office going forward. I think that's gonna be a logical place for us to start.

John Massocca (Senior Research Analyst)

Okay. And then, maybe what are the outlooks for some of the returns on some of these development projects, particularly the ones that are more kind of near term in the pipeline?

Steve Altebrando (Portfolio Oversight)

Yes, I mean, we generally target, you know, 75 basis points to a 100 basis point spread in terms of our return on cost versus the current market cap rate. And I think we're on track. But we, you know, we have the two assets underway, which we think are that is achievable. I think, you know, candidly, it's tougher to develop in the market today, given where cap rates are and where construction costs are. So, you know, we have a much more significant development pipeline, but, you know, we haven't really been rushing to start that just because the, you know, the return hurdles are not necessarily meeting our expectations. So we're, you know, doing all the pre-development work, but waiting for a little bit better environment.

John Massocca (Senior Research Analyst)

Okay. And then in terms of just the multifamily environment, I mean, how big is the divergence between what you're seeing in terms of operating fundamentals in Oakland versus Los Angeles? Just given where some of the, you know, some of your new products will be coming online in Los Angeles, it sounds like.

Steve Altebrando (Portfolio Oversight)

Yeah. Yeah, well, I mean, L.A. definitely is a better market at the moment, where, you know, we're seeing trends that are pretty strong. Whereas, you know, Oakland is, it's just a more challenging submarket because there was just a large amount of supply really hit all at once, and that was really a result of developers wanting to start projects before an affordable housing mandate was coming into place. And as a result, a lot of development started all at once. So that's just an unusual market, how much supply hit at once. It's just gonna take some time to work that off, and we've seen a lot of that excess supply being absorbed. I think at one point, the market was, you know, 20%...

There was 20% vacancy, now it's less than 10%. So you know, there's definitely been an improvement there on the occupancy, but it's just gonna take some time.

John Massocca (Senior Research Analyst)

Okay. And then with the Sacramento Hotel asset, I mean, what's the potential impacts broadly to the revenue contribution from that property, you know, while it's undergoing some redevelopment activity?

Steve Altebrando (Portfolio Oversight)

... Yeah. So we're expecting some disruption, but not, you know, it, it'll be limited, the way we're looking to manage this. So, you know, effectively, we'll be doing a few floors at once. So we're gonna go basically floor by floor and making sure there's a buffer, the floor up, the floor down, just so other guests are not impacted. So we're really hoping to complete this renovation without a really large impact to NOI. But, you know, certainly, we will have some rooms at all times, really, for about a nine-month period that will be offline. So, yeah, we'll -- it'll be... There'll be some disruption, but, you know, it's not-- we're expecting that it would not be a major falloff in NOI.

John Massocca (Senior Research Analyst)

Okay. And then maybe last one for me, just bigger picture. I mean, you know, you talked about potential levers you could pull maybe to reduce leverage, but, you know, maybe the other side of that, too. I mean, is there anything you can think of strategically, maybe to increase liquidity in the common stock or, or, you know, just overall size of the common stock to, to make it slightly more institutionally relevant? I'm just trying to think if there's other big picture ideas that are kind of being bounced around, you know, beyond the kind of selling of assets and, and deleveraging.

Steve Altebrando (Portfolio Oversight)

Well, I think, you know, the way, the way we really set up our balance sheet does give us quite a bit of flexibility. You know, we have non-recourse mortgages, we have the preferred stock outstanding, which obviously can be converted to common. And then we have our senior secured credit facility, which is a borrowing-based facility that's encumbered by 5 or 6 assets within the portfolio. So we really, you know, did set the balance sheet up for a tougher environment, like I think what we're seeing today. And, you know, I think clearly the way that our balance sheet is set up, it does give us a lot of flexibility and potential levers to pull, to improve the cash flow and improve the leverage for the company over time. So I...

You know, without getting into more detail than that, but, you know, I do think we have, you know, quite a bit of flexibility based on the way we set up the balance sheet.

John Massocca (Senior Research Analyst)

Okay. That's it for me. Thank you very much.

Operator (participant)

And this concludes the question and answer session as well as the conference. Thank you so much for attending today's presentation. You may now disconnect. Have a great day.