Creative Media & Community Trust - Q4 2023

Transcript

Operator (participant)

Good day and welcome to the Creative Media & Community Trust Q4 2023 earnings call. All participants will be in a 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 your touch-tone phone, and to withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Mr. Steve Altebrando. Please go ahead, sir.

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 is Shaul Kuba, our Chief Investment Officer, 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 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. Despite a challenging 2023 for the real estate market given the sharp rise in interest rates, we believe CMCT is well positioned to benefit from a real estate recovery given our strong asset base in top-tier markets, our differentiated capital structure that can amplify appreciation for common shareholders, and our expectation of savings on interest costs as short-term interest rates come down. Even through a difficult year for the market, CMCT had a number of highlights since we last spoke. Our multifamily occupancy rate improved. Our development pipeline made additional progress with construction continuing at our two new multifamily projects. Our office leased percentage has remained stable. We saw continued strength at our hotel asset, and our liquidity remains strong. I'd like to first discuss our progress in the multifamily segment of our portfolio.

As of the end of February, our multifamily occupancy improved to 84.5%, up 40 basis points from the Q3. We believe we will make additional progress as we head into the busier spring and summer leasing season. Also, we continue to believe that we will see improved net operating income at the three multifamily properties we acquired last year, two in Oakland and one in Los Angeles, totaling 696 units. Two of those three assets are still in the lease-up phase, and the third asset has significant NOI growth opportunity as the in-place rents are substantially below today's market. As for our development pipeline, we expect to deliver two multifamily assets in Los Angeles, one later this year and one in mid-2025. When completed, we will have investments in five operating multifamily assets totaling 800 units.

Between our acquired properties and development activity, we have made significant headway on implementing our plan to grow the multifamily side of our portfolio and achieve more balance between creative office and multifamily assets. In our office segment, our leased percentage remains stable in the Q4 at 84.4% in a challenging sector. We executed approximately 38,000 sq ft of office leases in the quarter and 141,000 sq ft for the full year of 2023. Our Q4 hotel segment NOI decreased 6% compared to the prior year as we faced a challenging comp. However, hotel NOI increased by 18% in 2023 compared to the year earlier. Our lending NOI decreased year-over-year primarily due to the securitization completed a year ago, which increased interest expense attributable to that segment.

As for our liquidity, at the end of the Q4, we had $19 million of cash on hand, $53 million availability under our revolver, and we continue to raise Series A1 Preferred Stock. With that, I will turn the call over to Shaul to give an update on our development pipeline.

Shaul Kuba (CIO)

Thank you. As David mentioned, we continue to make progress on our development pipeline. We expect to deliver two multifamily buildings in Los Angeles within the next year: our partial office-to-multifamily conversion at 4750 Wilshire and our 36 multifamily development in Echo Park. Currently, rental rates in Los Angeles are stable, while supply growth is well below the national average. The new properties will increase our investment in multifamily to 800 units across five assets, 90% of which were delivered in 2021 or later. At 4750 Wilshire Boulevard, work continues, and we expect to start leasing units in the Q4 of 2024. This will add 68 luxury residential units to the portfolio. We believe this is a very attractive project given its location in Hancock Park, an extremely supply-constrained neighborhood that is adjacent to multi-million-dollar single-family homes.

New construction as a percentage of inventory in the Mid-Wilshire submarket is just 1.5%, which is nearly 4x below the national average. Construction is now underway at the development in Echo Park on our 36-unit apartment building, which is a joint venture between CMCT and an international institutional investor. The property is on a parcel adjacent to our creative office building at 1910 West Sunset Boulevard. We see a lot of value in Echo Park, a highly sought-after, trendy, walkable submarket preferred by young professionals who enjoy its numerous dining and entertainment options. In Jefferson Park, we have entitlement to build two multifamily buildings on South Western totaling over 150 units. We are in the process of discussing this development opportunity with co-investors. For the balance of our development pipeline, we continue to work to obtain all the necessary approval as well as complete design work.

We believe making progress on our pipeline increases the value of an asset whenever we elect to sell to another developer or elect to move forward with development if it meets our criteria for on-growth. As we have previously mentioned on those calls, we will look to bring in co-investors for development assets to increase our diversification and supplement return by generating fee income when advantageous, just like we have done at 4750 Wilshire. With that, I will turn over to Steve to provide further updates on the portfolio.

Steve Altebrando (Portfolio Oversight)

Thanks, Shaul. I would like to provide an update on our operating assets, starting with multifamily. On a consolidated basis at quarter-end, our multifamily segment was 79.3% occupied compared to 84.1% at the end of the Q3. However, thanks to strong leasing activity in early 2024, occupancy improved to 84.5% by the end of February, which is a 40 basis point increase from the end of the Q4. As David mentioned, we believe we are well positioned as we head into the busier spring and summer leasing season. In the Bay Area, our two premier Class A assets that we acquired in early 2023 are still in their initial lease-up phase. There was significant supply growth in the Oakland market from 2018 through last year, which in part allowed us to acquire these assets at a substantial discount to what replacement cost is today.

The market is in the process of absorbing this excess supply, and while we continue to think this will take some time, we believe local rents would need to increase dramatically before it is economic to see new multifamily construction. The pipeline for new development in the East Bay is well below the average for the top 25 U.S. markets, but we believe these assets are well positioned for growth both by occupancy gains and rate over time. In Echo Park, Los Angeles, at our multifamily asset at 1902 Park, our in-place rents are well below market, and we have been executing new leases for new tenants at substantially higher rates. Occupancy increased to 89% at the end of February, up 150 basis points compared to the end of the first quarter, which is when we acquired the asset.

We have a waiting list for two-bedroom units demonstrating the strength of demand for this asset, and we recently increased asking rents for new tenants. Turning to our office segment, we leased approximately 38,000 sq ft in the Q4 and 141,000 sq ft for the full year. Our occupancy rate at the end of the Q4 was 83.8%, up 120 basis points from the prior quarter, and our leasing percentage was 84.4%, up 10 basis points from the prior quarter. Our leasing spreads remain stable, declining less than 2% for the full year of 2023. Leasing spreads reflect the rents we are achieving compared to rates of our expiring leases on a same-suite basis. With that, I'll turn it over to Barry.

Barry Berlin (CFO)

Thank you, Steve. Moving on to financial highlights. Let's start with our segment NOI, which was $10.8 million for the Q4 of 2023 compared to $11.7 million in the prior year comparable period. This decrease in NOI of around $1 million was driven by decreases of $1.5 million in our office segment, $440,000 from our lending segment, and $170,000 from our hotel segment. This was partially offset by an NOI increase of $1.1 million from our multifamily segment, which commenced operations when we acquired assets during the Q1 of 2023. For the office segment, NOI decreased to $5.4 million from $6.9 million in the prior year comparable period.

The decrease of $1.5 million was driven by a loss from our unconsolidated office properties, largely due to an unrealized loss at one of our joint venture investments recognized during the quarter, as well as a decrease in revenues at an office property in Oakland, California, due to the impact of an early lease termination. These were partially offset by an increase in rental revenues at an office property in Beverly Hills, California, due to an increased occupancy and rental rates. Our Q4 hotel segment NOI decreased to $2.9 million from $3.1 million in the prior period, primarily due to an increase in operating expenses. We began reporting multifamily segment NOI in the Q1 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 Q4, we reported NOI of $1.1 million from the new multifamily segment. Lastly, our lending division NOI decreased to $1.3 million from $1.8 million in the prior year comparable period. This decrease was primarily due to the increased interest expense related to the issuance of debt through a securitization transaction that closed in March 2023. Interest related to the securitization is directly expensed at the lending segment level, which in turn freed up capital to allow us to further our strategic business model, including the multifamily acquisitions. For our non-segment expenses, the largest impact was an increase in non-segment allocated interest expense, which increased by around $6.8 million.

The increase was related primarily due to market interest rate rises and the assumption of two mortgages in connection with the acquisition of our two multifamily properties in Oakland during the Q1of 2023, including borrowing on our revolver in connection with those acquisitions. Additionally, we saw an increase in depreciation and amortization expense of $1.2 million, primarily due to the incremental increases in our investments in real estate resulting from the acquisition of our multifamily properties in Oakland during the Q1 of 2023, and an increase in transaction costs related to organizational costs incurred to assist in future potential real estate acquisitions. Our FFO was -$0.44 per diluted share compared to -$0.16 in the prior year comparable period, and our core FFO was -$0.37 per diluted share compared to $0.11 per share in the prior year period.

These reductions were primarily driven by the increase in interest expense, largely due to our multifamily acquisitions. For the reasons mentioned by David earlier, we believe there is an opportunity to significantly grow our multifamily NOI and remain optimistic that our efforts to properly position our multifamily portfolio for growth will result in the growth in our NOI. Finally, our liquidity was bolstered by raising an additional $26.8 million in net proceeds from the sale of our Series A1 Preferred Stock during the quarter. For 2023, we raised a total of $101.7 million in net proceeds. With that, our hosts can now turn the call over for questions.

Operator (participant)

Thank you. 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 your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. And at this time, we'll pause momentarily to assemble our roster. And the first question will come from Brendan McCarthy with Sidoti. Please go ahead.

Brendan McCarthy (Equity Research Analyst)

Hey, everybody. Thanks for taking my questions today. I just want to start off in the multifamily development pipeline, looking at the Jefferson Park asset or assets, I should say. Can you talk about the timing of the leasing or the lease-up phase? When can we expect to see those units kind of progress through leasing activity?

Steve Altebrando (Portfolio Oversight)

Sure. Good morning. How are you? So with respect to, we really have two assets that are under development right now, 4750 Wilshire, which is the conversion, the office-to-multifamily partial conversion. We would expect that to be complete in the Q4 and lease-up would immediately start at that time. It's a fairly small building, only about 68 luxury units. So we would expect to hopefully start making progress right off the bat on the lease-up. But generally speaking, it can take a year or more to fully stabilize an asset. But these are on the smaller side, so we would hope to make a little bit more to really accelerate that progress. And then the other asset in Echo Park is about 36-unit apartments expected to come online in mid-2025.

And again, we would look to be as soon as that comes online to start the lease-up process. And again, a smaller building, which we would expect to stabilize a lot quicker than you would typically see on a much larger unit. And then I think you had mentioned the Jefferson Park asset. So those are entitled and really shovel-ready, but we are right now basically marketing those assets to potential co-investors because what we would like to do on most of the developments we proceed with is bringing additional partners to help fund the equity. So right now, the construction has not commenced yet on those two.

Brendan McCarthy (Equity Research Analyst)

Got it. Thanks for the insight. How's that process been marketing to co-investors? I know you typically look for international investors. Has the interest been on that front? And then as a follow-up, can investors maybe expect a potential sale in the same ballpark of the 80% interest sold in the 4750 Wilshire asset?

Steve Altebrando (Portfolio Oversight)

Yeah. So we really have just started that process of speaking to investors. I mean, right now, it's a little bit more challenging to make the returns pencil just given the environment we're in, where the development costs are elevated and cap rates are higher. So penciling the returns is a little bit tougher in the current environment. I mean, in those particular two assets, we have a pretty small investment in the land basis, so we can really afford to wait if need be. And then with respect to our ownership, what we have said in the past is we would be open to basically bringing co-investors for up to 80% of the potential asset.

So that is where we would like to maintain at least a 20% ownership interest. And if we did have co-investors come in, that would obviously bring our ownership percentage down. I would say our ownership generally would probably be in the 20%-50% range depending on the deal.

Brendan McCarthy (Equity Research Analyst)

Got it. Thanks, Steve. That's helpful. Then just want to change gears, switch gears to looking at just a line item on the income statement. The transaction cost, I think, was a little bit above $1 million for the Q4. Can you talk about what drove that?

David Thompson (CEO)

Sure. Yeah. Hey, Brendan. This is David. I can address that. So a lot of that has to do with some kind of legal costs that we were spending or incurring relating to a UPREIT structure that we're putting in place. And it's something that we think will potentially allow us to raise capital in a creative way going forward, but just kind of some of the legwork behind the UPREIT structure that will, again, enable us to do a couple of things potentially. One would be more easily issue units to acquire assets to the extent we want to do that, issue OP units, or maybe potentially further down the line, raise capital separately through that structure.

Brendan McCarthy (Equity Research Analyst)

Great. That's helpful. Thanks, David. And then kind of looking at the debt structure here, I know some of the proceeds from the Series A1 preferred were used to pay on the revolver. And then I also noticed there was, I think, a refinance of one of the multifamily mortgages. Can you talk about, I guess, was that the 1150 Clay asset? And maybe talk about the, I think there was another multifamily mortgage coming due in the summer 2025. Can you talk about the plan for that piece and then also just talk about the one that was refinanced in the Q4? Thanks.

Steve Altebrando (Portfolio Oversight)

Yeah. Sure. So we did refinance 1150 Clay and put in place a pretty attractive fixed rate of 6.25% in today's market. And that also pushed the maturity into mid-2026. And then with the other mortgage is Channel House, which we have an extension option. So really, the maturity is mid-2025. And we're in the process right now of looking to extend that mortgage as well, whether it's through an extension or a refi.

Brendan McCarthy (Equity Research Analyst)

Got it. Thanks, Steve. Maybe one more for me, just kind of looking at the lease expirations on the office side as a percent of annualized office rent, 16.3% coming due in 2024. Can you just kind of talk about the outlook there as far as renewals?

Steve Altebrando (Portfolio Oversight)

Yeah. Generally speaking, we are seeing north of a 50% renewal rate. We have the one particular tenant that is giving back some space that we mentioned in the investor presentation. But for the most part, we are seeing pretty high renewal rates across the board.

Brendan McCarthy (Equity Research Analyst)

Got it. Got it. I know you mentioned spreads. I think you mentioned in the introduction, spreads are positive there on the office side. Are they still- can you maybe go into detail just on lease spreads?

Steve Altebrando (Portfolio Oversight)

Sure. So generally, what we have seen, although the office market has been well-publicized, a little bit challenging, but we generally are seeing rate hold up for the most part. So what we mentioned that spreads were down just 2%. We're pleased with that given the environment. But we are generally seeing rate hold up, particularly in Austin. And I would say also that's the case in West LA, where the Bay Area has been a little bit softer on rate.

Brendan McCarthy (Equity Research Analyst)

Got it. Thanks, Steve. Thanks. One more question, if I may. Just kind of looking at multifamily NOI, obviously really strong in the Q4 of 2023 after a negative quarter in the Q3 of 2023. Can you just kind of talk about the outlook there? Is that going to be lumpy going forward? And was that differentiation just from kind of the lease-up phase?

Steve Altebrando (Portfolio Oversight)

Yeah. I mean, there's a lot of opportunity for us to pick up ground with respect to NOI in the multifamily segment. Generally, your costs are very highly fixed in multifamily. So when we have a building that's just one of Channel House is just 80% leased or sub-80% leased, as you get towards a stabilized mid-90s figure, a lot of the incremental revenue should flow to the bottom line. So we would expect to see continued pickup specifically in the back half of the year because as we start seeing leasing activity pick up into the spring and summer, that will benefit our NOI later in the year.

So I think throughout the year, we should see it really progressively improving. Although I would point out we did have a little bit of a one-time benefit in the Q4 from a real estate tax adjustment. Outside of that, we would expect NOI to really continue to be trending higher really over the next eight quarters.

Brendan McCarthy (Equity Research Analyst)

Got it. Thanks, Steve. Thanks, everybody. That's all from me.

Operator (participant)

This will conclude our question-and-answer session as well as our conference call for today. Thank you for attending today's presentation. You may now disconnect.