CSR - Centerspace: Improving Debt Position Shares Fairly Valued

2023-08-09 00:20:02 ET

Summary

• Midwestern and Mountain state multifamily operator, Centerspace, reported strong Q2 results that included positive revisions to full-year guidance.
• The company has also made significant progress in lowering their overall debt load.
• The increased flexibility is providing CSR with the ability to redirect capital to other priorities, such as acquisitions and value-add type renovations.
• Despite the positive outlook, I view shares as fairly valued in the current market environment.

Mountain state multifamily operator, Centerspace ( CSR ), has made significant strides this year in improving their capital structure. This appears to be providing the company with increased flexibility to engage in other capital priorities, such as acquisitions and increased value-add type work. This can be seen in the company’s revised full-year outlook. Despite the more favorable outlook, the past-peak market could limit the upside potential in the stock. Read my previous coverage on CSR here .

Centerspace Q2 Results

CSR reported total Q2 same-store revenue growth of 8.5%. This was led by strength in all major operating regions. Driving the gains was a 20 basis point (“bps”) increase in occupancy to 95.2% and a 7% increase in average monthly rental rates to $1,467/month.

While revenue growth was consistent across regions, occupancy levels were less so. Markets such as Denver gained 190bps of occupancy during the period. But Nebraska lost 250bps. Some of the loss is perhaps attributable to the region’s 12.1% increase in rents.

On the expense side, CSR benefitted from a much more favorable cost environment. Overall same-store expenses grew 3.3%, while controllable expenses grew just 1.4% due primarily to decreases in utilities and repairs/maintenance. The expense savings were more pronounced on a sequential basis, as expenses decreased about 5% from Q1 into Q2.

Resulting same-store net operating income (“NOI”) grew 12.1% YOY and 7.2% sequentially.

From a leasing perspective, CSR appears to be making progress on renewing upcoming lease expirations. In Q2, they addressed 30% of their expirations and achieved blended rent spreads of 4.9% on new and renewed signings. In July, blended spreads were slightly lower at 4.3%.

Two Takeaways From CSR’s Q2 Results

Positive Revisions To Guidance

The strong property level performance contributed to 14.3% YOY growth in funds from operations (“FFO”) per share. And looking ahead, the management team now sees full-year core FFO at a midpoint of $4.65/share. This is up significantly from the previous outlook of $4.42/share.

Contributing to the revised outlook are projections for higher same-property NOI, resulting in part in a significantly lowered outlook for same-store expenses. On the revenue side, same-store revenues are now seen growing 7.25% at the midpoint, up from 7% previously. And same-store expenses are seen growing 4.63%, down from 5.5%. Together, this resulted in full-year expectations for same-store NOI growth of 9.25% at the midpoint.

Also incorporated into guidance was increased expectations in the transactional market. Previously, CSR had expected to sell 11 apartment communities. They now expect to sell two additional communities. In addition, they are incorporating up to +$100M in acquisitions. And they also intend on pulling forward value-add renovation work, with expectations to spend +$7M more at the midpoint.

The increased transactional outlook also came as CSR significantly reduced their overall debt burden during the quarter.

Notable Drop In Total Debt Load

In Q2, CSR lowered their net debt multiple to an all-time low. In the past, they would run as high as in the upper 7x range. It is now about 6.5x.

The reduction occurred through actions taken at the end of the first quarter and early in Q2. This included applying proceeds from asset sales to the full repayment of their +$100M term loan that was in place at the end of last year. CSR also had reduced their floating rate exposure to less than 2% of their total stack through the issuance of fixed rate secured financing with a 12-year term.

At quarter end on June 30, the weighted rate on their total debt outstanding was 3.54% with a weighted average maturity of just under 7.0 years. This provides CSR with a higher degree of flexibility than they had in prior periods.

Interestingly, however, their debt service ratios didn’t change much following the reduction. In fact, through the first six months of the year, their debt service multiple of 2.99x was down from the multiple in the same period last year. This is due simply to the higher overall interest expense they are incurring, in particular on their credit facility and their secured debt.

Is CSR Stock A Buy, Sell, Or Hold?

One of my primary concerns for CSR was their debt load and its associated interest burden. The company appears to have made significant headway in this regard since my prior updates. For one, their debt multiple is now sitting at all-time lows. The material reduction in their floating rate exposure also protects them from further volatility in the rate environment.

The increase in the disposition target could also bring in additional funds for further paydown, if necessary. With the reduced load, the company is afforded more options with how to deploy capital. The increased transactional guidance indicates CSR will likely expand further into key markets, such as Denver.

With national rental rate growth on track to stall, or even decline in many cases, CSR has also prudently pulled forward their value-add jobs. Simply raising rents without giving tenants something new to pay for may prove to be a tough sell in the coming periods. By offering more renovated units, CSR may have a better case in continuing to raise rents.

Given the market is likely past its peak, one can reasonably ask whether it’s too late in the cycle for CSR to focus on expansion. They built in up to +$100M of acquisitions into their full-year guidance. Perhaps it would have been more effective for CSR to lower their debt burden even further. After all, even with the lowered load, CSR is still paying more in interest due to the higher overall interest rates.

At about 13x forward FFO, CSR trades appropriately in the current market environment. The stock received an initial boost following their earnings release that included the upward revisions in guidance, but shares have traded flat since then. The investor apathy could be due to the more pessimistic outlook on rental rate growth and new supply. While CSR’s results have said otherwise, I am still maintaining a more neutral view on the stock due to less favorable operating conditions with respect to rental rate growth.

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