Business context and reporting period
Independence Realty Trust, Inc. (IRT), an externally managed REIT focused on apartment properties, filed this unaudited Form 10-Q for the quarter and nine months ended September 30, 2015. The September 17 acquisition of Trade Street Residential, Inc. (TSRE) materially expanded IRT’s portfolio; TSRE’s operating results are included only from the merger closing date.
At quarter-end, IRT owned 50 apartment properties with 14,044 units. The merger added 19 properties and 4,989 units. IRT issued approximately 15.1 million shares as part of the consideration; after closing, legacy IRT shareholders held approximately 68% of the combined company and former TSRE shareholders approximately 32%.
Financial results and position
Unless otherwise indicated, dollar amounts below are in millions. Period comparisons are against the corresponding 2014 period.
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Total revenue | $25.5 | $13.0 | $69.9 | $32.8 |
| Operating income (loss) | $(5.8) | $2.2 | $2.6 | $5.4 |
| Net income (loss) | $25.6 | $(0.1) | $25.7 | $2.7 |
| Net income allocable to common shares | $24.0 | $(0.1) | $24.1 | $2.8 |
| Diluted EPS | $0.71 | $0.00 loss | $0.74 | $0.14 |
| Core FFO per share (non-GAAP) | $0.20 | $0.17 | $0.57 | $0.53 |
Revenue rose sharply, largely because of property acquisitions, including TSRE. Same-store rental rates increased 5.2% year over year in Q3; management reported same-store NOI growth of 2.0% for Q3 and 5.4% for the nine-month period. Portfolio NOI margin was 53.1%, compared with 52.9% a year earlier. Average occupancy was 94.0%, and average monthly effective rent per occupied unit was $950.
GAAP earnings were significantly affected by the TSRE merger: IRT recorded a $64.0 million bargain-purchase gain, alongside $13.0 million of acquisition expenses and $27.5 million of financing-extinguishment and employee-separation expenses. Core FFO, a non-GAAP measure that excludes specified items, was $7.0 million in Q3 and $19.4 million for the nine months. It is not equivalent to GAAP earnings or operating cash flow.
- Cash flow: Nine-month operating cash flow was $5.0 million, down from $10.5 million. Investing cash outflow was $169.6 million; financing cash inflow was $166.8 million. Cash and cash equivalents ended at $16.9 million, versus $34.8 million a year earlier. Restricted cash was $7.3 million.
- Debt: Carrying debt was $993.9 million at September 30, versus $418.9 million at December 31, 2014. Principal outstanding was $993.3 million; the weighted-average rate was 3.6%, and weighted-average maturity was 5.1 years. Approximately $429.6 million was floating-rate and $563.7 million fixed-rate.
- Liquidity: The new $325 million senior secured facility had $271.5 million drawn and $53.5 million of revolver availability. A separate $120 million interim term loan was fully drawn, bore interest at 1-month LIBOR plus 500 basis points, and had a 364-day term with a conditional extension option. IRT reported compliance with debt covenants.
- Equity and distributions: Common shares outstanding were 47.1 million at quarter-end. Regular monthly dividends were $0.06 per share, with September’s dividend split into two prorated payments around the merger.
Material changes versus prior period
- The TSRE merger and other acquisitions drove much of the increase in revenue, property expenses, depreciation, interest expense and debt. Nine-month revenue more than doubled year over year, while operating income declined.
- Merger-related one-time items drove reported net income and made GAAP earnings less representative of recurring property operations. The $64.0 million bargain-purchase gain reflected, among other factors, IRT’s share price at closing and higher appraised values for TSRE properties than the negotiated purchase-price expectations. Purchase accounting remained preliminary.
- Debt increased substantially to fund the merger and related transactions. IRT also replaced its prior Huntington facility with the new KeyBank senior facility and interim loan.
Outlook, commentary, risks and unusual items
- Management said available cash, financing arrangements and operating cash flows should meet liquidity needs for the next 12 months. It intends to reduce leverage over time, primarily through property sales.
- IRT identified properties for sale outside its core Southeast footprint and expected to sell three by the end of Q1 2016. Proceeds were intended to reduce the interim loan; management expected to repay or substantially reduce its $120 million balance by the end of July 2016. Five property mortgages maturing in April 2016 were also potential sale or refinancing opportunities.
- The company gave no specific earnings or revenue guidance in the provided filing text. Management cautioned that forward-looking results are subject to uncertainty and may differ materially from expectations.
- Interest-rate exposure is material: $429.6 million of debt was floating-rate. A 100-basis-point increase in rates was estimated to increase annual interest expense by about $4.3 million. IRT entered a $200 million interest-rate cap on September 30, 2015, with a 3.0% strike and maturity in October 2017.
- A putative TSRE-stockholder class action alleges unfair merger terms and fiduciary-duty violations. Defendants intended to defend the case; IRT accrued estimated legal defense costs but said it could not reasonably estimate additional possible loss.
- Disclosure controls and procedures were deemed ineffective at September 30, 2015 because of a previously identified material weakness involving qualified resources and reconciliation, review and accounting-estimate controls. Management described remediation efforts but had not yet concluded the weakness was remediated.
- The external advisor’s amended compensation terms applied from October 1, 2015: a quarterly base fee of 0.375% of cumulative equity raised and an incentive fee of 20% of Core FFO above $0.20 per share. The advisor and property manager are related parties.
Important facts for investors to verify
- Whether final TSRE purchase-price allocations support the $64.0 million bargain-purchase gain and how post-merger operations perform on a comparable basis.
- Whether planned property sales occur on schedule and generate enough proceeds to reduce or repay the interim loan by the stated target.
- Debt maturities, floating-rate exposure, revolver availability and compliance with facility terms as the enlarged portfolio is integrated.
- Progress and effectiveness of remediation of the material weakness in internal controls.
- Developments in the TSRE merger litigation and any resulting costs or liabilities.
- The impact of the revised related-party advisory fees on future expenses and Core FFO.