Kennedy-Wilson Holdings, Inc. (KW) Q1 2012 Earnings Report, Transcript and Summary

Good morning, everyone. And welcome to the Kennedy-Wilson's First Quarter 2012 Earnings Conference Call. [Operator Instructions] I'd like to now turn the call over to Christina Cha, Kennedy-Wilson's Director of Corporate Communications. Please proceed.

Thank you. Joining us on today's call are Bill McMorrow, Chairman and CEO of Kennedy-Wilson, Justin Enbody, Chief Financial Officer and Matt Windisch, Executive Vice President. I'd like to remind you that this call is being webcast live and will be archived for replay. The replay will be available by phone for 1 week and by webcast for 1 year. Please see the Investor Relations section of the Kennedy-Wilson website for more information. Statements made during this conference call may be forward-looking statements. Actual results may materially differ from forward-looking information discussed on this call due to a number of risks, uncertainties and other factors indicated in reports and filings with Securities and Exchange Commission. I'll now turn the call over to Bill McMorrow.

Thanks, Christina. Good morning, again, everybody. As is our normal practice on this call, what I'm going to do is take you through the highlights of the first quarter, which you saw on the release yesterday. And then we're going to open it up for questions. We had a very good first quarter that was clearly in line with our expectations that we've set out for the year. Our EBITDA increased 27% to $19.2 million in the first quarter. And also just as a frame of reference if you think back to 2010, our EBITDA for that full year in 2010 was $35 million approximately. So now I'm going to turn to the balance sheet. Our investment account at the end of the first quarter was approximately $567 million, down from $582 million as we have some sales in the first quarter. Today as we sit here, our investment account is back up at $587 million. And as we'll talk about here in a little bit, we've got commitments of another $35 million approximately that will take the investment account here by the middle part of June back up to $625 million. In the first quarter, we received distributions of $18.5 million from our various joint-ventures and loan pools, versus $3.4 million in the first quarter of 2011. Our cash position at the end of the quarter was $122 million, versus $116 million at the end of the year. That does not include roughly $19 million of cash that we generated in April from the sale of 2 apartment buildings. I've mentioned, I think, in the first quarter call that our game plan for the year was to generate on a net basis to Kennedy-Wilson somewhere between $100 million and $150 million of cash for the full year of 2012. And since January through the end of April now, we've generated about $50 million in net cash, including the $19 million that I previously mentioned. And then the 2 other points that I really want to make about our balance sheet, that I said many times, is that we are doing this. We're very mindful, really, of what went on in 2008 in the capital markets. And with that in mind, both at the corporate level and at the property level, I think one of the great underlying strengths of our company is that we're using very modest amount for leverage. And so when you look at the corporate balance sheet, our total debt-to-net worth at the end of the first quarter was 0.7 to 1.0. And then when you look through the property level, and remember that this is that depreciated cost, our debt at the property level was 53% to our depreciated cost. And without giving any projections about what the market value of those assets are, you can kind of easily interpolate that our equity -- our debt, as a percentage of our market value at the property level was significantly below that 53%. In the -- we didn't close lot of acquisitions in the first quarter. However, we have under contract now $441 million of acquisitions that will close, as I mentioned here, between now and the middle part of June. So since the beginning of 2010, when we embarked on what was then a 3 year plan to buy $6 billion of assets. By the middle of June, we're going to be at $5.6 billion of assets that we've required during that period of time. As we also said at the beginning of the year, we're beginning to sell some assets that we acquired in 2009, 2010 and a little bit into 2011. So in the first quarter we sold our apartment building in North Hollywood, which generated a total gain of $16 million, which our share was $2.2 million. We also sold marketable securities in the first quarter, which generated a gain of $2.9 million. And then as I mentioned, subsequent to the end of the quarter, we closed the sale of a 213-unit residential building in Northern California, and a 440-unit building in Portland, Oregon. Our share of the roughly $65 million worth of cash that we distributed to us and our partners was $15 million -- sorry, the gains were roughly $15 million of which our share was $5.5 million. As we sit here today, our apartment business, including the units that we have under contract, we own roughly 13,900 units. Now one of the other important things to understand about what we're doing right now is as these assets mature, and we're taking not only the gains out of these assets, we're redeploying that cash into transactions that are actually producing higher current EBITDA than the things that we're selling. And I want Matt to walk you through kind of the dynamics of what's going on there.

Thanks, Bill. So if you look where we are today through May 4, 2012, as Bill mentioned, we've sold five assets. And on those assets we've booked gains on sales of approximately $11 million. And if you look at what those assets were producing before we sold them, on an annual basis they were producing about $1.3 million of EBITDA to the company. We've now taken the proceeds from those sales, roughly $50 million, and invested or are under contract to invest in 7 assets, which will have a combined EBITDA for the company of $11.3 million. So all in all, we'll be booking gains from these 5 sales of $11 million, and adding an additional $10 million of recurring EBITDA to the company. So in total, that's $20.8 million of gains and recurring EBITDA from these 5 asset sales being reinvested into 7 new assets. And there are other assets that we have slated for this year with similar type metrics that we anticipate to sell and reinvest with a very robust pipeline.

Thanks, Matt. Okay. The next item I want to talk about is the debt financing that we've been doing at the property level. And it's really quite an interesting statistic in my mind. We, since the beginning of January 2011 now, we've done $1.7 billion of property level financing, both on new acquisitions that we've been doing and on the refinance of existing deals. So we've done almost $1 billion of refinancing. When you look at that $1.7 billion, the new financings that we've done have been at an average interest rate of 4.1%. And the average maturity of those financings is 4.1 years. And so we continue to look at the overall portfolio, and we continue to take advantage of these lower interest rates. We're closing an acquisition on Thursday of a pretty good size apartment deal in the Sacramento area. The total capitalization of that deal is roughly $70 million, but we're rate-locking on that today on a 7-year financing. And with what's happened on the 10-year rates, we're now financing these 7-year -- the interest rate on these 7-year loans, we're going to rate-lock today somewhere around 355 fixed for 7 years, interest only for 2 years and then amortization over a 25-year period of time. In Europe, that as you all know we started in earnest there in 2011. We bought and had our final closing in December 2011 of the big portfolio of loans that are secured by assets in the United Kingdom. The unpaid principal balance of that was $2.1 billion. And in the last slightly over 4.5 months, we have resolved now $688 million of those loans are almost 1/3 of the entire pool. What is happening in Europe is the very well capitalized insurance companies are now taking the place of the banking system in Europe and they are the entities that are in the main refinancing outside of those existing loans that we have. In spite of also what you read in the papers, the U.K. real estate market, particularly the market in London, continues to be a very liquid market with investors from all over the world. One of the most recent settlements that we had was the -- actually the sale of an office building that our borrower owned. We got paid off at $0.100 on the loan, and it was roughly a £90 million payoff. So the loan portfolio itself continues to operate very well. We're seeing many, many opportunities right now in Europe that were in various stages of underwriting and looking out and so on. We also announced, subsequent to the end of the first quarter, that we had entered into a new platform with Fairfax Financial, which is €250 million that will be used to fund -- in part, fund either the debt purchases or the hard asset purchases that we're doing in Europe. We were non-refundable last Friday on our first apartment building acquisition in Europe. That's in a relatively new building in Dublin adjacent to the Google headquarters. Google just as in aside has invested somewhere between $150 million and $200 million in their European headquarters, which are in Dublin. This property that we're buying, which was originally built as a condominium building we're buying and closing here in the 1st of June. And has happened in the United States when we started buying aggressively in 2008 in the multifamily space here, you, obviously, have a declining homeownership base in Europe, in general, but Ireland specifically because of the mortgage -- lack of mortgage financing. Also of the -- roughly 5 million to 6 million people in Ireland, half of the population there is under 30 million. And you've got a handful of really good multifamily assets in and around Dublin that this will be the first one that has been acquired in this cycle by, really, anybody on the investment side. In Japan, our 50 apartment buildings continue to run at 95% occupancy. In fact, at one point in the first quarter we touched 97% occupancy. On the assets in Tokyo, we're actually seeing rent growth for the first time. We were very pleased to complete in the first quarter, an $80 million refinancing of an existing loan. We fixed the interest rate at 1.6% for 5 years. What is happening in Japan where the bank lending market, historically, has been 3 years, the banks are now going out 5 years. The interest rates are obviously very attractive. The other thing that has happened for us in Japan is that the -- we basically now refinance the entire portfolio in the last year at an average interest rate of slightly over 2%. And that interest -- we cut our debt service in Japan by almost 1/2 in the last 12 months. Japan also, because of these low interest rates and because of the high occupancy levels that we're running, has been a very real cash machine for us. And so since September of 2010, we distributed almost $45 million worth of cash out of that venture, of which our share of that cash has been almost $21 million. Also, I think, as most of you know, we have a very favorable gain in the currency as most of the cash that we send over there over the years was roughly at $105 million. Today, with the strengthening of the Yen, it's down touching right around $80 million. So with all of that background, I'd like to open it up to questions.

[Operator instructions] Your first question comes from the line of Jason Ursaner with CJS Securities.

Bill, just first on the U.K. loan portfolio, I think this is the first quarter you began accreting it. And I was just wondering, in the supplement you give sort of your book equity versus what you believe your pre-promote share would be on an accretion basis. But can you talk a little bit about what the total value might be when you're done with that with the promoted interest?

Jason. It's Matt. You're correct at the -- in the supplement, we're only showing our pre-promote piece of that deal. And so you could expect that promote on that could be somewhere between 50% and 75% of the non-promoted piece. So, for example, and we're saying it 60% on our books and we're going to accrete it up to a value of, say, 90%, the promote could be almost 1/2 of that -- of the gain that's the non-promoted gains.

Okay. Great. And then, in terms of generating the net cash to Kennedy-Wilson that you mentioned, without getting too specific on number of properties or location, how are you thinking about the properties that you are considering for divestiture? What sort of the common element there? Is it just ones where you sort have done what you can on stabilizing it and want to move on?

Yes. I think, what you just said is accurate to the extent, but in our mind properties have reached stabilization. And to the extent that there continues to be the kind of liquidity that there is looking for yield. We're using that opportunity to sale assets, takes gains, as Matt mentioned, and then redeploy that -- an assets that on a current basis not only do we have the potential to make future gains, but on a current basis where the NOI and the resulting EBITDA attach to that is producing greater current income for the company. So the example that Matt went through where we have roughly, through the end of April, $11 million worth of gains. But we redeployed that into assets that are on a current basis, on an annualized basis, producing $10 million more in that in EBITDA than we had before. So what you're going to see happen over the balance of the year as we continue some of these asset sales, we're just simply taking cash out of things that have reached, in our opinion, kind of maturation of value for us, and we're redeploying it into assets that not only do we think we have future gains in on the -- what I'm calling the long-term gains by future sales, but we're also generating more current income. This transaction that we're closing in Sacramento on Thursday, I think, is kind of a good example of what I'm talking about. It's a 400-unit building. It sits on roughly 10 acres right smack in downtown Sacramento. And so there is a, we think, a meaningful upside, not only in terms of the rents, but also in terms of kind of a repositioning play and a re-entitlement play for this asset. But the asset itself is producing in the high almost $4 million on an annualized basis of EBITDA. So if you think about the deal that we just sold in Portland, Oregon, that deal was producing $1,700,000 in EBITDA. We've taken the cash out of that deal and just redeployed it into another asset that we're going to also own 50% of. The deal we sold in Portland, we owned 50% of producing a total NOI of $1.7 million. We're redeploying, basically, that same amount of cash into an asset that's producing over double the same NOI.

And just staying with that, I mean, that the ability to continually recycle into higher producing assets over time, it's something pretty special. I mean, you talked a lot about your ability to source proprietary deal for, but are you not seeing any increased competition on the deal side? It sounds like the pipeline is still pretty robust there.

We have a very robust pipeline, really, both here and in Europe. So we're not seeing any lack of opportunities to redeploy cash in the way that I just mentioned to you. And then, again, just to reiterate though, we're doing it all against the backdrop of maintaining, what I would call by real estate standards, modest leverage both at the property level and at the corporate level.

Your next question comes from the line of David Ridley-Lane with Bank of America Merrill Lynch.

Sort of thinking about the pipeline and the opportunities you're seeing in Europe, are you seeing more on the loan pool side or for direct investments in real estate?

I would say, David, that the most of what we're looking at, I'm going to give you a percentage, I would say, 70% to 80% of what we're looking at right now, are debt purchases similar to the debt purchase that we closed last December. The banks in Europe are really starting to gear up right now on asset sales. And as I said at one of the conference, there's all kinds of numbers flying around in the market. But the banks in Europe, in our view from the things that we read, are going to have to shed somewhere between $2 trillion and $4 trillion worth of assets over the next 3 to 5 years. At this stage of the cycle, a lot of that is going to be debt secured by real estate.

Okay. And then in terms of -- I guess to follow-on to an earlier question, are you seeing more competition for those loan pools?

I would say that there -- it's the same handful of companies if you're talking about Europe that are actively looking for opportunities. And I think the one -- we have several in our opinion, anyway, clear advantages. Mary Ricks, as you know, who has been here with me as my partner here for the last 20 years is now in Europe full-time. And so all of the investment activity that we've done over the years, we've kind of done side-by-side. So we have our senior most person there overseeing what we're doing there. The second part of it is that you cannot underestimate the value of the acquisition that we did from the Bank of Ireland's, The Asset Management Group that we purchased. And so we've ended up now including that group together with some people that we've hired, a team of 22 really great real estate operating people on the ground there. And so unlike -- again, I'm not picking on the private equity funds. As I've always said, we're real estate operators. At the root of it, we really get in and really, really understand the real estate at the operating level. And so having that team in place just like we did in Japan in the 1990s, and we've done here in the United States, in our view, gives us a great skill set on the ground. And then the other piece of this is that we've actually done some big transactions now in Europe. And so, we have a database and an information base in terms of values that really I don't think any other company has. When you look at the first U.K. loan portfolio we did, debt secured by 170 different assets that we went through, not only a credit underwriting process, but an appraisal process really on every one of those assets. And so that all starts to form a database for you that you can do future acquisitions out of. Similarly, in Ireland, I mean, this apartment deal, not to minimize it, which is a €40 million purchase, or roughly $60 million at purchase price, that's a big deal for Ireland. And it's the first, I would say, meaningful hard asset other than the things that I mentioned to you that Google purchased in Dublin, that has been done in that market in order to get comfortable with that market and buy that asset. We obviously have to look at all the demographics and all of the things that you'd look at when you're underwriting an apartment building like that. And so now we have all that information and it's kind of, so to speak, in our database.

Okay. Great. And then, maybe, finally, just sort of -- what portion of your U.S. multifamily portfolio is kind of fully stabilized now and could be sold and the proceeds reinvested? Just trying to get a sense of how much of that portfolio is kind of at that stage now?

David, it's Matt Windisch. I'd say, roughly, 50% of the portfolio is stabilized, not to say that we would be selling 50%, but that's the amount that's reached, what we would call stabilization.

Yes. I think, the only thing though, Matt, that I would add to that, even though it's reached stabilization, we're continuing to see in our markets significant rent growth. And you all are seeing analysts' articles-after-articles about what's happening to the declining homeownership here in the United States, and the number of people, particularly younger people, that are actually getting added to the rental pool. And I would also add, in spite of the articles that you might read about California here, or this or that, there's still 38 million people here in the state of California. And we're seeing, I would say on the low side now, 4% to 8% to 10% rent growth at the property levels because there has not yet been, and I don't think there will be even though there is some new construction going on, here hasn't been significant new construction. So you've got a bigger pool of people moving into the rental market with no new construction. And that's continuing to force rental rates up. So we're going to continue to get lift and, in my opinion, from those assets that we continue to own even if we think they've reached stabilization just from these rent increases.

[Operator Instructions] Your next question comes from the line of Richard Eckert with B Riley & Company.

Yes. A couple of questions. Matt, can you go over the arithmetic? You said you sold, or you received $50 million in net proceeds from the sale of properties and that were generating $1.3 million in EBITDA and reinvested them and other assets generating 11 points. I just want to make sure I have all of the numbers straight.

Sure. So, yes, we sold 5 assets. The total sales proceeds were $49.1 million. The gain on sale was $10.9 million. So the book equity was $38.2 million, and we sold it for $49.1 million. The EBITDA of those 5 assets, KW share of the EBITDA was $1.3 million. We then bought 7 assets, or are under contracted by 7 assets, that we expect to produce $11.3 million of EBITDA to KW.

Okay. Thank you. Second question, you actually gave me a -- I was going to ask you about the return on that, the $10.9 million gain. What was the weighted average life of those investments?

They were approximately 2.5 years, 2 to 2.5 years. Most of them were purchased in 2010.

Okay. Second question is, I believe I saw in one of your press releases, perhaps the one announcing the sale of the North Hollywood property or -- that the cap-rate, or the implied cap-rate on the sales transaction was 4.5%. Would you say that that's a prevailing rate in the multi-family market now?

Yes. I think, Rich, that what you're seeing now in the apartment market is kind of the prevailing cap-rates. And it depends on where it is geographically, okay?

Yes, I know. Every market is local.

Exactly. And so in some cases, you're seeing cap rates that are touching slightly below 4%. But I would say in general, cap-rates are somewhere between 4% and 5% today. And rates have actually come down here when you think about this. I mean, I'm remembering the project we bought in Alameda in May of 2010, we thought we had rung the bell on 7-year financing there at 431. Maybe it was a 10-year loan. 10-year loan at 431. So that was 2 years ago. And so now you're seeing these rates on 7-year financing, as I mentioned earlier, somewhere around 350, 355. And the 10-year financings are coming in somewhere sub 4%. So I think that that all -- if you think about not only the rental increases that I mentioned to you before combined with actually lower interest rates today than there were 2 years ago, you've got more compression that's happening in a good way for us on these cap-rates in the apartment side. The other part of it, which I'd mentioned before, which is driving these cap-rates too is not just the institutional buyers. You've got wealthy individuals or partnerships of wealthy individuals that have now moved into the multi-family market. And with almost zero yield coming out of banking system today, even though bank deposits continue to grow, people are willing to buy at these lower cap rates, say down around 4%, which is better than getting 0 in the bank. And some portion, or all of their income, is tax sheltered because of the depreciation that's generated by these properties. So you've got a whole set of things that are influencing these cap rates: lower rates, rent growth and then kind of a new element of buyers that's come in to the market also.

Your next question comes from the line of (indiscernible) with Post Advisory Group.

Hey, guys. It's Andrew. Just a quick question. What's the availability on the revolver net [indiscernible]?

We are in the process of increasing the revolver to $100 million. And we're currently using $30 million on the revolver right now.

Okay. When do you hope to complete the increase?

I would say by the beginning of July.

Okay. And, Bill, the existing facility is 70?

75.

75. Okay. Great.

And at this time, I'd like to turn the call back to Mr. Bill McMorrow for closing remarks.

Okay. So, thanks to everybody for taking the time to join the call this morning. And as you get through and look through everything if there are any follow-up questions, feel free to call Matt or myself. Thanks very much.

We thank you for your participation in today's conference. This does conclude your presentation. You may now disconnect and have a great day.