The following information should be read in conjunction with our condensed
consolidated financial statements and accompanying notes included in Part I,
Item 1 of this Quarterly Report on Form 10-Q and with our 2022 Annual Report.
OVERVIEW (dollars in thousands)
RMR Inc.is a holding company and substantially all of its business is conducted by RMR LLC. RMR Inc.has no employees, and the personnel and various services it requires to operate are provided by RMR LLC. RMR LLCmanages a diverse portfolio of real estate and real estate related businesses. As of December 31, 2022, RMR LLCmanaged nearly 2,100 properties in 46 states, Washington, D.C., Puerto Ricoand Canadathat are principally owned by the Managed Equity REITs.
Business Environment and Outlook
The continuation and growth of our business depends upon our ability to operate the Managed Equity REITs and SEVN so as to maintain, grow and increase the value of their businesses, to assist ALR, TA and Sonesta to grow their businesses and operate profitably, and to successfully expand our business through the execution of new business ventures and additional investments. Our business and the businesses of our clients generally follow the business cycle of the
U.S.real estate industry, but with certain property type and regional geographic variations. Typically, as the general U.S.economy expands, commercial real estate occupancies increase and new real estate development occurs; new development frequently leads to increased real estate supply and reduced occupancies; and then the cycle repeats. These general trends can be impacted by property type characteristics or regional factors; for example, demographic factors such as the aging U.S.population, the growth of e-commerce retail sales or net population migration across different geographic regions can slow, accelerate, overwhelm or otherwise impact general cyclical trends. Because of such multiple factors, we believe it is often possible to grow real estate based businesses in selected property types or geographic areas despite general national trends. Beyond general real estate industry trends, we also take into account general economic factors impacting our clients. More specifically, in the U.S., the Federal Reservehas increased the federal funds rate seven times since the beginning of calendar 2022 and has announced an expectation that it will continue to raise rates, in an attempt to slow inflation, which has in turn lead to increased borrowing costs and disruptions in the financial markets. In a period of increased borrowing costs, real estate transaction volumes often slow along with real estate valuation growth, which the commercial real estate industry has been experiencing. Rising interest rates also adversely impact our clients with floating rate debt, which they, in some instances, attempt to address with interest rate caps and other strategic actions to reduce leverage. Further, while the Federal Reserveis looking to slow inflation, its efforts may not be successful. The impact of rising costs, both for goods and human capital, are impacting us and our clients and we and our clients are continuing to implement mitigation strategies to minimize the impact of increased costs on our and our clients' earnings, where possible. We consider industry and general economic factors when providing services to our clients and attempt to take advantage of opportunities when they arise. For example: (i) since March 2020, ILPT and DHC have completed several joint venture transactions with institutional investors and subsequently grown some of those ventures by acquiring additional properties; (ii) SVC transitioned over 200 hotels from other hotel operators to Sonesta, which on March 17, 2021, completed its acquisition of RLH Corporation, establishing it as one of the largest hotel companies in the U.S.and expanding its franchising capabilities; (iii) on September 30, 2021, SEVNand Tremont Mortgage Trustmerged, resulting in a larger, more diversified mortgage REIT with an expanded capital base; and (iv) on February 25, 2022, ILPT completed its acquisition of 126 new, Class A, single tenant, net leased, e-commerce focused industrial properties as a result of its acquisition of Monmouth Real Estate Investment Corporation, or MNR, in an all-cash transaction valued at approximately $4.0 billion. In addition, we balance our pursuit of growth of our and our clients' businesses by executing, on behalf of our clients, prudent capital recycling or business arrangement restructurings in an attempt to help our clients prudently manage leverage and increased operating costs. We also look to reposition their portfolios and businesses when circumstances warrant such changes or when other more desirable opportunities are identified.
Managed Equity REITs
The base business management fees we earn from the Managed Equity REITs are calculated monthly in accordance with the applicable business management agreement and are based on a percentage of the lower of (i) the average historical cost of each REIT's properties and (ii) each REIT's average market capitalization. The property management fees we earn from the Managed Equity REITs are principally based on a percentage of the gross rents collected at certain managed properties owned by the Managed Equity REITs, excluding rents or other revenues from hotels, travel centers, senior living properties and wellness centers, which are separately managed by ALR, TA, Sonesta or a third party. Also under the terms of the property management agreements, we receive construction supervision fees in connection with certain construction activities undertaken 18
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at the properties owned by the Managed Equity REITs, ALR and Sonesta based on a percentage of the cost of such construction. For further information regarding the fees we earn, see Note 2, Revenue Recognition, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
The following table presents for each Managed Equity REIT a summary of its
primary strategy and the lesser of the historical cost of its assets under
management and its market capitalization as of
Lesser of Historical Cost of Assets Under Management or Total Market Capitalization as of December 31, REIT Primary Strategy 2022 2021 Medical office and life science properties, senior DHC living communities and wellness centers
$ 3,235,870 $ 4,457,630ILPT Industrial and logistics properties 4,504,774 1,897,426 Office properties primarily leased to single tenants, OPI including the government 3,105,356 3,813,203 Hotels and net lease service and necessity-based retail SVC properties 9,093,152 8,651,159 $ 19,939,152 $ 18,819,418A Managed Equity REIT's historical cost of assets under management includes the real estate it owns and its consolidated assets invested directly or indirectly in equity interests in or loans secured by real estate and personal property owned in connection with such real estate (including acquisition related costs which may be allocated to intangibles or are unallocated), all before reserves for depreciation, amortization, impairment charges or bad debts or other similar non-cash reserves. A Managed Equity REIT's average market capitalization includes the average value of the Managed Equity REIT's outstanding common equity value during the period, plus the daily weighted average of each of the aggregate liquidation preference of preferred shares and the principal amount of consolidated indebtedness during the period. The table above presents for each Managed Equity REIT, the lesser of the historical cost of its assets under management and its market capitalization as of the end of each period. The basis on which our base business management fees are calculated for the three months ended December 31, 2022and 2021 may differ from the basis at the end of the periods presented in the table above. As of December 31, 2022, the market capitalization was lower than the historical cost of assets under management for each of the Managed Equity REITs; the historical cost of assets under management for DHC, ILPT, OPI and SVC as of December 31, 2022, were $7,364,926, $5,698,191, $5,903,729and $11,273,106, respectively.
The fee revenues we earned from the Managed Equity REITs for the three months
Three Months Ended December 31, 2022 Three Months Ended December 31, 2021 Base Base Base Base Business Property Construction Business Property Construction Management Management Supervision Management Management Supervision REIT Revenues Revenues Revenues Total Revenues Revenues Revenues Total DHC
$ 3,664 $ 1,492 $ 1,300 $ 6,456 $ 5,866 $ 2,345$ 914 $ 9,125ILPT 5,902 2,948 170 9,020 2,768 1,633 114 4,515 OPI 3,639 3,404 3,165 10,208 4,574 4,112 1,878 10,564 SVC8,168 990 610 9,768 10,446 993 231 11,670 $ 21,373 $ 8,834 $ 5,245 $ 35,452 $ 23,654 $ 9,083 $ 3,137 $ 35,874Other Clients We provide business management services to ALR, TA and Sonesta. ALR operates senior living communities throughout the United States, many of which are owned by and managed for DHC. TA operates, leases and franchises travel centers along the U.S.interstate highway system, many of which are owned by SVC, and standalone truck service facilities. Sonesta manages and franchises hotels, resorts and cruise ships in the United States, Latin America, the Caribbeanand the Middle East; many of 19
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earned from business management services to ALR, TA and Sonesta are based on a
percentage of certain revenues.
In addition, we also provide management services to certain
clients that earn fees based on a percentage of average invested capital, as
defined in the applicable agreements, property management fees based on a
percentage of rents collected from managed properties and construction
management fees based on a percentage of the cost of construction activities.
Our fee revenues from services to these clients for the three months ended
Three Months Ended December 31, 2022 Three Months Ended December 31, 2021 Base Base Base Base Business Property Construction Business Property Construction Management Management Supervision Management Management Supervision Revenues Revenues Revenues Total Revenues Revenues Revenues Total Sonesta
$ 2,111$ - $ 15 $ 2,126 $ 1,814$ - $ - $ 1,814Other private entities 3,012 2,077 426 5,515 1,401 903 96 2,400 ALR 1,264 - - 1,264 1,145 - - 1,145 TA 4,191 - - 4,191 3,611 - - 3,611 $ 10,578 $ 2,077$ 441 $ 13,096 $ 7,971 $ 903$ 96 $ 8,970Advisory Business Tremont provides advisory services to SEVN, a publicly traded mortgage REIT that focuses on originating and investing in first mortgage loans secured by middle market and transitional commercial real estate. Tremont is primarily compensated pursuant to its management agreement with SEVN based on a percentage of equity, as defined in the applicable agreement.
We earned advisory services revenue of
The Tremont business acts as a transaction broker for non-investment advisory clients for negotiated fees. The Tremont business earned fees for such brokerage services of zero and
$53for the three months ended December 31, 2022and 2021, respectively, which amounts are included in management services revenue in our condensed consolidated statements of income. 20
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RESULTS OF OPERATIONS (dollars in thousands)
Three Months Ended
The following table presents the changes in our operating results for the three months ended
December 31, 2022compared to the three months ended December 31, 2021:
Three Months Ended
2022 2021 $ Change % Change
$ 48,548 $ 44,897 $ 3,6518.1% Advisory services 1,091 1,118 (27) (2.4)% Total management and advisory services revenues 49,639 46,015 3,624 7.9% Reimbursable compensation and benefits 14,323 14,397 (74) (0.5)% Reimbursable equity based compensation 2,289 1,598 691 43.2% Other reimbursable expenses 184,489 119,558 64,931 54.3% Total reimbursable costs 201,101 135,553 65,548 48.4% Total revenues 250,740 181,568 69,172 38.1% Expenses: Compensation and benefits 33,264 31,791 1,473 4.6% Equity based compensation 2,850 2,219 631 28.4% Separation costs 438 - 438 n/m Total compensation and benefits expense 36,552 34,010 2,542 7.5% General and administrative 9,163 7,671 1,492 19.4% Other reimbursable expenses 184,489 119,558 64,931 54.3% Depreciation and amortization 268 236 32 13.6% Total expenses 230,472 161,475 68,997 42.7% Operating income 20,268 20,093 175 0.9% Interest income 1,770 57 1,713 n/m Unrealized (loss) gain on equity method investments accounted for under the fair value option (5,314) 1,196 (6,510) n/m Income before income tax expense 16,724 21,346 (4,622) (21.7)% Income tax expense (2,484) (3,054) 570 18.7% Net income 14,240 18,292 (4,052) (22.2)% Net income attributable to noncontrolling interest (7,903) (10,250) 2,347 22.9% Net income attributable to The RMR Group Inc. $ 6,337 $ 8,042 $ (1,705)(21.2)%
n/m – not meaningful
Management services revenue. Management services revenue increased
$3,651primarily due to (i) growth in base business management fees of $3,134and base property management fees of $1,315earned from ILPT, primarily due to its acquisition of MNR in February 2022, and (ii) an aggregate increase of $2,453in construction management fees earned primarily as a result of increased development activities at our clients. These increases were partially offset by a decline in base business management fees earned from SVC and OPI of $3,213, due to declines in the enterprise values of these respective clients during the current fiscal period.
Advisory services revenue. Advisory services revenue was relatively unchanged
from the prior period.
Reimbursable compensation and benefits. Reimbursable compensation and benefits include reimbursements, at cost, that arise primarily from services our employees provide pursuant to our property management agreements at the properties of our clients. A significant portion of these compensation and benefits are charged or passed through to and paid by tenants of our clients. Reimbursable compensation and benefits was relatively unchanged from the prior period. 21
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Reimbursable equity based compensation. Reimbursable equity based compensation includes awards of common shares by our clients directly to certain of our officers and employees in connection with the provision of management services to those clients. We record an equal, offsetting amount as equity based compensation expense for the value of these awards. Reimbursable equity based compensation revenue increased
$691primarily as a result of our clients' annual employee share awards and increases in our clients' respective share prices.
Other reimbursable expenses. For further information about these reimbursements,
see Note 2, Revenue Recognition, to our condensed consolidated financial
statements included in Part I, Item 1 of this Quarterly Report on Form 10Q.
Compensation and benefits. Compensation and benefits consist of employee salaries and other employment related costs, including health insurance expenses and contributions related to our employee retirement plan. Compensation and benefits expense increased
$1,473primarily due to annual merit increases that were effective October 1, 2022. Equity based compensation. Equity based compensation consists of the value of vested shares awarded to certain of our employees under our and our clients' equity compensation plans. Equity based compensation increased $631primarily as a result of annual employee share awards and increases in certain of our clients' respective share prices. Separation costs. Separation costs consist of employment termination costs. For further information about these costs, see Note 6, Related Person Transactions, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10Q. General and administrative. General and administrative expenses consist of office related expenses, information technology related expenses, employee training, travel, professional services expenses, director compensation and other administrative expenses. General and administrative costs increased $1,492primarily due to strategic technology investments and increases in temporary help, recruiting and other professional fees.
Interest income. Interest income increased
interest earned during the current period primarily as a result of higher
interest rates compared to the prior period.
Unrealized (loss) gain on equity method investments accounted for under the fair value option. Unrealized (loss) gain on equity method investments accounted for under the fair value option represents the unrealized gain or loss on our investments in SEVN and TA common shares. For further information, see Note 3, Equity Method Investments, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.
Income tax expense. The decrease in income tax expense of
attributable to lower taxable income for the current period compared to the same
period in the prior fiscal year.
LIQUIDITY AND CAPITAL RESOURCES (dollars in thousands, except per share amounts)
Our current assets have historically been comprised predominantly of cash, cash equivalents and receivables for business management, property management and advisory services fees. As of
December 31, 2022and September 30, 2022, we had cash and cash equivalents of $200,965and $189,088, respectively, of which $24,503and $21,492, respectively, was held by RMR Inc., with the remainder being held at RMR LLC. Cash and cash equivalents include all short term, highly liquid investments that are readily convertible to known amounts of cash and have original maturities of three months or less from the date of purchase. As of December 31, 2022and September 30, 2022, $198,319and $181,219, respectively, of our cash and cash equivalents were invested in money market bank accounts. We believe that our cash and cash equivalents leave us well positioned to pursue a range of capital allocation strategies, with a focus on the growth of our private capital business, to fund our operations and enhance our technology infrastructure, in the next twelve months. Our liquidity is highly dependent upon our receipt of fees from the businesses that we manage. Historically, we have funded our working capital needs with cash generated from our operating activities and we currently do not maintain any credit facilities. We expect that our future working capital needs will relate largely to our operating expenses, primarily consisting of employee compensation and benefits costs, our obligation to make quarterly tax distributions to the members of RMR LLC, our plan to make quarterly distributions on our Class A Common Shares and Class B-1 Common Shares and our plan to pay quarterly distributions to the members of RMR LLCin connection with the quarterly dividends to RMR Inc.shareholders. Our management fees are typically payable to us within 30 days of the end of each month or, in the case of annual incentive business management fees earned from the Managed Equity REITs, if any, within 30 days following each calendar year end. Quarterly incentive fees earned from SEVN, if any, are payable generally within 30 days following the end of the applicable quarter. Historically, we have not experienced losses on collection of our fees and have not recorded any allowances for bad debts. 22
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During the three months ended
December 31, 2022, we paid cash distributions to the holders of our Class A Common Shares, Class B-1 Common Shares and to the other owner of RMR LLCmembership units in the aggregate amount of $11,442. On January 12, 2023, we declared a quarterly dividend on our Class A Common Shares and Class B-1 Common Shares to our shareholders of record as of January 23, 2023in the amount of $0.40per Class A Common Share and Class B-1 Common Share, or $6,641. This dividend will be partially funded by a distribution from RMR LLCto holders of its membership units in the amount of $0.32per unit, or $10,113, of which $5,313will be distributed to us based on our aggregate ownership of 16,603,262 membership units of RMR LLCand $4,800will be distributed to ABP Trustbased on its ownership of 15,000,000 membership units of RMR LLC. The remainder of this dividend will be funded with cash accumulated at RMR Inc.We expect the total dividend will amount to approximately $11,441and we expect to pay this dividend on or about February 16, 2023. See Note 7, Shareholders' Equity, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information regarding these distributions. For the three months ended December 31, 2022, pursuant to the RMR LLCoperating agreement, RMR LLCmade required quarterly tax distributions to its holders of its membership units totaling $8,094, of which $4,255was distributed to us and $3,839was distributed to ABP Trust, based on each membership unit holder's then respective ownership percentage in RMR LLC. The $4,255distributed to us was eliminated in our condensed consolidated financial statements included in Part 1, Item 1 of this Quarterly Report on Form 10-Q, and the $3,839distributed to ABP Trustwas recorded as a reduction of their noncontrolling interest. We expect to use a portion of these funds distributed to us to pay our tax liabilities and amounts due under the tax receivable agreement described in Note 6, Related Person Transactions, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. We expect to use the remaining funds distributed to us to fund our long-term tax liabilities and pay dividends.
Our changes in cash flows for the three months ended
December 31, 2022compared to the three months ended December 31, 2021were as follows: (i) net cash from operating activities decreased $6,868from $34,968in the prior period to $28,100in the current period; (ii) net cash used in investing activities increased $752from $165in the prior period to $917in the current period; and (iii) net cash used in financing activities increased $2,555from $12,751in the prior period to $15,306in the current period. The decrease in net cash from operating activities for the three months ended December 31, 2022compared to the prior period primarily reflects unfavorable changes in working capital, partially offset by increases in net income, after the exclusion of non-cash gains and losses. The increase in net cash used in investing activities for the three months ended December 31, 2022compared to the prior period was primarily due to purchases of property and equipment. Net cash used in financing activities for the three months ended December 31, 2022increased from the prior period primarily due to higher tax distributions based on current estimates for taxable income in this fiscal year. As of December 31, 2022, we had no off-balance sheet arrangements that have had or that we expect would be reasonably likely to have a material effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
Tax Receivable Agreement
We are party to a tax receivable agreement which provides for the payment by
RMR Inc.to ABP Trustof 85.0% of the amount of savings, if any, in U.S.federal, state and local income tax or franchise tax that RMR Inc.realizes as a result of (a) the increases in tax basis attributable to RMR Inc.'sdealings with ABP Trustand (b) tax benefits related to imputed interest deemed to be paid by it as a result of the tax receivable agreement. See Note 6, Related Person Transactions, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and "Business-Our Organizational Structure-tax receivable agreement" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019. As of December 31, 2022, our condensed consolidated balance sheet reflects a liability related to the tax receivable agreement of $25,583, of which we expect to pay $2,275to ABP Trustduring the fourth quarter of fiscal year 2023.
Market Risk and Credit Risk
We have not invested in derivative instruments, borrowed through issuing debt securities or transacted in foreign currencies. As a result, we are not subject to significant direct market risk related to interest rate changes, changes to the market standard for determining interest rates, commodity price changes or credit risks; however, if any of these risks were to negatively impact our clients' businesses or market capitalization, our revenues would likely decline. To the extent we change our approach on the foregoing activities, or engage in other activities, our market and credit risks could change. See Part I, Item 1A "Risk Factors" of our 2022 Annual Report for the risks to us and our clients. 23
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Risks Related to Cash and Short Term Investments
Our cash and cash equivalents include short term, highly liquid investments readily convertible to known amounts of cash that have original maturities of three months or less from the date of purchase. We invest a substantial amount of our cash in money market bank accounts. The majority of our cash is maintained in
U.S.bank accounts. Some U.S.bank account balances exceed the Federal Deposit Insurance Corporationinsurance limit. We believe our cash and short term investments are not subject to any material interest rate risk, equity price risk, credit risk or other market risk.
Related Person Transactions
We have relationships and historical and continuing transactions with
Adam D. Portnoy, the Chair of our Board and one of our Managing Directors, as well as our clients. For further information about these and other such relationships and related person transactions, please see Note 6, Related Person Transactions, to our condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q, our 2022 Annual Report, our definitive Proxy Statement for our 2023 Annual Meeting of Shareholders and our other filings with the SEC. In addition, see the section captioned "Risk Factors" in our 2022 Annual Report for a description of risks that may arise as a result of these and other related person transactions and relationships. We may engage in additional transactions with related persons, including businesses to which RMR LLCor its subsidiaries provide management services.
Critical Accounting Estimates
The preparation of our condensed consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions that affect reported amounts. Actual results could differ from those estimates. Significant estimates that impact the condensed consolidated financial statements include the revenue recognized during the reporting periods and our principles of consolidation.
A discussion of our critical accounting estimates is included in our 2022 Annual
Report. There have been no significant changes in our critical accounting
estimates since the fiscal year ended
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