Good morning, ladies and gentlemen, and welcome to AvalonBay Communities' second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. Following remarks by the company, we will conduct a question- and- answer session. You may enter the question and answer queue at any time during this call by pressing star one. If your question has been answered or you wish to remove yourself from the queue, press star two. If you are using a speakerphone, please lift the handset before asking your question, and we ask that you refrain from typing, and please have your cell phone turned off during the question and answer session. Your host for today's conference is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.
Thank you, Matt, and welcome to AvalonBay Communities' second quarter 2020 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements, and actual results may differ materially. There's a discussion of these risks and uncertainties in yesterday afternoon's press release, as well as in the company's Form 10-K and Form 10-Q filed with the SEC. As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms which may be used in today's discussion. The attachment is also available on our website at www.avalonbay.com/earnings, and we encourage you to review this information during the review of our operating results and financial performance. With that, I'll turn the call over to Tim Naughton, Chairman and CEO of AvalonBay Communities, for his remarks. Tim?
Thanks, Jason. Welcome to the Q2 call. With me today are Kevin O'Shea, Sean Breslin, and Matt Birenbaum. Sean, Kevin, and I will provide commentary on the slides we posted last night. All of us will be available for Q&A afterwards. Our comments will focus on providing summary Q2 results, an update on operations, and some perspective on development of the balance sheet now that we've entered an economic recession. Before we start on the deck, I thought I'd offer a few general comments about the environment we are currently facing. To say things have changed over the last four months is certainly an understatement. We are in the middle of the largest global healthcare crisis in a century. The economic downturn is the most severe we've seen since the Great Depression. On the heels of the longest expansion on record.
Social unrest is at a level we haven't experienced since Vietnam and the Civil Rights Movement over 50 years ago. It's been said that these are indeed unprecedented times. These events aren't just having an unprecedented impact on economic activity, but also on income and wealth distribution across industries and the broader population. For those companies and workers leveraged to the virtual economy, they're actually doing quite well, and some are even thriving. For those companies and workers that operate in a real economy of bricks and mortar, like AVB, we're certainly feeling the normal effects and then some of the downturn. For those companies and workers in the travel, leisure, and entertainment sectors, among others, they are basically in shutdown mode. These sectors, as well as others, will undoubtedly need to be restructured over the next few years.
Many companies will not survive, their employees, even if temporarily furloughed for now, will join the ranks of the permanently unemployed over the next several quarters. Unfortunately, those impacted by these events, or most impacted by these events, are those in lower-paying service jobs and minority populations. As a result, this downturn carries not just the normal economic risk of prior recessions, but also profound health, social, and political risks that are likely to shape the length and of the economic recovery. While this was a sudden and quick downturn, the timing and shape of the recovery is hard to project, and that presents a unique challenge in managing our business and communicating our expectations to you, our shareholders.
Having said that, we'll do our best to be as transparent and direct as possible as we all try to understand and gauge how the current environment will play out in our business in the months and quarters ahead. Let's turn to the results for the quarter, starting on slide four. As expected, Q2 was a challenging quarter. Core FFO growth was down almost 2%, driven by a same-store revenue decline of almost 3%, or 2.2% of retail excluded. On a sequential basis from Q1, same-store revenue was down 4.5%, or 3.9% excluding retail. We had no development completions or new development starts this quarter, and we've had no starts since so far year- to- date.
Lastly, we raised over $700 million in capital this quarter at an average initial cost of 2.8%, with most of that coming from a $600 million long 10-year bond deal at a rate of around 2.5%. As Kevin will share in his remarks, our liquidity, balance sheet, and credit metrics are very well positioned heading into this downturn. I'll turn to slide five. I wanted to drill down a bit more on the decline in same-store residential revenue this past quarter. As this slide demonstrates, the decline was primarily attributable to a loss of occupancy and uncollectible lease revenue, or bad debt. Economic occupancy was down 120 basis points, while bad debt was 200 basis points higher than normal. Higher than normal bad debt is likely to continue given the breadth and depth of the downturn, coupled with eviction moratorium in many of the markets in which we operate.
We also experienced higher concessions in the quarter and lower other income as we waive various fees this past quarter for our residents, including late payments, common area amenities, and credit card convenience fees. Average lease rate for our same-store portfolio in Q2 is actually up 1.8% over Q2 of 2019, reflecting embedded rent growth from leases entered into in 2019 through Q1 of this year. I'll turn to slide six. As I mentioned in my opening remarks, this downturn poses a unique risk relative to other recessions. In addition to the household contraction and consolidation that occurs due to job losses in any downturn, the pandemic is driving other trends that are impacting rental demand. These include work from home flexibility that is shifting some renter demand from higher cost and urban infill markets.
Many renters are relocating, perhaps only temporarily, to lower cost markets or sub-markets, leisure areas, or even back home with their parents. Second, record low mortgage rates and the desire for space is accelerating demand for single-family homes. Many home builders have reported strong orders and sales this past quarter, particularly towards the back half of the quarter, and home ownership rate is on the rise. Lastly, we're seeing reduced demand from two important segments of renters, corporate and students. As most temporary corporate assignments have been canceled, while higher education is adopting remote learning models and limiting on-campus activities for the fall. These factors will likely weigh on performance until the public health crisis is abated. They'll also likely contribute to a more robust recovery once employees begin to return to the workplace.
With that, I'll turn it over to Sean to discuss operations and portfolio performance in more detail. Sean.
All right. Thanks, Tim. Turning to slide seven, the factors Tim highlighted on the previous slide impacted leasing volume throughout the quarter, which is down roughly 10% year-over-year. Turnover for the quarter fell about 5% as the volume of resident notices to leave our communities exceeded leasing velocity, most materially in May when we experienced about a 25% increase in lease breaks for a variety of reasons, including corporate apartment operators shutting down operations in certain markets. As a result, move-outs exceeded move-ins for the quarter. As of yesterday, net lease volume for July is roughly on pace for the volume of notices to vacate our communities, which should help stabilize occupancy as we move into August.
Moving to slide eight, we experienced 120 basis point decline in physical occupancy from April to June, with most of it occurring in May as a result of the lease break volume I mentioned a few moments ago. Chart two on slide eight depicts both leased and effective rent change for the quarter. As detailed in our earnings release, blended leased rent change was down 40 basis points in Q2, while effective rent change was down 3.1%. The nature of the health crisis and economic environment will dictate the ongoing demand for rental housing and our pricing power as we move through the balance of the year. Turning to slide nine, you can see the regional distribution of both leased and effective rent change for Q2.
Northern and Southern California were the most challenging regions for a variety of reasons, while the Pacific Northwest performed the best. Moving to slide 10 to look at performance metrics by sub-market type. Urban sub-markets deteriorated more materially during Q2 as compared to suburban sub-markets. From an occupancy standpoint, urban sub-markets declined by 270 basis points from April to June, while suburban sub-markets fell by only 50 basis points. From a rent change perspective, urban sub-markets trailed suburban by roughly 200 basis points. While the weakness in urban environments is pretty broad-based across our portfolio, it's most pronounced in San Francisco, Boston, and parts of L.A.
Unfortunately, demand in urban sub-markets is suffering from a variety of factors, several of which Tim mentioned in his prepared remarks, including a desire for more affordable price points, extended work from home policies across corporate America, a lack of short-term and corporate demand, uncertainty regarding on-campus learning at urban universities, and a general concern about population density. Skipping to slide 11 to discuss our development portfolio. Construction delays at the beginning of the pandemic weighed on both deliveries and occupancies during the second quarter. As noted in chart one on slide 12, deliveries and occupancies for the first half of the year fell short of our expectations by roughly 450 and 650 units respectively, which translated into an NOI shortfall of approximately $2 million.
Fortunately, following some initial shutdowns at about 1/3 of our construction sites for a short period of time, all our jobs are currently underway, albeit with a slower pace of deliveries expected across certain assets. I'll now turn it over to Kevin to further address development starts, funding, and the balance sheet. Kevin?
Thanks, Sean. Turning to slide 12, in response to the current environment, we have chosen not to start any new construction projects so far this year, despite having initially guided in the beginning of the year to about $900 million in new construction starts for 2020. Looking ahead, we expect lower construction costs will affect many of our future planned starts, and we are prepared to wait for the expected correction in hard costs.
Before breaking ground so that we can lock in a lower basis on these investments. Although real-time construction cost data are difficult to come by, initial indications suggest we are beginning to see a softer labor market and a reduction in overall construction activity make their way into subcontractor pricing. As for development that is currently under construction, as you can see on slide 13, we are in a remarkably strong position from a financial point of view. Development under construction is already 95% matched funded with long-term capital, which not only mitigates the financial risk of development, but also means that we have locked in the investment spread profit on these developments by having matched the long-term expected return on the project's equity and debt price when we were starting these projects. Finally, as shown on slide 14, we continue to enjoy an exceptionally strong financial position today.
This is particularly evident in comparing our key credit metrics today to those from the fourth quarter of 2008, when we entered the last recession. Specifically, since late 2008, our net debt to EBITDA ratio has improved to 4.9 x from 6.5 x. Our interest coverage ratio has increased to 6.9 x from 4.5 x. Our unencumbered NOI percentage has increased to 94% from 77%, and our credit rating has improved to A3/A- from Baa1/BBB+. This strong balance sheet position provides us with great flexibility to pursue attractive investment opportunities that may emerge as this downturn unfolds. With that, I'll turn it back to Timothy Naughton.
Thanks, Kevin. Just turning to the last slide and offering a few summary comments. Q2 was a challenging quarter, driven by the suddenness of the pandemic and the depth of the downturn. Far, the impact on same-store performance has been driven by lower occupancy and elevated vacants. Contributions from NOI and new development lease ups were less than expected due to construction delays and lease absorption. We have curtailed our new development dramatically and have not started any new communities so far this year. Despite the strength in the for-sale market, we do expect construction costs to fall over the next few quarters, and we'll incorporate that into our capital allocation plans.
Lastly, the balance sheet is very well positioned in both an absolute sense and relative to prior downturns which as Kevin noted, just gives us plenty of financial flexibility to address challenges or opportunities as they arise. With that, Matt, we'll open the call up for questions.
Thank you. As a quick reminder for those on the phone, it is star one if you'd like to enter the queue. Our first question will come from Nick Joseph with Citi.
Thanks. Appreciate the color and the rationale behind pausing new starts. Just curious how long you think the delay will be until you actually start your projects again, and then what signals are you looking at before actually making that decision to proceed?
Hey, Nick, this is Matt. Yeah, we have deals that we could start. We do have a fairly high degree of conviction that hard costs should start to correct here. The main thing we're looking at is kind of where are hard costs trending, what's the subcontractor bid coverage look like. There may be one deal that we would start here that's kind of got some exceptional circumstances that's actually in an opportunity zone, and we're looking at starting with some third-party joint venture capital, which is, as you know, is very unusual for us.
For whole-owned balance sheet stuff, that's really what we're watching, is kind of that interplay between potential reduction in hard costs and frankly, reductions in NOIs on the other side, and kind of looking at what the total basis looks like, what costs look like relative to their long-term trend line, and what rents and NOIs look like relative to their long-term trend line as well.
Yeah, Nick, it's hard to know exactly. You look at last cycle, we paused about four or five quarters. Part of my introductory comments around what this economic downturn might look like, it may be different from others that we've seen, where others may have been sort of maybe drifted a little bit more into the recession. Others may have been a quicker bounce back. We think this could be a more drawn-out bounce back and likely to be more and more you've heard certainly the Nike swoosh from more people, more and more you're hearing sort of the K-shaped recovery, where it's going to be very uneven depending upon demographic and the population. Just given the public health and economic access aspect of this one, it's hard to know for sure.
As we showed on that one slide, we're just starting to see construction costs correct. Last cycle, they corrected on the order of 15%, maybe a little bit more. We're probably going to need to see kind of double-digit corrections before we start to have a little bit more faith that we're buying deals out at a basis that will look good sort of next cycle.
Thanks. You announced the $500 million share repurchase program. How do you think about actually executing on that? Where does it currently stack up in terms of the use of proceeds, maybe relative to development or any other kind of acquisitions or redevelopment kind of other options that you have for that capital?
Yeah, hey Nick, this is Kevin. I'll jump in here and Tim may want to add a couple of comments. You're right. As you saw in the earnings release, we did announce a share repurchase program of $500 million. Really the genesis behind that is we believe our stock is, as you allude to, trading at a compelling value, both absolutely and relative to other investments, including development. Because of the balance sheet strength and liquidity to pursue a program, we intend to do so. Though, as you indicated in the earnings release, we're likely to fund that on a long-term basis with asset sales and potentially some incremental debt. We do intend to proceed and probably do so initially on an as-needed basis until we have clarity on those issues. I think at this point, that's probably our most attractive investment that we have today.
Yeah. I maybe just add a little bit to Kevin. I agree. I think you have two things working. It's the most attractive investment, and you've got the disparity between what equity is costing and what some of the debt costing is being supported artificially by the Fed right now, as we know. Our belief is while there's not a lot of visibility on asset pricing, we feel pretty strongly that asset prices have corrected near what equity prices have corrected, which being 90% or [quated percent] on the equity. We think probably less than 10% on asset sales. That informs our conviction as well in terms of what the alternatives are in terms of capital sources.
Thank you.
Our next question will come from Rich Hightower with Evercore.
Hey, good afternoon, guys. I'm on the second chart on page eight, just on the blended like-term rent change chart. Just help us understand some of the details there, across new and renewals and what you're seeing currently, urban and suburban and maybe some of the weaker markets you mentioned, Boston, San Fran, and L.A. Just help us understand what goes into the mix there.
Yeah, Rich, it's Sean. Happy to walk you through it a little bit. As we noted on an effective basis, rent change was down about 3% for the quarter. If you look at it on the lease basis, it was down only about 40 basis points. Certainly, based on what I mentioned in my comparative remarks, we've seen the greatest weakness in Northern and Southern California. If you double-click through those regions, probably the softest spots are San Francisco and throughout L.A., particularly in some of the entertainment-oriented economies around L.A. So think about Hollywood, West Hollywood, Burbank, San Fernando Valley, et cetera. Then the other markets were basically anywhere from sort of zero to minus 2%. Across the other markets, the softest spots are probably New York City and throughout the urban submarkets within Boston.
As I mentioned in my comparative remarks, generally across the portfolio, what we're seeing in the urban submarkets is rent change is trailing suburban by about 200 basis points. As you probably noted in the charts, economic occupancy and physical occupancy are both trailing what we're seeing in the suburban submarkets as well. Certainly a tougher place to be as it relates to both rent change and occupancy in those environments. As it relates to kind of where things are today, if you look at it in the context of July, effective rent change is down about 3.5%, a little bit better than June. Lease rent change is down about 2%. In both cases, renewals do remain positive right now, sort of in the 50 to 70-basis-point range.
Slightly lower than what we experienced in Q2 but still positive in July at this point.
Okay. Sean, that's helpful. Just thinking maybe a little more broadly on some of the bullets highlighted in the prepared comments about the work-from-home shift and the fact that suburban is outperforming urban. I would also assume with respect to home purchases and given the price points in Avalon's markets, maybe you're a little more insulated from that effect than the average apartment landlord out there. At what point does that sort of mix start to help Avalon in the sense of having a highly concentrated suburban portfolio? When do you think we'll really see that show up in the numbers there as a net positive, you think?
Yeah, Rich, it's Sean. I can provide a couple of comments, then Tim can chime in. It's really a function of how some of those factors evolve over the next few months here. Urban submarkets, we've mentioned several of the factors that are sort of driving it. I think what I mentioned in my comparative remarks is sort of the nature of the health crisis and economic environment will dictate when people sort of come back to the urban submarkets in at least some more material way. On the suburban side, it's really a function of sort of portfolio mix. In some places, it certainly is very helpful. There are some submarkets where even though it's suburban, it's a little bit painful right now.
I'll pick one specifically like Mountain View in Northern California, where Alphabet is headquartered, given their extended work-from-home policy, it seems to be a weaker submarket even though it's technically considered suburban. I'm not sure there's a one-size-fits-all answer here as it relates to that, at least that's my general thoughts at this point in time. Tim, do you have anything you want to add?
Yeah, maybe just mention, suburban had been outperforming urban prior to the pandemic, and we had been seeing a trend both on the demand- [audio distortion] year urban supply to outpace suburban by a fair amount in our markets. Also on the demand side, which last cycle supply and demand was stronger in the urban sub-market. This cycle, it's probably going to be the opposite, where you get the offset of 21.2, where you're likely to see stronger demand in some of the suburban sub-markets and more supply.
That's partly because millennials are coming of age. It's more economic activity starting to occur in the suburbs, and part of it's affordability. As you see more economic activity, that ought to drive more rental entry demand in the suburbs as well. We already started to see that trend before the pandemic, but it's just a longer cycle than I expected. [audio distortion]
All right. Thank you.
Our next question will come from John Pawlowski with Green Street Advisors.
Thanks a lot. Sean, I wanted to go back to your comment that you see some stability in lease occupancy heading into August. Does that comment hold for the current pockets of weakness that you allude to, L.A., Boston, San Fran?
In short, John, yes. We are starting to see some student demand come back in some of these urban sub-markets based on announcements that have been made to date as it relates to hybrid learning environments both on campus and distance learning. Anecdotally, getting a lot of feedback from some of the student population that they've had enough time at home, and even if they only can be on campus a couple days a week, they want their apartment back. Whether that holds or not, obviously, is a function of the health crisis and the decisions that are made across these university systems. In general, I would say we are seeing it relatively sort of stabilize a little bit.
That being said, between now and year-end, as I mentioned in my prepared remarks, the health crisis and the economic environment will dictate whether things kind of shift up or down in terms of demand as we move forward here.
Makes sense. The 200 basis points drag from bad debt in the quarter on the residential portfolio, the opening remarks were something to the effect that it had been delegated. Is that a reasonable budding line just in terms of the trajectory over these coming months? Will it get meaningfully worse, meaningfully better? I guess I don't know how to completely think through markets like in L.A., where this eviction moratorium keeps getting kicked down the road. Just curious if comments around the trajectory of bad debt from here would be helpful.
Yeah, John, happy to comment, and Kevin or Tim can chime in as well. At this point in time, it's obviously difficult to predict given the nature of what I mentioned, the health crisis, the macroeconomic environment. Obviously, there've been federal support for people to date in terms of being able to sort of subsidize their incomes, which I think came through this morning in terms of personal income growth. I think, assuming it's a relatively static environment through year-end, you'd probably expect those sort of collection rates to hold within reason. To the extent there is significant shift in any one of those variables in a meaningful way, obviously, that could tick it up or down as a result. I think those are the primary variables we'll all be monitoring to try and determine whether we think it's going to tick up and/or down. So
Okay. Thank you.
That's it on my end.
Our next question will come from Jeff Spector with Bank of America.
Thank you. Good afternoon. I just want to go back to some of the big-picture comments, Tim, that you've discussed so far, including some of the comments during the Q&A. I very much appreciate how difficult it is to figure out the medium to long- term. Just thinking again, your comments about the lower-cost options elsewhere, the top fees increasing homeownership. Can you talk a little bit more how this is impacting, let's say, Avalon's medium to long-term strategic plans, whether that includes new markets? I guess, can you share some thoughts on that?
Yeah, sure, Jeff. I think we've spoken to this in the past. As many have said, I think the pandemic, these trends aren't necessarily new. A lot of them are being accelerated. Certainly, you think about sort of big tech and employers in places like New York and California are already diversifying their workforces in other markets, whether it's Amazon in D.C. or having bases in Austin or Denver. We want to be leveraged really to the innovation and knowledge economy. That means kind of going where those workers are going. To the extent jobs and employers continue to chase the employee rather than the employee chasing jobs in a lot of those markets. There's a lot of reasons we got into Denver and Southeast Florida.
I would say, one of the things is that you look at just the fiscal situation of some of the blue states, obviously are being exacerbated as well. I think that probably informs our thinking. Also just its overall affordability, and driving some of the populations in some of these markets. We want to be in those sort of spillover markets. We think what's happening is good for the innovation economy. I don't think it's bad necessarily for San Jose and San Francisco, and Boston, but recognize that some of those benefits are going to spill over to some other sort of secondary innovation markets as well, and those will be good markets for us to be in. We look to do a few things. One is to kind of reallocate or recycle capital, some capital out of New York, certainly.
Probably in the future, some out of California to both our existing expansion markets as well as markets like D.C., Seattle, and Boston. Then also potentially some new markets that we're not into today.
Appreciate the comments. I guess your thoughts on work from home and the permanency of work from home, does that impact the decision process at all? Do you feel like that is just a temporary adjustment right now, but maybe there'll be more going forward, but not to the extent that some in the media are portraying it, some on the street are portraying it?
Yeah. It's hard to know. I know the office guys get that question a lot. I can sort of speak from our own experience. We do expect you to have more work from home activity kind of going forward. There are certain jobs where there are kind of individual contributors where they can be efficient working away from the office space. That is not close to the majority of the jobs in this company or most companies. We view it as kind of more of a marginal effect. It gives people a little bit more flexibility about where to live. If they want to work from home, they're definitely probably not that focused on career growth. They're probably not going to manage a lot of people working from home at least over the next few years, in my view.
I would say, does it really affect our view in terms of where we want to be? Probably less so than the fact that big employers like the Googles and Apples of the world are already diversifying their workforces in other markets with satellite operations there. Whether it's a satellite operation or people working from home, they're likely to go to some of the same markets over time.
Thank you. Stay well.
Thank you. You as well. Thank you.
Our next question will come from Rich Hill with Morgan Stanley.
Hey, good afternoon, guys. Wanted to follow along the lines of bigger picture questions and go back to some of your prepared remarks. Specifically about home ownership. We've seen some similar trends with home ownership, particularly under the age of 35 cohort. Do you think those are just near term given the decline that we've seen in interest rates? Do you think there's a more secular shift that's going on there?
Rich, I can speak to it. Others may have a view. I think part of it may be, if you just look at the composition of millennials, a little bit is the pig going through the pythons. There's a lot more of those that are under 35 in that 30 to 35 cohorts than there were five years ago. They're sort of starting to enter into this kind of prime home ownership years. I think a lot of it is being stimulated by demographics and really being accelerated by what we're seeing in terms of interest rates. We're not seeing it yet with our residents. Our [audio distortion] actually went down 3%. Home ownership is going up nationally, and it has an impact on the overall renter pool that affects all of us as landlords at some level.
We think we're probably less than sort of the epicenter of it. It's probably mostly coming from single-family rental and other demographics in other markets. It does have an impact on the broader sort of renter pool if you will.
Got it. That's helpful. I've been a little bit surprised there hasn't been more focus this earning season on the election coming up in a couple of months. Potentially, with regulation depending upon what parties have power. I'm wondering if that is something that you're focused on. Obviously, the Biden plan has housing as a big focus. Affordability on the other side of COVID-19 is obviously more challenged. How are you thinking about that maybe over the medium to long- term?
Rich, the fact is that, most of the regulatory risk we face is really at the local and state level. Not as much at the national level. I think we'd probably be a little bit more concerned if there was another nominee that was a Democratic nominee, certainly at the national level. Our markets have always been more regulated than other markets. We are in blue states.
It's part of what's been the appeal of our markets, is sort of the barriers to entry has created some supply constraints on new housing, which has helped elevate rents and rent growth over time. I think the issue that you're starting to touch on is the key one, which is when it starts to leak into price controls and rent controls, that becomes the issue for us, and the type of rent control. Certainly in New York and parts of California, you have vacancy decontrol. That's usually pretty manageable in terms of as an owner of the policy. When you have control pricing on vacants, as they become available, that's the kind of rent control as an industry we have to absolutely avoid, and it'll be awful for the housing markets if that occurs. That's something we're going to continue to watch.
We're going to continue to fight as an industry. It's not effective for us as landlords for sure, but it's not good for the housing market long- term. It's not a way to solve any housing crises at any local level. It's politically expedient, but it's poor policy standpoint. It's absolutely poor policy.
Understood. One more question, if I may. In the past, you've done a really good job thinking about how your development and your land development is really under option, and you don't have to move forward with it. I'm wondering, as you survey the landscape post-COVID-19, are there any land that you have under option in maybe high barrier blue states that you might want to not move forward with? You mentioned Florida, I think earlier in your remarks. Are there any other markets where you prefer to maybe focus on the development going forward versus some of the markets that you're in right now?
Yeah. Hey, Rich, it's Matt. As it relates to our current development rights pipeline, you're right. We only own two of those 28 deals as land only we bought from a third party. We do have a lot of optionality, and it's really deal by deal. There may be deals in there that are not going to work without some type of restructuring. There are other deals that probably will work, and there's some deals where we may say the land is a good price, and we may close on the land and carry it for a while and wait for hard costs to come down. It's a little bit of all of the above. It doesn't really factor into the geographic mix. It's really bottom up in terms of where we're finding the best opportunities.
We have a couple development rights in some of our expansion markets, including two in Denver and one in Florida that are working their way through the system. We have development rights in our legacy markets as well. I don't think we've seen any particular trend yet in terms of an impact to the land market or development economics, more so in one market than another, other than where you're seeing, obviously, rents taking the biggest hits thus far.
Got it. All right, guys, thanks for your time, and I appreciate the answers.
Next question will come from Wes Golladay with RBC Capital Markets.
Hi, guys. Another development question for you. I was wondering if you could frame up how the development pipeline at AVB is positioned relative to the headwinds you cite on slide six. Then basically kind of give a sense of the potential volatility around your 5.7% projected development yield.
Yeah. I'm sorry, is that about the development underway or the development rights?
Yeah
pipeline future stuff?
Yeah, sorry, the active pipeline. I believe you guys pivoted a few years ago to more of a suburban footprint, but I don't know if they technically qualify under you guys as though the infill that you cited as a headwind on page six.
Yeah. When you look at the $2.4 billion in development underway, you can kind of look at it. The current yield is at 5.7%. There's only five of those 19 where we've actually done enough leasing that we've rented to market yet. On those five, actually, the rents are slightly ahead of pro forma by about $30. Now the deals are a little bit behind because there's been some cost overruns on a couple of those deals. Generally speaking, so five of the 19 are more or less marked to market. The other 14, you could handicap them. A lot of them are in markets that have seen less downward rent pressure so far. It is a predominantly suburban portfolio.
In fact, looking at, I think the only deal in there that we would consider urban, other than Hollywood, which is under construction, would be the one doing Downtown Baltimore.
Yeah. That's exactly what I was looking for.
Yeah.
Got it. What about with the work from home trend? Are you noticing any demand for your larger units, people looking for maybe another room for an office or maybe rooms with a view?
Yeah. Wes, this is Sean. We've been digging into that, and at least based on sort of early returns, I would say it appears as though suburban direct entry product which often is a town home, is doing a little bit better in the current environment. Again, it's a little bit mixed, but overall, that appears to be a positive trend for us in terms of that product type across the portfolio.
I would say, just to add to that, this is Matt. When you look at our development, as an industry, the average unit size has been trending down really for the last cycle. It probably came down 10%. What we've seen, at least the last year or two, our development starts, the average unit size has started to move the other direction. A lot of that is in our shift to more suburban assets. Also even before the pandemic.
We were starting to see just the demographics heading where there were greater demand for three-bedroom units, which we didn't used to hardly build at all. Now almost every project we build has a three-bedroom unit and more of the kind of one-bedroom and two-bedroom lofts. We're definitely building more of that product than we were five years ago.
Got it. Thanks a lot, guys.
Our next question will come from Nick Yulico with Scotiabank.
Hi, guys. This is Sumit Sharma in for Nick. Question about your bad debt expense. I just want to be clear, maybe you've stated this earlier, so I apologize in advance, but of the 2.7% of uncollectible rent, I guess how much was part of the bad debt provision or reserve? Some of your peers have talked about reserves of the tune of 200 basis points or so. Just getting a sense of how much went into reserves, how much is deferred, how much is just write-offs and cash bad debt?
Sumit, this is Kevin O'Shea. I'm having difficulty hearing you, but maybe just to give you an overview of what we did with respect to bad debt, and then you can ask questions to the extent that I'm not responding to some of your questions. First of all, our policy is to reserve the delinquent-based residential rent for three months and those delinquencies after two months. For residential revenue, we typically take a reserve of about 50 basis points of residential revenue, and we did so in Q2 in our same-store portfolio. In addition, in Q2, we took a further reserve of about 200 basis points or $10.7 million, including for residents who didn't pay anything during the quarter. That resulted in a total reserve for the same-store residential revenue portfolio of about 250 basis points or $13.6 million.
Of course, we continue our collection efforts, and we're certainly encouraged by recent collection trends, which show collections against unpaid April and May rents improving to about 97.5% from about 93%-94% at month end. That's the story on residential revenue. Is that helpful? Is that responsive?
Yeah, no. That's great. Thank you so much, and apologies for the bad sound quality. Another question following up a different kind of way. I'm just wondering in terms of the concession activity, you actually provide a lot of information on urban versus suburban. Trying to understand what kind of unit types are seeing the biggest concessions, two bedrooms, three bedrooms. I think a few moments ago someone was talking about developments and how they're changing with the unit mix. I'm just wondering from a concession standpoint, where are you seeing the biggest drop in rents, or where you have to give the largest amount of concession?
Yeah. This is Sean. I can give you some general thoughts on that. First, as you might imagine from what we described in our prepared remarks, concessions are generally greater in urban environments compared to suburban environments. We'll start with that. Within urban environments, we tend to see fewer concessions on the more affordable price points, which tends to be the studios and one bedrooms in those sub-markets as compared to the larger units. Initially we thought there might be sort of steadier demand for larger units and people looking to work from home with extra space. I think the affordability issue sort of weighed on that a little bit, and we've seen better performance out of the studios and smaller one bedrooms. In the suburban environment, I wouldn't say there's a common theme as it relates to unit type.
It's really sub-market driven and the nature of the demographics within that environment. We've got very high-quality towns in suburban Boston with great schools, and two and three bedrooms are in solid demand, and one's not quite as much. If you revert to some sub-markets in L.A., the more affordable price points in the studios and one bedrooms are in better shape as compared to the larger two and three bedroom units given the shutdown of some of the entertainment studios and such. It's not a common theme as much as it relates to suburban unit types as much as the specific suburban geography.
Great. Thank you so much. Appreciate all the answers. Thanks.
Yeah.
Our next question will come from Alex Kalmus with Zelman & Associates.
Thank you for taking my question. Looking into bad debt and delinquencies, have you guys run analysis on your resident base to see what age, income, or profession this is mostly centered on?
Alex. It's Sean. We have run some data on that. I guess what I would tell you is it's more industry specific than it is typical demographic makeup in terms of gender, age, things of that sort. It tends to be self-employed sort of freelance workers, content producers, folks like that have been impacted most materially. Some of our e-community, some of the service-based sectors that have been impacted as well, whether it's food service, hotels, things of that sort. Some of the occupations that Tim alluded to earlier in his opening remarks. It really is more occupation driven than anything else.
Got it. Thank you. Just to touch upon The Park Loggia sales, how was the selling on that this quarter? I noticed the average unit price was a little higher, so I'm assuming some of the higher units got sold. Was there any discount to February levels that you needed to offer to enhance the sale process?
Hi, Alex, it's Matt. The closings that we saw in the second quarter were almost completely deals that had been under contract earlier than that. Not entirely. There were a few deals we did in the second quarter that were quick closes, including, I think, one of the penthouse units. The average price that's settled in any given time period is really more a function of just what units happen to settle based on scheduled settlements and so on. You can't draw a lot of conclusions, I don't think, from that. We have 54 units closed right now. We have another 12 under contract. When you add that together, it adds up to a little bit more than $200 million. There certainly is negotiation, and there's probably more negotiation at the higher price points, and that was a trend even before the crisis hit.
We have not really taken a different approach to pricing post-COVID. There hasn't been enough traffic and transaction velocity in the market to really even justify it. I'm not sure that if we were to drop prices, we would see a significant change in the volume. We were offering a very compelling value, we believe, before, and it's still a pretty compelling value. That was validated by the pretty strong sales pace we had before everything shut down in early March. There is more supply coming, and I would say that there is a little bit more negotiation at the higher price points, but we expected that. Relative to our expectations, nothing's really changed with our pricing yet.
Got it. Thank you.
Yeah.
As a reminder, for those on the phone, it is star one to ask a question, and this will be your last opportunity to enter the queue. Our next question will come from Alexander Goldfarb with Piper Sandler.
Good afternoon, and thank you. Two questions. The first one is, do you guys have an idea of how many residents are living in your apartments who are paying rent but aren't actually there? They've moved away, but they're still paying rent.
Yeah, Alex, it's Sean. That's a tough number to come up with. The blunt answer is no, we don't. Unless they voluntarily come to us and say, "Hey, I'm going to be gone for X period of time. Can you do something for me?" There's not necessarily a tracking mechanism for that that would give you any real sense of accuracy there.
As your apartment managers are seeing, I guess, maybe mail not being picked up or what have you, there's not a way to sort of track and understand if those people plan on coming back or they're going to exit whenever their term ends?
Not necessarily. People have mail picked up. When you think about buildings that are 500 units and you have 1,000 people in them, it's really hard to get a sense for that, unless there is something specific related to a mail hold that we're aware of or package delivery. I wouldn't say you could count on that as a representative sample that would give you an accurate estimate.
Okay. Kevin, on the development program, you guys were planning on doing meaningful starts this year. You haven't. At what point as you deliver, but you don't replace the delivery, at what point do the current capitalized costs start to burn off, and those expenses start to accrete to the income statement? How far would the delays have to go, meaning before you would see the expenses start to appear on the income statement because they could no longer be capitalized?
Hey, Alex, this is Tim. Maybe I'll jump in, and Kevin may have something to offer. Generally, if we have people working in development or construction that are not actively working on a job, whether it's one that's under construction or one that's going through the planning process, they get expensed. They go to the income statement. They don't get capitalized. While we haven't started anything year to date, we still have over $2 billion under construction and $4 billion going through the process. We're still managing a $6 billion pipeline. Now we are trying to right-size it. If you look at this quarter, it's about 10% lower than the last four-quarter average of total capitalized overhead.
It's been trending down as we've had some recent departures and retirements over the last 6-12 months of some senior folks as we try to really start to sort of right-size it for the sort of the next cycle and where we currently at. Living in that, well, you probably noticed that roughly about half that group's comp is in separate pay. If they're not doing things or if they're not doing as much production, there's a sort of automatic adjustment factors in the overhead piece as well. Our objective is really just to be well-positioned and right-sized kind of for the early part of next cycle to be able to flex up if we need to as the opportunities arise. The capitalized overhead this quarter is about $11 million.
About six and a half of that is development, about three of that's construction, and about a little over 1 million of it's new development. If you annualize that, you get about $25 million in development, about $12 million in construction. That is a level that supports kind of in the, I think we were talking about $800 million-$900 million range sort of plus or minus, and that's what we're still geared for. To the extent we saw that over the next three or four years, it doesn't make sense to be doing that kind of volume. Obviously, headcount will need to be adjusted. I fully suspect over the next couple of years, we're going to be in existence sort of ramp up that curve. We want to make sure we've got the leadership and the right personnel in place.
We're still managing as we go into this recession, about $6 billion worth of total pipeline, which is probably only about 25% off of kind of where its peak level, probably in the $7.5 billion, $8 billion range.
Okay. That's helpful. Thank you.
Sure.
Our next question will come from Rob Stevenson with Janney.
Good afternoon, guys. What's the positive impact that you typically see in terms of traffic and leasing-wise in the May, June, July time period from the influx of new college graduates renting for the first time in your core markets in a normal year? What have you seen thus far this year? It seems like very few college grads in your core markets have actually rented apartments this year versus a normal year, given how early COVID hit, that might be a big driver.
Rob, Sean. Good question. A couple thoughts on that. Not necessarily specific data since it's a little hard to capture. In our particular case, and we don't have a lot of student-oriented assets, they're pretty select across certain markets, particularly in the urban environments, I would say. Your broader question really probably relates to the percentage of the market that is really made up of the student population that sort of brings the occupancy up in the entire market. That's something, to be honest with you, we are trying to get our arms around. We are not quite there yet in terms of what that represents in each one of those sub-markets. There are certain sub-markets, like we have a property here in the D.C. that's pretty tied to AU that when they announced their plan to have a hybrid learning model, we did 80 leases in one week.
There's some markets that are like that are highly dependent upon it. I think the broader question is one we're still trying to answer, which is sort of collectively, what the demand is from the student population is one segment, and then from the short-term and corporate rental market is the other segment. We think the short-term corporate piece is probably in the 2% to 3% range. We try to understand that in terms of the student population, particularly as universities may shift their on-campus housing options to the extent that they're trying to sort of de-densify some of those communities. It's a little bit of a moving target that's probably hard to answer right at this exact moment.
Certainly the peak time for that demand is, as you described, is the moving through the pre-leasing season that you're going to see sort of from basically April through June, that you might see on some of the student housing rates. You want to be pre-leased in those buildings in the 90%+ range as you get towards the end of July before they show up in August. We're on track for that at some of the buildings, but there are places in and around urban Boston, Berkeley, places like that, where they are falling short because of the uncertainty around the ultimate learning model.
Well, beyond the student stuff, I was really focused on the 21, 22-year-olds who just graduated that have a job with, let's say, an investment bank, a tech company, a consulting firm or whatever, that you'd normally get in New York, San Francisco, Boston, et cetera, renting for the first time, where they're bringing an offer letter to you and they're leasing off of that. That influx of former students now people entering the workforce for the first time, how significant is that typically in these big sort of gateway cities?
It's probably a couple of answers. The stuff that's related to people that are coming in for a specific kind of program, like a training program or some other kind of corporate program, could be 2%-3% of the market. Our market, what you're really talking about is just ongoing demand as people are graduating from universities, moving into the rental market. That's a little tougher to quantify overall at this point in time.
Yeah, Rob, I was talking earlier in my remarks about the typical household contraction and consolidation that you see in a downturn. That is part of it, what you're describing. Kids that can't get jobs when they get out of college and stay at home, or they go into a house with six people instead of getting their own apartment. You'll see in past recessions, we've seen occupancies fall by a couple hundred basis points as they still became a little bit of new supply. It's not unusual to see a contraction of household demand on the order of 1 million, 2 million housing units across the country in a normal downturn. A big portion of that is, I think, exactly what you're really focusing on.
Okay. Lastly for me, what are you guys seeing today versus at the beginning of the year in terms of construction costs, both hard and soft? How meaningful has been the delta, and where's the greatest amount of slack today, and is there any of these buckets that you're seeing more pressures either up or down on now, given what's happening with single family or what's happening elsewhere, the falling off of new construction in other sectors?
Yeah. Hey, Rob, this is Matt. We are starting to see it, but it is little. Where we started to see it first is really in some of the smaller contract CapEx work
If you think about it, those are the types of jobs that are short in duration. If you're a subcontractor that's doing a facade restoration project for us or some concrete repair work, that might be a two or three-month or six-month job. If they finish one up, they don't necessarily have stuff to replace it. We are starting to see it there. In some markets, we've seen mid-single digit buy-up savings on that work, which isn't all that meaningful, but given where we've been coming from, where we've just been seeing construction costs growing much faster than inflation for the last four or five years, it is a significant change. On the new construction, it's probably still too early in almost all markets because everything's underway, and there's a lot underway that's going to have to get finished first.
Again, where you're going to see it first is going to be in the early trades, earthwork, pipe work, demolition, maybe a little bit concrete. Regionally, it's going to vary as well. What we've heard others say is maybe we'll start to see it a little bit in South Florida because a big part of what drives that is also, there's no wood frame construction there, for one thing. It's all concrete because of the hurricane codes. There's a lot of cruise ship restoration work and hospitality work that's not happening, that's been canceled. The subject there has more excess capacity. It hasn't really worked its way into most of our markets yet. Some commodities are down. Lumber is up. Lumber is up quite a bit right now.
That's probably a response what's gone on in the single-family market and just home renovation market. There's some cross-currents there, but it generally takes a while. Construction pricing is a lagging indicator, it's going to take a while for it to work its way through the system.
Okay. Thanks, guys.
Our final question will come from Rich Anderson with SMBC.
Thanks. Good afternoon. Hope everyone's well. Tim mentioned, or maybe somebody else, but the kind of suddenness of what happened made a lot of decisions for you, particularly as it relates to development postponement. If memory serves, in the 2008, 2009 time frame, you did have a sizable write-off related to your development pipeline. And if I'm wrong on that, I apologize, but going on memory. I'm curious, though, if you fast-forward to 12 years later today, is there anything about what happened then that you took from, a lesson learned, and is sort of allowing you to sort of walk a tightrope here without having any sort of disruption like that? I'm just wondering how that experience during the Great Financial Crisis has manifested itself in how you look today.
I know you mentioned the difference in balance sheet in your prepared remarks, but I'm just wondering just in terms of how you approach the business, particularly on the development side. Thanks.
Yeah. Hey, Rich. Tim, I'd say it's largely been in land. When you say we had, I think we wrote off or had impairments on the order of about $80 million total, and a good portion of that was in land. Look, I would just say, relative to the size of the development pipeline, we've had deals where profits have been larger than that in terms of value we've created. Home builders were taking impairments of into billions. I think we took an impairment on the order of $60 million. This time, we just done it on land. We've been really very disciplined about maintaining optionality. As I was talking earlier, some of the deals may not make, and we may have sellers that are unwilling to restructure to the extent restructuring sort of could close the gap.
We could have some future write-offs, I suspect. It really was a perceived cost, which is pretty cheap capital relative to the size of the pipeline that we control. I would say the biggest issue is just we just don't have land inventory of any significance aside from the last one.
The only thing I'd add to that, this is Kevin, Rich, is just obviously we've discussed many times in recent years, one key lesson we took from that long-term was to be a whole lot more match funded with respect to the development underway in terms of having the long-term capital in place. You see that lesson being applied here in a very visible way with respect to [audio distortion] underway right now that are 95% already match funded. That obviously leaves us a lot more foot forward this time around if there's new opportunities and they pop up.
Great. Then secondly, a lot of talk in this call about suburbs beating the urban core. You guys are, I think, correct me if I'm wrong on this one, I think you're 60, 2/3 suburban, 1/3 urban. Perhaps you're still an expensive option in those suburbs, but do you think that sort of breakout could ultimately help you out long term here as this sort of situation settles, in that people maybe don't go all the way back in, but they come back close enough where it benefits you and your suburban portfolio?
Again, Rich, I think I said earlier, there already was a trend. We already were starting to tilt the portfolio suburban. If you look kind of at our history, probably where we've created the most value, at least in development pipelines, sort of kind of that suburban infill. I think as millennials get a little bit older, you see more activity out there in the suburbs. I think this kind of urban light kind of lifestyle, mixed use kind of in infill suburban areas probably offers one of the more attractive opportunities that's less dense than an urban environment also generally is more affordable than what can be delivered in an urban area. We were already kind of moving in that direction, and maybe this just pushes us a little bit harder.
I think the demand factors that were already in place are just probably just being magnified by what's happened here the last few months.
Great. Thanks very much. I appreciate it.
Thank you.
With that, I will now turn the call back over to Tim Naughton for closing remarks.
Okay. Well, great. Thank you, Matt. I know all of you have a number of calls you need to be on today, so we just want to thank you for being with us, and enjoy the rest of your summer. We'll talk with you soon.
Once again, that does conclude our call for today. Thank you for your participation. You may now disconnect.