Good morning, ladies and gentlemen, and welcome to the AvalonBay Communities Third Quarter 2018 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.
Your host for today's conference call is Mr. Jason Riley, Vice President of Investor Relations. Mr. Riley, you may begin your conference.
Thank you, Brandon, and welcome to AvalonBay Communities Third Quarter 2018 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 is a discussion of these risks and uncertainties in yesterday afternoon's Press release as well as in the company's Form 10 ks and Form 10 Q filed with the SEC. As usual, this press release does include an attachment of definitions and
www.avalonbay.com/earnings,
and we encourage you to refer to this information during the review of our operating results and financial performance. And with that, I'll turn the call over to Tim Lawton, Chairman and CEO of Avalon Bank Communities, for his remarks. Tim?
Great. Thanks, Jason, and welcome to the Q3 call. Joining me today are Kevin O'Shea, Sean Breslin and Matt Birenbaum. Matt and I will provide management commentary on the slides that posted last night and then all of us will be available for Q and A afterwards. Our comments this morning will focus on providing a summary of the results for the quarter, An overview of economic and apartment fundamentals and their impact on current portfolio performance a review of investment and portfolio management where we were very active this past quarter.
And finally, we'll share some progress on our Columbus Circle mixed use development. Starting now on Slide 4. Highlights for the quarter include core FFO growth of 4.1%, which was $0.03 per share above the midpoint of our Q3 outlook. You'll note that we've increased the midpoint of Full year 2018 outlook by $0.03 to $9 per share. Same store revenue growth came in at 2.3%, and same store NOI growth was 3.1% for the quarter.
The midpoints of the range for same store performance, Revenues, expenses and NOI remain unchanged from our midyear updated outlook. You'll note, however, we did provide Additional ranges for revised same store basket that excludes the New York JV assets, assuming that deal closes prior to the end of the year as expected. We completed $315,000,000 in new development for the quarter at an average initial projected yield of 6.2% And have now completed $740,000,000 as a 6.4% projected yield for the year. We also started 2 new communities towing just over $200,000,000 in Q3. And lastly, we raised 100 $70,000,000 of external capital through the sale of 1 Community at an average cap rate of just under 4.5%.
Turning now to Slide 5 and an overview of fundamentals. I'll just go through this quickly. As all of you know, the U. S. Economy is very healthy currently with GDP growth running around 3.5%, corporate profit surging by double digits, Labor markets, that are the tightest we've seen so far this cycle and household wealth recently reaching record highs before the recent pullback in the equity markets.
Turning to Slide 6. The economy is being driven by both with the business sector and the consumer. Strong business and consumer sentiment is translating into increased levels of capital investment and household formation, both of which are good signs for the economy and the housing market over the next few quarters. While these and most other leading indicators are still pointing out, there are some potential risks that are worth watching, including rising geopolitical tensions, the threat of trade wars and the normalization of interest rates through continued Fed tightening. But overall, it appears we'll have a solid macro environment in which to operate over the next few quarters.
Turning to Slide 7. This favorable macro environment is, in turn, supporting apartment fundamentals, which are showing signs of renewed strength with several drivers of rental demand turning up, Including young adult job growth, which is running above 2% again, wage growth reaching a cyclical high And housing affordability actually hitting a cyclical low, all positive trends for apartment demand. These drivers are all further supported by demographics as the young adult age cohort of those under 34 is projected to experience decent growth The next 5 years and not peak until 2024. Turning now to Slide 8 and the supply side of the equation. It appears we're beginning to see some early signs of relief in supply as both permits and starts have been declining in our markets for most of the year.
In fact, over the last two quarters, on a seasonally adjusted basis, starts and permits were down by 20 by over 20% in the prior two quarters. This is probably mostly due to construction cost inflation that we've been talking about, and it's been averaging in the high a single digit range over the last year with some regions like the Bay Area even reaching double digit growth. With rent growth generally averaging 2% or 3% over the last year, projected yields on prospective deals have deteriorated by 25 to 50 basis points over the last year or so depending upon the market. It stands to reason then that this would begin to have An impact on new development investment that seems to be occurring in our markets and to some extent nationally. We've also seen a pullback in the public markets as the apartment REIT sectors cut back on development underway by roughly 35% since year end 20 16.
Of course, this recent pullback and start activity in 2018 won't be felt Really in terms of deliveries until 2020 or late 2019 at the earliest as we expect new deliveries to remain elevated over the next 4 quarters So as you can see in the box in the lower right in this chart. Turning now to Slide 9. As you might expect, improving demand 4 quarter moving average and light term rent change for our same store portfolio. As you can see, rent change has started to turn up. Again, this is a 4 quarter moving average, driven by improvement in Q2 and Q3, which posted stronger rent growth than the same quarters last year with Q3 average rent growth of 3.2 percent or 70 basis points greater than Q3 of last year.
Similarly, growth potential for the same store portfolio started to turn up and Q3 was at 2.3% or 60 basis points higher than the Q3 of 2017 for the same store portfolio. Turning to Slide Ken, most of our regions saw solid improvement in the quarter. Northern California saw the biggest bounce With rent growth of 4%, which was 250 basis points higher than Q3 of last year, All three East Coast regions saw good improvement in the 50 to 100 basis points range. Southern California saw modest deceleration And Seattle, more significant deceleration from the prior year. Q3 rent growth in both those regions, however, We're still at or above the portfolio average of 3.2%.
These trends have largely continued into Q4 with like term rents up by about 3% in October. In addition, rent growth is broad based with every region currently in the 2.5% to 4 And the East and West performing roughly in line with one another for the first time since 2011. I'll now turn it over to Matt, who will discuss investment and portfolio management activity this past quarter.
Matt? Hi. Thanks, Ken. Turning first to our current development activity. As you can see on Slide 11, our completions this year have continued to meet our initial underwriting deliver very healthy value creation with yields of 6.4% compared to estimated cap rates for the same assets of roughly 4.5%.
In addition, our development portfolio is generating lease up NOI as expected, contributing to earnings in 2018, right in line with our initial guidance. This quarter, we completed Avalon Dogpatch, our largest development completion of the year. This wood frame community, which is uniquely positioned in an emerging neighborhood of San Cisco that offers mainly HiRise product was delivered at a very compelling basis, which in turn contributes to its 6.2% yield, This is in large part due to us acting as our own general contractor in most cases and having a majority of our trading costs locked in at the time we start a new project. This is particularly important given the increasing cost base in our industry. As Tim indicated, construction inflation is running well ahead of rent increases, a particularly acute issue in the tech markets on the West Coast.
This quarter, we did recognize cost increases on 2 wood frame projects Currently under construction in the East Bay in Emeryville and Walnut Creek. These budget increases, which collectively total approximately $40,000,000 or 15% of our original estimate for those 2 projects, were the result of unexpected union pressures and subcontractor performance issues. These two projects are exceptions to the general trend, which continues to reflect excellent construction execution. And across our current overall development portfolio, even including these Our actual costs are tracking within 1.6% of the original budget as shown on the slide. Turning to Slide 13, Our sector leading development platform continues to provide excellent risk adjusted returns with approximately $3,000,000,000 in value creation so far this cycle and another $800,000,000 expected from the development currently underway.
While new starts may be less profitable than early cycle deals due to the cost pressures just mentioned, We are confident that long term returns will still be highly accretive, consistent with our track record as shown in the chart in the upper left. And we continue to manage capital markets risk by match funding our development activity as shown in the lower right. Turning to Slide 14. Our transactions team has had a productive year. As we execute on our strategy to rotate capital into our expansion markets of Denver and Southeast Florida, We are on track to complete the acquisition of 4 communities before year end, including 2 suburban garden properties in the Denver area, a high rise in downtown West Palm Beach And a garden community in the Baltimore Washington corridor just north of BWI Airport and the NSA headquarters at Fort Myers.
We've been opportunistically funding both our acquisition and development activity primarily through the transaction market as shown in the table on the left hand side of the slide. We will have sold over $1,200,000,000 in wholly owned assets by year end, which after netting out $335,000,000 in planned acquisitions, This leaves us as net sellers of roughly $895,000,000 during the course of the year, providing cost effective capital to fund our external investment activity. To provide a little bit more detail on the Manhattan JV transaction, as we announced earlier this month and as shown on Slide 15, We are selling an 80% interest in 5 stabilized properties, valued at $760,000,000 on a gross basis. As we've indicated for the past several years, our allocation to the Greater New York region is a bit higher than we would like, and this imbalance Otherwise, we're trending even higher due to the development pipeline we have in the region. We have sold about $1,100,000,000 in suburban New York assets over the last 4 years, but have not sold any wholly owned properties in New York City itself until now.
This transaction further reduces our allocation to the Greater New York region, while preserving our brand presence and rebalances our allocation within the region to roughly 1 third each in the city, the New Jersey suburbs It is important to note that while these are among the most highly valued assets in our portfolio, There is a material difference between the short term earnings yield or initial investment return and the transaction cap rate as that term is defined by various market participants. This is due to the presence of property tax abatements on all five assets and a brown lease structure on 2 of the assets, which provide a short term boost to cash flow until their expirations and or resets. Consequently, the unlevered earnings yield on the assets is in the low 5% range, but this yield is roughly 150 basis points higher than what might be considered a normalized cap rate after adjusting for these factors. The impact of the JV transaction on our portfolio can be seen on Slide 16. Metro New York share of our total NOI will drop from 24% to 22%, closer to our long term target of 20%.
Moving to Slide 17, I'd like to provide an update on our Columbus Circle development. This asset includes approximately 67,000 square feet of prime retail space on Broadway and 172 residential units and is on track for completion next year. Turning first to the retail component of the project. This slide shows our leasing progress today. We are pleased to report that we have executed a 35,000 for the 2 below grade floors and a main entrance on Broadway to target.
In addition, we are in advanced negotiations to lease just under half of the second floor space as well. These two tenants will bring us to 65 percent leased by square footage and 45% leased by revenue, and both are at economics at or We expect to turn over both spaces for TI work to these tenants in early 2019. As for the residential component, We are currently exploring a shift from rental apartments to for sale condominiums. From the beginning, one of the most appealing aspects of this Apart from its absolutely AAA location has been the flexibility it provides with no tax abatements, zoning restrictions or affordable components that would impede a condominium strategy if it offers a better return profile. While the Manhattan condo market has softened somewhat over the last year, as shown in the lower left corner of Slide 18, Our building offers some compelling advantages as indicated in the upper right hand side of the slide.
Our average unit size of roughly 1100 square feet, While large for a Manhattan rental building would actually be on the smaller side for a condominium offering, which in turn allows for lower whole dollar pricing than most other new product on the market. As a result, 85 percent of our homes would be priced below $5,000,000 at our initial projected target pricing, with
a wide variety of price
And between the Ace With Deep Lojos facing Broadway and the balconies on the other frontages, more than 40% of the units have private outdoor space, an extreme rarity for such a prime Manhattan address. The outdoor space is not included in the average unit size, providing even greater value to potential buyers. We're still studying this option in greater detail, but our economic analysis suggests that at current market pricing, there could be more than $150,000,000 in additional pre tax value through a condo To maximize our optionality, we are proceeding with some modest upgrades to the finishes in the building, which we believe would have value under either scenario and which will increase the expected total capital cost by less than 5%. If we decide to proceed with the condo execution, we would open for sales in March or April of next year, Establish a threshold level of minimum sales contracts, which we would require before finalizing the condo regime and proceeding to first settlement. Of course, we will continue to keep you apprised of our progress and our thinking on the set it evolves.
With that, I'll turn it back to Tim.
Thanks, Matt. So in summary, a healthy U. S. Economy is supporting stronger apartment market fundamentals in most of our regions With same store rent change improving over the last two quarters and so far in Q4, development activity is generally Tracking expectations in terms of lease up and yield performance, although we are experiencing some cost challenges in certain markets, as Matt mentioned. We continue to make progress on our portfolio management objectives through activity in the transaction joint venture market.
And lastly, as Matt just mentioned, we're making really solid strides in retail leasing at our Columbus Circle mixed use development, where we're also evaluating a Condo execution on the residential component. And we'll certainly continue to share our thinking with that as we explore this opportunity further over the next couple of quarters. So with that, Brandon, we'd be happy to open the call for questions.
Thank
The first question will come from Nick Joseph with Citi. Please go ahead with your question. Thanks. On Columbus Circle, when do you need to make a final decision on condo execution versus rental?
Yes, Matt, why don't you walk Nick through kind of
the time line there? Sure. Yes. So Nick, what we're thinking is that We would start some early pre marketing shortly in the next month or 2, just to start building a prospect list. And then if we're feeling comfortable with it, we would open a sales center on-site probably in March.
One of the things we have to offer that most other new condos don't is that we would have the product to actually show. So we think by March or April, we'll have So we're not thinking presales before we actually have product to show. But if we open on that schedule, we'd open in kind of March, April. And then if we were going to do that, we would just see how it goes. We would establish internally a minimum threshold percentage of units that we would want to have under contract before we lock in.
And that might take anywhere from 2 to 4 months depending on how sales go. So but it wouldn't be until after we reach That threshold, whatever it would be, 30%, 40%, 50% of whatever we want, that we would then actually record the condo and start settlement. We would have optionality all the way up until that point.
Yes, Nick, maybe just to add to that, it's probably obvious, but the opportunity cost would be potentially some loss Lease up revenue over the 2 to 3 or 4 months that Matt mentioned as we were seeing the kind of traction that condo execution With Jared.
Makes sense. And if settlements do begin in the back half of next year, what do you want to argue in terms of timing for a total sellout?
To some extent, that's going to be a function of pricing and that gets into some of our tactics and strategy. I don't think we're really at a point where we want to throw a target out there yet at this point for that. Thanks.
And then just finally, given the progress made on the retail leasing. What are the longer term plans for the retail? And will you look to sell it once it's leased? Are you comfortable owning and operating longer term? Yes.
Hi, Nick, it's Matt again. I think we would probably expect to complete the lease up of the retail space in the next year or 2. And then we'll look and we'll see. Hopefully, there'll be a good NOI stream in place, but we may well turn around decide to sell that in a couple of years because obviously it is a large retail asset and that's not our core business. But to get Maximum execution on that is that you can go ahead and lift it up and then we'll kind of see what it feels like at that time.
Thanks.
Thank you for the question. The next question will come from Rich Hightower with Evercore ISI. Please go ahead with your question.
Hey, good morning, everybody.
Maybe just a quickly follow-up
on the Columbus Circle retail question there. Can you give us a sense of just how competitive the leasing Process was for the space to target tip down and then also what is currently being offered to the market there?
Sure, Rich. It's Matt. I can speak to that a little bit again. There's been a lot of interest from a lot of different categories and for all different kinds of space. We have 3 very different price spaces.
We have the subgrade space. We have the Broadway frontage Ground level space and then we have the 2nd floor space. So at this point, all the subgrade space, a little bit of the ground floor For the entry to for Target and the entry for the 2nd floor tenant and about half of the second floor is spoken for. So what we're left And we continue to see it's different categories of users. Obviously, there's a very different rent level, so they're different kind of tenants.
So we've We have pretty good interest from a wide variety of tenants for the space Target took. We've had a reasonable amount of interest on the 2nd floor. The ground floor space is the most expensive space and Probably the space that the thought was we needed to get the anchor tenants set first, and that would generate more traction there. We are talking to folks, but we always expected that to probably be the last space to lease. So we're kind of not surprised with where that sits today.
All right. Thanks for the color there. And then my second question, I appreciate the detail in the earnings release surrounding the New York City JV portfolio impact on same store results for 2018. Can you help us understand, I guess, in rough terms what the impact on 2019 same store Would be from those assets being excluded from the portfolio?
Yes, Rich, this is Sean. To the extent that we complete the of the JV, whether it's December or January, those assets would be removed from same store, so there would not be an impact on same store per se. It would be removed for both periods for both 2018 2019 in terms of the calculation of the same store metrics for the calendar year 2019, if that's your The issue that led to the potential change in guidance as a result of the closing of the JV Related to 2 specific issues. One is the ground lease that we disclosed previously that we acquired the fee for Mullins Pointside Park last December. That's about $2,300,000 And then there's another roughly $700,000 that relates to the write off of a retail lease from Q3 of last year.
So those are obviously a tailwind as it relates to the 2018 same store results, particularly in operating expenses and there's an impact on NOI. So that's why it was necessary to basically indicate what the impact On the same store performance would be by a change in the composition of the bucket with and without the New York JV assets.
Aside from those two factors, the impact was negligible to the overall So that's okay. We're pretty
much tracking where we thought we'd be in terms of all the same store metrics except for the impact of the New York transaction.
Okay. Yes. I guess to be clear, I mean, obviously, the pool will change in terms of the calculation next year. But I guess my question Would be let's assume they were in the pool for all of 2019 and then compare that number to what the pool without them in 2019 would be, just to get a sense of growth across the rest of the portfolio, if that helps frame it a little better.
Yes. I mean, we're not ready to talk about 2019 in detail just Chad, but certainly New York is the market that we've been talking about that there's for a matter of supply this year, The supply starts to fall off somewhat next year. So you might see some marginal improvement there, but we haven't run through all the metrics in terms of the calculation of what we from New York and those assets in 2019 yet to be able to give you enough insight into what the impact would have been if we didn't sell them and they remain in the same store.
Got it. Okay. Thank you.
Yes. Thank you.
Thank you for the question. The next question will come from Nick Yulico with Scotiabank. Please go ahead.
Thank you. So your forecast for supply in 2019 is a little bit higher than this year. Could you break that down, the impact among some of your major markets where you see supply getting tougher or easier? Yes. Nick, this is Sean.
Happy to address that, maybe at a sort of regional level and an insight on a few markets. But As it relates to 2019, in terms of what we expect relative to 2018, we do see supply drifting down a bit in New England, primarily in Boston, up a little bit around 30 basis points in the Mid Atlantic And then up about 80 basis points in Northern California. And if you look at the markets where there is some meaningful change to really talk about In terms of increases in supply in 2019 relative to 2018, that's DC is about 3,500 units. And then the East Bay and San Jose are each about 2,400 units in 2019 beyond what they delivered or projected to deliver in 2018. In terms of meaningful declines, what we can see for sure, Boston about 1100 units, Baltimore about 2,000, Orange County, about 1200, about 2000 in San Diego.
We do expect to see a decline in New York City. Given the nature of the construction and delivery cycle there, there's some question as to what's going to be delayed moving into next year. So we expect some modest reduction there, probably not what would have been anticipated mid year when we saw it at that point, which is more meaningful. But we'll be scrubbing that pipeline later in Q4 to provide good solid updates when we get into the January call. Okay.
That's helpful. And then going back to the potential condo sales now in New York. I get that the overall NAV impact may be higher, the NAV benefit may be higher, but How do you weigh that versus taxes you'd have to pay on sales and units, economic risk for Selling units rather than leasing them. And lastly, how this all sort of plays into FFO and it Feels like investors have kind of discredited condo sales, income and FFO historically for REITs. So how do you kind of weigh all that?
Yes. Nick, Tim here. First of all, as an investment, when we We had a sense that maybe condo may be the highest and best use just given the fact there's no affordables here, just the outstanding location. We program the community to give us some optionality while the units are smaller than a typical condominium, they're larger than the Typical rental. So we'd always sort of program this to provide some optionality.
As we got further into construction and we saw what the potential differential was between rental value capitalized and condominium. We just thought we owed it to ourselves as a good capital steward to explore it further. And as Matt mentioned, we think We think the differential may be about $150,000,000 on a pre tax basis. So even if you calculate some tax in there, so that's probably We're talking about a 9 figure differential, and we think that we owe it to ourselves to explore that. And just the fact that this building is almost It's going to be ready for occupancy sometime next year.
It is a unique advantage in that we have existing units that we can sell, whereas a lot of condos that are on the market They are on a presale basis that are well beyond sort of the time that kind of time period in which they can deliver. So The cost here, the opportunity cost is a few up is a little bit of upgrades that we think we can capture value on the rental side as well. It's really sort of foregone lease up NOI for a few months. We can turn if we decide that demand just isn't there, the kind of values that we thought, We can always turn the lease up on this thing in really a couple of weeks. So it's I think the risk Profile, this is maybe a little different than somebody's thinking about this from ground up perspective.
Renting is our base business. And so if that's the fallback, we don't really see where the extra risk is, and we'll probably ultimately will require a higher presale requirement before making the condominium effective than There may be somebody who's holding a condominium purpose built from beginning. So hopefully, that's responsive To the question, something we've been thinking a lot of terms of how to just risk manage this opportunity. And as Matt laid out in We think we've done that. And as we said, we'll continue to keep both the analyst investment team very well informed as to how we're How we're seeing the market and how it's playing
out. Okay. Appreciate that. Thanks, Tim.
Thank you for the question. The next question will come from Juan Santaria with of America. Please go ahead.
Hi. Just a question on the strength or Lactobre seasonality this year. Have you Seeing any benefits from an elongated seasonal lease up period that may act as a headwind as we think about 2019 versus 2018?
Juan, it's Sean. Not really. I mean, things are pretty much falling within a traditional cycle for us in terms of seasonality. So I I don't think there's any material impact if you look at it. I mean, there was some discussion around that topic a couple of years ago, as it relates to some Market and what was happening in a shortened duration to the leasing season, but nothing unusual in terms of what we're seeing This year, that would bleed into 2019.
And just going back to Nick's question about developments and kind of the earnings impact From an FFO perspective, I guess, is there any development or should we think about any risk to FFO On developments coming online for 2019 kind of with and without going condo on the Upper West Side project?
Paul, this is Kevin. The only development that really is relevant here would be, Club Circle. And as Tim alluded to, there would be as a consequence of pursuing a condo strategy if we go that route, a couple of impacts We wouldn't have the lease up NOI, capitalized interest ceasing as it would for a rental, but it would be Stop when those units were made available. And then probably get some marketing costs associated with the pursuing the pursuit of a condo strategy that would probably be carved out of core FFO. So those are probably the 2 big things.
In fact, if there might be kind of gains, it would be carbonated core FFO,
lock in
costs would be carbonated core FFO. And then I guess the third thing is Lisa Benoit that wouldn't be present on the residential piece.
And when we give our In January 1, we'll be explicit as to what our underlying assumptions are with respect to Columbus Circle and lease up income as we have this year.
One, just one other thing to add to that. I'm not sure if you referred to this or not, but there was some discussion as we moved into 2018 that our deliveries in 2018 We'll be down a fair bit relative to 2017. As we move into 2019, we do expect deliveries to come back up to levels that are more What we saw in 2017, obviously, if I saw at Columbus Circle, we could have different queues, but You start to see more deliveries coming through, which obviously look different to us in terms of earnings impact in 2019 versus 2018.
Okay, great.
And do
you guys mind giving the portfolio wide new and renewals for the Q3 and what you're setting out the 4th quarter numbers at for renewals?
Yes. In terms of portfolio wide numbers as opposed to individual markets, I mean, as Tim alluded to, in terms of October, we're running around 3% In terms of the blended rent change for the entire portfolio and then if you're looking at offers, offers are sort of in the mid-six percent range for November December.
Okay. Thank you.
Yes.
Thank you for the question. The next question will come from Austin Wurschmidt with KeyBanc Capital Markets. Please go ahead.
Hi, good morning. Thanks for taking the question. This is really the Q1 we've seen turnover increase in some time. And I'm just curious if this was necessarily by design or just a function on the higher rents on renewals, is starting to force tenants out? And then, did
Yes. Austin, this is Sean. What you're seeing is a little bit of an anomaly. We really we had down about 2 20 basis points, pretty consistent with what we've seen, through most of this year in terms of reduced turnover. But There is a change to the expiration profile that moves the numbers a little bit from quarter to quarter.
So in general, the trend has been down in terms of reduced turnover, and That remains the case. So in terms of reasons for move out, no material changes whatsoever in terms of what we've seen this year Relative to last year, so that's pretty consistent.
Thanks for the clarification. And as you evaluated the New York City Joint venture, I mean, did you consider including any assets in the outer boroughs? I guess, considering that's where it seems like a significant portion of the new
Yes. Austin, it's Matt. We didn't actually. The portfolio that we brought to the market was all Manhattan assets, and it was all stabilized And that was by design that for the types of capital we were looking to partner with and selling a partial interest sale. We wanted a portfolio that had a fair amount of consistency to it.
And so we were advised Sorry, the folks who are working with on it, and I think appropriately that the more consistent the portfolio could be, the better. And For many capital sources, there's still obviously deep, deep institutional demand in the boroughs as well, but that would be kind of the thing that would get the most attention from the capital that we were targeting.
Great. Thanks for taking the question.
Thank you
for the
question. The next question will come from Drew Baden with Baird. Please go ahead.
Hey, good morning.
Question on New Jersey. It looks like revenue growth year over year decelerated a bit in 3Q relative to 2Q. And I was just wondering with A decent amount of supply, looking to come to North Jersey next year. Is that a market that you expect to maybe be a bit softer going forward? And I guess, can you talk about In Northern Jersey versus some of the properties you own in Central Jersey and what's going on there?
Yes. Drew, this is Sean. Happy to chat about that. In terms of Northern New Jersey, we don't have a significant portfolio there. And I'd say what's Most exposed to new supply as it normally is, is our Jersey City asset.
There's a fair amount on the Gold Coast being done, but we don't Big presence there other than potential impacts on Jersey City. So you will see some impact there. And the rest of the assets in Bergen County are generally at this point in terms of the nature of how they perform, they tend to be not Super high data assets is the way I described them. So they're not right along the Gold Coast in terms of sensitivity to new supply. So they tend to just chug along and performed quite well.
The same thing with the Central Jersey assets for the most part. So they're not They don't present a lot of volatility, but they tend to be stable in environments like this where there's a
lot of supply at the
high end, whether it's in the city or on the Gold Coast in Northern New Jersey. So We'll provide better insight into it in terms of the supply as we get into next year, but it's a pretty stable book of business. Overall, it kind of runs Like Long Island in terms of performing pretty well without a lot of volatility.
And I guess a related question as you kind of rotate around New York City, The Fairfield New Haven market, it's not in your New York Metro disclosures. It doesn't really grow like Boston, But also not a lot of new supply. I guess, how should we think about that market long term? And is it potentially a point where that might make sense for harvesting some capital?
Yes, I'm happy to comment on that in the Meccan as well. We certainly have been a net seller in the Greater Fairfield market Over the last few years and based on what we're seeing overall in terms of demand drivers in that environment, independent of supply, we probably will likely be a net But again, that market tends to perform just like the other ones that I mentioned, tends to run. I mean, we're talking about 2% year over year kind of numbers right now, It tends to hold between, I'd say, 1.5% and 2.5% historically in terms of revenue growth, if you look at it over a longer period of time. But to the extent that we find opportunities to sell some of those assets, some of which are uniquely positioned essentially as for sale assets or others Or I guess, this is rental. We certainly consider that.
Yes. Drew, this is Matt. I'll just add to that a little bit. We do think of Fairfield and New Haven, they are 2 separate MSAs. So we're pretty much out of New Haven at this point.
We've sold Milford last year, which I think was our last Asset in the New Haven MSA. But of what we have left in Fairfield, a lot of it is much further Kind of down county and closer to New York City with better train connectivity. But there are still probably a few assets that are a little more far flung That we are likely to sell there in the next couple of years. That helps. And then lastly,
a question for Kevin on the balance sheet. Seeing property yields on sales, obviously, kind of the mid-four range, is 30 year debt sort of in the mid-four range. Is there a certain point where if debt costs begin to creep up more that you might consider even lower leverage model if the economics between Selling properties and secured bonds, if the difference, at least in the short term, kind of equals out, Is that something that might be explored? Or should we continue
to think
about roughly 5 net debt to EBITDA as sort of a lower bound to the leverage target?
Drew, this is Kevin. Yes, I think for now, probably thinking about our leverage target in the low 5. Net debt The return level seems to make sense. As you're older, we're tracking where capital costs are today, and we have been able to sell some attractively priced assets to help support Our investment activity, but I think we're pretty comfortable with where our leverage is right now.
Great. That's all helpful. Thank
you. The next question will come from Richard Hill with Morgan Stanley.
This is Ronald Camden
on for Richard Hill. Just two quick ones from me. I'm just looking at the projected long term goals in terms of New York and Given that, that's going to be one where you continue to sell. Just curious between New York City, New Jersey, New York Suburban,
Do you guys have
a sense of where some of the low hanging fruits are? Is it going to be more sales in New York City? Is it Jersey? Or is it sort of all around?
Sure, Ronald. This is Matt. As I mentioned in the prepared remarks, we have been selling more in the suburbs So this is really the first time we've sold fully owned asset in the city this cycle. And we kind of I think the balance we're at now, which is roughly a third, a third, a third Feels pretty good. So we may lighten up a bit more in the New York Metro area.
There may be but I would look for kind of those proportions to the extent we Central Jersey, we might be a little heavy still because we have a lot of development actually coming to Central Jersey. So it might be a little bit more weighted that direction, but we'll try and keep it the same rougher portion.
Got it. And the other one, I was just it was interesting when you mentioned the 2 communities in Northern California, where those construction costs increase and so forth. One, is there any other markets where you're seeing that sort of pressure? And 2, can you just talk about maybe some of the long term benefits in terms of Reducing supplies to those areas.
Yes. It's interesting. The flip side of the pain, right? Right. Certainly, in terms of hard cost pressure in Northern California would be the most extreme right now.
Frankly, Denver has also We're not building anything in Denver, but that is one thing that's informed our approach to partner with others and frankly lay off some of that risk to partners, through potential kind of capital JV type structures that we've been looking at similar to what we're doing in Southeast Florida with TCR and Doral. So Seattle has seen quite a bit of pressure. I think it has, For whatever reason, a little bit of a deeper labor market and subcontractor base. So while it's seen also a great ramp up in supply, it hasn't responded quite as aggressively as Northentown, but that would be the other region where we're seeing still very strong hard cost growth. The impact on supply, we'll see.
I think as Tim mentioned, we're starting to see it in the start numbers in our markets in general, Perhaps more so in Northern Cal. I'll tell you on the development side, we haven't signed up a new third party development by Northern Cal in years. What we are focused on is entitlements where we'd be densifying in our own portfolio, and we have a couple of great opportunities there and or public private partnerships like the deal we have with the city at Balboa Reservoir. We've certainly seen it in our behavior. And you would think at some point, it would start to impact starts there.
Again, we're seeing that the process went slow. I don't know that it's disproportionately the million count right now,
though. Helpful.
Thank you. That's all I got.
Thank you for the question. The next question will come from Dennis McGill with Zelman and Associates. Please go ahead.
Hi. Thanks for taking my question. First one, just going back to Columbus Circle. I just want to make sure I understood the catalyst more near term. When you have the flexibility over time to think about condo versus rental, I think since the transaction was initially announced, the for sale market probably has gotten softer.
And then you took tax reform on top of that kind of creates some additional risk on the ownership side. So just wondering, is there something that happened more recently or something as you think rental assumptions that would have tilted this towards condo?
Dennis, I'll start and let Matt, jump in if you'd like. I think one thing that maybe we underestimated was the value of selling a new Condominium versus a conversion. So just from a pure value and execution standpoint, we probably underestimated that as we thought about kind of what our Well, we made the investment in the 1st place. So that's informed our view a bit in terms of exploring it now rather than saying let's just lease it up and Explore when the market is white hot. So that's probably been the biggest factor.
From a rental standpoint on the market's been pretty flat to slightly up, I think Sean mentioned. That really hasn't changed in terms of our view of the rental economics, at least on the revenue side.
Okay. And then as you think about just the backdrop of the market, you noted a couple of stats there on the slide there about contract activity being down and pricing incentives being up. What would you be assuming over the next 18, 24 months as far as the backdrop of the market? Are you just kind of holding that steady as far as the competitive nature?
Well, I guess the way we're thinking about it is, we're going to go into this pre marketing period and see how strong the market is and let the market tell us. And
so to
the extent we get a great response there through the brokerage community, the brokerage network, where we think we can start converting some of those prospects We then have sort of the 2nd milestone to actually try to get try to start building contracts. And again, we have sort of a second opportunity to decide whether we want to move forward or not based upon the strength of the market. And again, we don't have to be committed to this route if the weakness just It's stronger than I think than we always have the ability to lease these units up. So and essentially cancel any deals that we may have had in the market. So we think we got a couple of sort of milestones here that we can sort of test the depth of the market.
And if it's there, we'll go. If it's not, we'll go back to sort of plan A.
Okay. That's helpful. And then one just one last On the supply outlook, today you're looking for relatively stable deliveries in your markets 2018 versus 2017 and then 2019 to be up a little bit. We go back to earlier in the year, I think 2018 was going to be up more, 2019 would have been a fairly sizable drop. Can you just maybe Kind of the shifting between the years.
How much of this is a net net increase if you look at 2018 2019 together versus just maybe delay from some of the competitive supply?
Yes. I think, Dennis, this is Sean. We talked about it earlier in the year. I think what we said is that we expected some Now a reduction probably in 2019, but given what we've seen historically, to the extent that we see More delays than what has been normalized 2, 3 years. Those numbers could even out.
And based on what we see today, that appears to be happening. So the same assets are under construction. What's actually getting delivered in 2019 is increasing as a result of some movement from 2018. So As I said earlier on one of the in response to one of the questions, we'll be scrubbing the pipeline hard here in Q4 before we finalize our guidance for 2019 and be able to provide a good update at that point. But to be honest, just based on where we are on the cycle for construction and the labor availability, You can say that 2019 number, you expect that probably to come down some as you move through 2019.
It's just hard to get visibility on exactly where it's going to be and how much.
But net net, as you sit here today, is that collected 18, 19 in your markets higher today than earlier in the year or just distributed differently?
Distributed differently based on what we know.
Okay. Okay. That's helpful. Thank you, guys. Thank
you for the question. The next question will come from John Kim with BMO Capital Markets. Please go ahead.
As a nearby resident, thanks for bringing targets in the neighborhood. On your developments, with the pullback in starts among your competitors, is your strategy now to increase your pipeline Going forward or elevated costs kind of keeping you at current level? Yes, John, it's Matt. It's really I mean, our pipeline is driven by 2 things. Bottom up, where are the opportunities, where are we seeing the opportunities and Are we getting appropriate risk adjusted returns based on our underwriting?
And then a little bit top down as we talked about a couple of quarters mode, kind of what can our balance sheet support in a leverage neutral manner in terms of funding. So right now, I would say the constraint, the Bottom up constraint is probably at least a significant is the top down constraint. So we don't look at it and say, well, if the other public are developing less, We should be developing less or more. We really look at it in terms of what deals are there out there that are underwriting that are providing us reasonable returns. And there are fewer of those.
We've only signed up 3 new development rights all year this year, interestingly, 3 in the past quarter, but those The first three for the year, and one of those is a joint venture on a mall site with GGP Brookfield. So that's a deal we've been working on for a long time. One of them is identification of an existing asset that we already own, kind of like what I mentioned earlier in Seattle, taking that strategy from Northern Cal to Seattle. We're looking at maybe an opportunity in Southern Cal now to do the same. So it's more of that kind of business.
So I think it's more a reflection of the reality that where hard costs are, it's harder to find deals The ones that do tend to be more in the suburban and in the Northeast. You look at, for example, we just started a deal This quarter in Old Bridge, New Jersey, that's a deal we've had under contract for 4 or 5 years, a market that doesn't see a lot of volatility, has seen less pressure on hard costs and still has a very strong year. And Tim, do you want to add?
Yes. John, just put some numbers here. I think we talked about this since last Quarter, if you look at the 2013 to 2016 period, we probably average somewhere around $1,300,000,000 in starts. And as our Expectation in 2017, 2018 2019, that's probably going to be down. Kind of commensurate with what I said, the overall wheat sector is down by about 35%, 40%, more in the $800,000,000 maybe $900,000,000 range.
And that's kind of consistent with
kind of the market opportunity that we've seen as well as Matt was mentioning in his remarks. So
That's kind of where
we see it, at least for the foreseeable future, all subject to kind of What the economics actually look like at the time which we have to actually make the capital allocation decision.
And is the 6.4% yield that you've Had on completion year to date, is that representative of your overall pipeline ex Columbus Circle or what you're underwriting for new projects? The new development rights I'm sorry, the development rights that haven't yet started, the basket as a whole is probably in
the low 6s. That's probably just
a little bit under that. But it varies a lot based on where you are in terms of geography and product type. Okay. And just one quick one on Columbus Circle. The local press is referring to the building as 1865 Broadway.
Is the retail basically being rebranded or branded differently than the residential? No. I mean, the residential address is actually 15 West 61st Street, whether rental or condo. That's where the front door to the residential is. It's obviously not on Broadway, Which is the prime most valuable retail space.
So, and the retail address It's probably a Broadway address. There may be a second floor tenant who technically has a 61st Street address as well, but the retail Engages with broadway and our financial revenues with the 5th Street.
Got it. Thank you.
Thank you for the question. The next question will come from John Guinee with Stifel. Please go ahead.
Great. Thank you. A bit of an oversimplification, but on the condo conversion, looks like, let's say, dollars 110,000,000 profit after tax, 172 units, about $650,000 in additional value created after tax. What happens to the retail? We're assuming that you get out of that.
Can you Make any money on the retail? Or would the retail offset the value created on a condo?
We don't expect John, we don't expect to lose money per se on the retail as damage. It's not our core business. Average, they're probably a little less confident in our projections. But based upon our pro form a and the kind of rents that we're currently running at, We think it's it probably contributes modestly to the profitability of this project. Great.
And then second question, what's your crystal ball look like for hard costs over the next 2 or 3 years, Assuming the economy remains reasonably healthy, is it north of 5% annual increases or more inflation esque at 2 to 3.
Yes. No, it's a great question, John. When you're kind of in the middle of seeing these really healthy single digits, you kind of ask yourself what's going to change to So to change that outcome, we are seeing a drop And starts in our market. So that's the first sort of canary in a coal mine where it might actually see some relief on pricing. You are starting to see The builder is reporting order volumes being down, so that might help a little bit.
But we're at full employment And we're losing we're not replacing some of the skilled labor we have in the construction trades. And so this is Maybe both a secular issue and a cyclical issue. So I don't think we're we're not betting that it's going to be 2% or 3% or in line with rents, and it's one of the reasons why we're trying to maintain as much optionality on the development of our portfolio as we can. So, faded out until there's some kind of correction or ultimately if we need to write off some of those deals, we will if we just view them as uneconomic.
Last question. Any effect on land prices? Are land prices sort of remaining sticky?
Yes, I think it's still too early. John, this is Matt again. We do get that question, seems like every quarter. We're waiting. But land prices are sticky.
I would say, for the most part, they've probably stopped going up. And there are deals that aren't trading. There are deals that aren't trading. So terms of maybe getting a little more favorable. People don't always expect Put it under contract today and close tomorrow.
But we haven't seen any material decline in land prices that would make up for the increase in land cost.
Yes. The thing to remember, John, is land costs are generally 15% to 20% of total capital costs, whereas construction is like 65%, maybe as high as 70%, Yes, soft costs are another 15%. So, bank also has come down a lot to make up for the kind of appreciation An escalation received on the construction side.
Great. Thank you.
Thank you for your questions. The next question will come from Alexander Goldfarb with Sandler O'Neill. Please go ahead with your question.
Hey, good morning down there. Two questions. First, as far as the condo and the retail at Columbus Circle, are those now both in like a TRS? Or As far as the retail goes, is there some sort
of holding period that you need
to maintain to allow that to be good REIT income versus having it be taxable?
Yes, Alex. They actually are both in TRSs.
Okay. That's easy. And then the second question is just as far as New York state goes, With the whole the rent control coming up for renewal next year and the possible change in the Senate and Albany composition, Is there any concern that if they change the rent control laws that, that would impact your affordable units that are part of your 421A or those are separate from any legislation changes they may consider.
Yes, Alex, this is Sean. A good question With a whole lot of speculation around it and whether the impact would be on affordable homes specifically For or more of the market rate homes that are subject to rent stabilization because of the 421a program, I suspect anything that Would be related to the 421a program, given the 5 hits already occurred over that, would probably be very difficult to get through. And that's what would impact potentially our portfolio. It wouldn't impact it in a meaningful way. There's only about 7% of the units in the portfolio that are Basically, at legal caps at this point in terms of the rents that are allowed.
So the impact wouldn't be material, but I wouldn't suspect that, that would happen given everything we've been through on the 421a program over the last few years in New York.
Okay. But if they change and do away with vacancy decontrol, You don't think that that would impact you or that could impact you?
It depends on what they're talking about in terms of the population of units that would be impacted Any change, whether it's affordable units or just the stabilized units, because remember there's different programs in New York that you have to work through. So I'd be surprised If it was on the market rate units that are subject to stabilization because of 421a as opposed to a Technically affordable units that are set aside that are different. So there's a lot of speculation around this, but there's nothing It's actually being drafted or negotiated. So I think we'd likely be okay. But even if something came through that affected the piece that we'd be worried about, It wouldn't be a material impact on the assets.
Okay. Thank you, Sean.
Yes.
Thank you
for your question. The next question will come from John Pawlowski with Green Street Advisors. Please go ahead with your question.
Thanks. On Columbus Circle, if you have kept it or if you do keep it, for rental, what would be unlevered to IRR expectation over the long
John, we typically don't provide disclosure on projected Long term IRRs, but I think we gave a sense that we thought the economics here were on the development basis were in the Mid-four range, including the retail. So you'd have to sort of
kind of
you can probably input your own assumptions there in terms Growth and reversion of cap rates as to what that would translate into a non levered IR.
Yes, understood. Could you share the contracted retail rents per foot and what's under negotiation? How does that How will compare to initial underwriting? Yes. Hey, John, it's Matt.
Yes. We're not going to disclose what the actual rents were in the lease. But as I did mention, the 2 deals that we Have either signed or very close to being signed. They're both better than at or better than the economics we had underwritten, both in terms of rent and also in terms of TIs and free rent. So, So far, we're tracking a little ahead of our performance.
Obviously, we still have a lot of space left to lease. Okay. That helps. Thanks a lot.
Thank you for the question. The final question will come from Wes Golladay with RBC Capital Markets. Please go ahead. Yes.
Hi, everyone. I want to go back to those East Bay developments. I think you mentioned you had a $40,000,000 cost overrun. But when I look at Avalon Public Market and Avalon Walnut Creek, it looks like the cost went up 30,000,000 So the developer the subcontractor $8,000,000 to $10,000,000 And then if you have costs locked in Ahead of time for developments, was this driven by increased labor costs? Or does the whole thing just have to be reworked?
Yes. Hey, Wes, it's Matt. You're right. What we recognized this quarter across those projects compared to last quarter was $30,000,000 higher. To be fair, there was an additional $10,000,000 in cost we had already recognized on Emeryville, if you go back to the very beginning when we first started the project.
So relative to what we thought what our initial budgets were, that's where the $40,000,000 came from. And you're right in that normally, 90 plus percent of the time when we start a project, we have Most of the trade costs locked in with subcontractors who perform. And consequently, that's why if you look at that slide, Over a long, long period of time, we're generally doing projects in within 1% of budget, plus or minus. This is the kind of environment in Northern California, in particular, right now, kind of the once a market one market, Once every cycle where you see while you thought you had your costs locked in, the subcontractors failed to perform. You can't you force them to build it if They're not making money doing it.
They thought they could get labor at a certain price. They couldn't. One of those deals in Walnut Creek, we had a further complication, which was It's a public private deal with regard as the ground lessor, and there's some prevailing wage requirements, which in turn created additional union requirements for the execution that we were not expecting there. So that was a piece of it as well. But generally, we are very successful in locking down our costs at the Sorry.
But there are extreme situations and this would be one of them where the subcontractors just won't perform and you Basically, have to switch finding subs at whatever the prevailing market price at that time is. Yes. Let's try to just add
a couple of general comments. I think they do apply to what's happened in these day. As you get late in a cycle like this where we have a lot of production going on, I mentioned earlier just the lack of skilled labor. They are adding Labor, but it's oftentimes not as productive, not as good. And the market is so stretched that the margin for errors is Just very low.
So if one sub fails, it tends to have a cascading effect on all the subs behind them. So it's In a normal market, sometimes if one sub fails, you can oftentimes replace them quickly without an impact to schedule or to the or cost That's not this kind of market right now, particularly in Northern California. So it's a very low margin of error, and something that we're trying to be mindful of From a risk standpoint, at this point in the cycle.
Okay. And then last one for me. We obviously just had Sears file bankruptcy and we're hearing from a lot of We're hearing from a lot of the retail landlords that this can unlock some densification opportunities. So have you noticed an uptick in inbound cost to Avalon Looking at potential multifamily on retail sites?
Yes, John, we've actually I'm sorry, Wes, that's something we've been working on for a while. And in fact, the deal I mentioned, the new DevRel this quarter, which is at the Alderwood Mall outside of Seattle, That is actually a former Sears box. So it's we're working with GGP on it, but actually Seritage is in the deal as well. So and we assigned a fairly senior development person to kind of work on those opportunities Really about a year or 2 ago. So we continue to talk to model owners, to retail owners, and we do view that as a great opportunity for us.
I don't think there's anything we're not seeing any more specifically because of a Sears bankruptcy yet. And frankly, a lot of those locations are not locations that we're going to be all that interested in. But As a general macro trend, absolutely.
Okay. Thanks a lot, guys.
Thank you. This concludes the Q and A portion Today, I'd like to turn the conference back over to Tim Martin for closing remarks.
Thank you, Brandon, and thanks for all of you being on today. And I look forward to seeing you in the near future. Take care.
Thank you. Ladies and gentlemen, this concludes today's event. You may now disconnect your lines.