Good morning, ladies and gentlemen, and welcome to the AvalonBay Communities' second 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. You may enter the question and answer queue at any time during this call by pressing star 1. If your question has been answered or you wish to remove yourself from the question queue, just press star 2. If you are using a speakerphone, please lift the handset before asking your question, and we ask that you refrain from typing and have your cell phones turned off during the question and answer session. Your host for today's conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, please go ahead.
Thank you, Travis, and welcome to AvalonBay Communities' second 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-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 refer to 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 Chief Executive Officer of AvalonBay Communities, for his remarks. Tim?
Thanks, Jason, and welcome to our Q2 call. With me today are Kevin O'Shea, Sean Breslin, and Matt Birenbaum. Sean, Kevin, and I will provide a brief commentary on the slides that we posted last night, and then all of us will be available for Q&A afterwards. Our comments will focus on providing first, an overview of results for the quarter. Secondly, an update to our outlook for the full year. Lastly, we want to touch on how we're managing risk at this point in the cycle. Starting on slide 4, highlights for the quarter include core FFO growth of 6.7%, or $0.04 per share above the midpoint of our Q2 outlook. Same-store revenue growth came in at 2.5%, which was about 20 basis points higher than budget for the quarter, and roughly 30 bps above budget year-to-date.
We completed $140 million in new development at an average initial projected yield of 6.4%. So far this year have completed $430 million at a projected yield of 6.5%. Lastly, we raised about $300 million of external capital through the sale of four communities at an average cap rate of 4.7% as the transaction market continues to be very healthy. Turning now to slide five and touching on our outlook update for the full year. Core FFO growth is now projected at 4.1%, or 50 basis points above our original outlook. Same-store revenue and NOI growth are expected to come in at 2.4% and 2.3% respectively, both up by about 30 basis points from our original outlook. Expected NOI from development is unchanged at $52 million as deliveries, occupancies, and rates are all largely consistent with plan.
Projected development starts for the year are still tracking our plan of roughly $900 million. Lastly, planned external funding for the year is now $950 million, or about $300 million less than originally expected, mainly due to reduced development spend as some new developments have started or are expected to start a little later in the year than we'd originally planned. Turning now to slide six. Slide six provides a breakdown of our revision to core FFO of $0.04 in the revised outlook. As you can see, higher than expected stabilized community NOI from same store and redevelopment is driving the upward revision, with virtually all of that coming from stronger than expected revenue growth. Minor revisions to our capital plan and updated overhead projections more or less offset one another for the balance of the revisions to our forecast. Turning now to slide seven.
What's driving this upward revision? It's really coming from stronger than expected economic and job growth. If you look at it nationally, job growth is expected to be about 400,000, or about 20% higher than initial forecast. That was embedded in our original outlook. About 150,000 jobs are about 30% higher than originally anticipated in our markets, which are even stronger. On the supply side, if you look at projected deliveries in our markets, we now expect to be off by about 5% from what we had anticipated at the beginning of the year. That operating performance is really being driven by stronger than expected fundamentals on both the demand and supply side. I'm now going to turn it over to Sean to provide a little bit more color on portfolio performance across our markets. Sean?
All right. Thanks, Tim. Turning to slide eight. As Tim mentioned earlier, we increased the midpoint of our same store revenue growth outlook by 30 basis points to 2.4%. This outperformance is supported by our outlook for stronger growth in New England and Northern California, which represents about 35% of our portfolio, and is being partially offset by weaker performance in Seattle, which only represents about 5% of assets. For New England, it's benefiting from better than expected performance in the Boston market. Job growth, which has been running at an annualized rate of 1.6% over the past six months, and reduced level of supply have resulted in fairly positive momentum thus far this year. At the portfolio level, reduced turnover, which was down more than 400 basis points in Q2 alone, has allowed us to maintain roughly 96% occupancy as we push rental rates.
We achieved 3.8% rent change from our primarily suburban portfolio during Q2 and are trending above 4% for July. In Northern California, better-than-expected job growth, strong wage growth, and overall confidence in the tech sector has led to increased demand in both San Jose and San Francisco. Job growth has accelerated to an annualized pace of 2% in San Francisco and 3% in San Jose over the past six months. This healthy level of demand, combined with moderating supply, has resulted in better pricing power over the past quarter. Many of our year-over-year key performance metrics for San Jose and San Francisco improved materially during Q2. Turnover decreased more than 700 basis points in San Jose and 900 basis points in San Francisco. Occupancy increased 60 basis points in San Jose and 80 basis points in San Francisco. For the quarter, occupancy averaged roughly 97% in each market.
The median household income of new residents was up 7.5% compared to Q2 last year. Rent change averaged 4.7% in San Jose and 4.6% in San Francisco, up 160 and 350 basis points respectively compared to Q2 last year. When you look at July, rent change is trending above 5% in both markets. Moving to the Pacific Northwest, performance is moderated as new supply, which is at a cyclical low of 5% of inventory, comes online. Job growth remains strong but has also slowed from the blistering pace of a couple of years ago. Rent change in our portfolio averaged 3% in Q2, about 400 basis points below what we achieved in Q2 2017. In terms of portfolio revenue growth, year-to-date results have also been impacted by activity, including lease terminations associated with our retail portfolio in the region.
On a year-to-date basis, our 3% same-store revenue growth rate represents 3.5% revenue growth from the residential portfolio and a roughly 15% reduction in the revenue generated from the retail portfolio. The performance in our New York, New Jersey, Mid-Atlantic, and Southern California regions is expected to be relatively consistent with our original outlook. Moving to slide nine, the healthy demand we've experienced over the past year, combined with a leveling off of supply, has resulted in relatively stable rent change at the portfolio level. This slide depicts the trailing four-quarter average rent change to eliminate the effect of seasonal patterns in our business. We've averaged roughly 2% since Q2 last year, which has supported revenue growth in the low to mid 2% range the last four quarters.
In terms of recent activity, blended rent change for July is currently 3.25%, about 50 basis points greater than what we achieved in July 2017. This is the first month the portfolio has produced a material year-over-year increase in rent change since October 2015. Renewal offers for August and September are running in the high 5% range, about 25 basis points greater than the offers made at the same time last year. Now I'll turn it over to Kevin to talk about development in the balance sheet. Kevin?
Thanks, Sean. Turning to slide 10, as the business cycle has matured, we have focused on reducing development risk while further enhancing our credit profile. As you can see on slide 10, we have reduced development starts for 2017 and 2018 to about $900 million per year. This is $500 million or 35% lower than the average start volume of $1.4 billion per year in the preceding four-year period. At this reduced level, new development starts can be funded on a roughly leverage-neutral basis through a combination of internal free cash flow, leveraged EBITDA growth, and disposition activity. As shown on slide 11, we have focused on increasing timing flexibility within our $3.5 billion development rights pipeline so that we have greater flexibility to adjust new development starts to real estate and capital market conditions.
Specifically, in the first two bars on the left, about 40% or $1.4 billion of the pipeline represents projects that are likely to start over the next two and a half years. In the middle bar, about $400 million of potential development activity represents opportunities to densify existing apartment communities on the West Coast and an opportunity with flexible timing in the Mid-Atlantic. These opportunities can proceed as starts when entitlements are complete if they continue to make economic sense at that time, or these can be held in inventory for the next cycle at little cost if necessary since there is no third-party land to be purchased. About one-third or $1.2 billion represent projects that are likely to start at least a few years from now, sometime in the next cycle.
Much of this business is public-private partnerships with flexible timing and representing a different risk profile than our typical development right. It is also worth noting that we are controlling this $3.5 billion development pipeline with a total investment of only $170 million as of quarter end. This amount consists of approximately $130 million in land held for development, of which we expect to put about $115 million into production by year-end and $40 million in development pursuit costs. Altogether, this increased timing flexibility and modest financial exposure reflects the more defensive risk management posture that we adopted several years ago in anticipation of a more challenging development environment. Turning to slide 12. As we have throughout this cycle, we continue to remain focused on mitigating a key risk of development, which is lagged funding risk, by continuing to substantially match fund development underway with long-term capital.
By doing so, we are able to lock in much of the development profit by substantially reducing the amount of remaining capital that is exposed to future changes in our cost of capital. At the end of the second quarter, we were approximately 85% match funded against development underway, which is in excess of the high end of our target range of being roughly 70%-80% match funded against outstanding development commitments. On slide 13, we show how we have remained focused on enhancing our balance sheet strength and flexibility by highlighting two important credit metrics, namely overall leverage and refinancing risk. Specifically, at the end of the second quarter, net debt to core EBITDARE remained low at 5.0 times and at the low end of our target range of about five to six times.
In addition, by issuing longer-dated debt in recent years, we have increased the weighted average years to maturity of our total debt outstanding from 8.3 years to 10.2 years, which is one of the highest in the REIT sector. In doing so, we not only reduced our near-term refinancing risk over the next few years, but also have put the company on stronger footing for the long term. With that, I'll turn it back to Tim for concluding remarks.
Thanks, Kevin. Just finishing up on slide 14 and some of the key takeaways for the quarter. Healthy economic growth is supporting apartment markets with revenue growth now stabilizing in the 2%-3% range. Our revised outlook is ahead of our original plan, driven by better-than-expected fundamentals. Development deliveries and NOI are in line with our original plan. As the cycle ages, as Kevin just mentioned, we are increasingly turning our attention to risk management, particularly how we are managing the development portfolio on the balance sheet. Then lastly, we are currently on pace to deliver better than sector average core FFO growth for the eighth consecutive year. With that, we'd like to open up the call for questions. Travis?
Yes, sir. Just a reminder, if you would like to ask a question, please press star one. Star two will also get you out of the queue. Our first question comes from Nick Joseph.
Thanks. Can you mention risk management? There've been media reports now of Avalon exploring a larger New York disposition transaction. What's your appetite for selling there to being a portfolio of assets?
Nick, Tim. We are aware of some media reports out there as it relates to the Manhattan portfolio of assets. We can't really comment on it. I guess what I'd say is we often do explore, either opportunistically or strategically, disposition or portfolio-type agreements, either outright sales or JVs, and they are often subject to confidentiality. As it relates to that specific deal, when it makes sense to comment on anything, we will. As I mentioned in my earlier remarks, the disposition market, the transaction market is very healthy. We've sold in excess of $1 million this quarter at a sub five cap rate. Those aren't necessarily the lowest cap rate assets in the portfolio. As we look at across kind of our opportunity set for capital, asset sales and debt are easily sort of screen the most attractive to.
It's just a matter of what form, and we're trying to marry that against our capital allocation objectives. As you know, we entered Denver and Southeast Florida recently, and looking to some extent to reallocate some capital from the Northeast to those markets. We've done a fair bit of sales in the suburban New York area as of late, and we're looking at other opportunities as well.
Thanks. You've resized or reduced the development pipeline and leverage is at the low end of the targeted range. Should we expect similar levels for the remainder of the cycle? Is there anything you're monitoring that would make you more aggressive or conservative from here?
Nick. Tim again. Great question. As Kevin mentioned, we have brought it down a bit from an average of $1.4 billion a year in starts, about $900 million in the last two years. As many of you know, you just look at kind of what's happening on the construction side, construction cost side. Construction costs have been running in the mid-single digit, or probably in the mid-to-high single digit escalation today, whereas rents are more in the 2%-3% range. If you just play that out over a couple of years, that could erode yields by call it 20 basis points a year. As a result, a lot of this is bottom-up at some level.
There's fewer deals that are going to make sense. Therefore, we're likely to see some of that volume come down, assuming we see the same kind of trends we have been seeing, which is construction costs outpacing rent growth. Land markets have not yet adjusted yet. Something else we didn't mention, but we really haven't added a development right so far this year other than the Doral deal that we started in Southeast Florida. As you look at our bucket, it's one of the reasons why we want to have flexibility and optionality with our development right portfolio. If you look at that group of opportunities, there's probably one bucket that sort of cleared the bar easily that we'll continue forward with and start.
There's probably another bucket that maybe it just barely clearing the bar or the hurdle, and a third bucket where it's more of a stretch. Where it's more of a stretch, we'll probably hold off or renegotiate or potentially abandon. Where it's just clearing the bar, it's probably going to be a little bit more of a game time decision. I know it's a long-winded way of saying it kind of depends. It's not a simple answer, but I would guess if we see the same kind of trends in construction costs, you'll continue to see the total level of development volume sort of continue to drift down from this point forward.
Thanks. Appreciate the color.
Our next question comes from Richard Hightower.
I just want to pick up quickly on Nick's question on the Manhattan JV potential transaction there. Maybe you've already answered this question, but as we think about the motivations for doing something like that, is it sort of equal weighted between a source of funds for additional development? Is it to reduce your New York City exposure? Is it a mark to market on those assets that you think the public market's going to appreciate? Just help us understand some of the thinking behind that from a strategic perspective.
Rich, again, can't comment on anything specifically, but anytime we're looking at doing something opportunistically, it's going to be a function of, is it a good source of capital first, which this position generally isn't attractive source of capital, certainly more attractive than equity today. It's going to be a function of kind of where we want to allocate capital across our market footprint. Thirdly, based upon how we think about valuation in a particular market versus maybe some other opportunities that we may have to reallocate the capital. Those are the kind of things that we're using as a screen to look for opportunities, particularly ones that are maybe a little bit more opportunistic in nature.
Okay. That's fine. Thanks, Tim. My second question here. I think reducing turnover has been sort of a theme the past couple of quarters, not just from Avalon, but also from your public competitors. Is there anything structural going on there? Is it asset specific, portfolio specific, market specific? Then if you think about what a normalized turnover rate might be, I mean, how much of that has impacted OpEx year-to-date, and what do you think sort of a normalized OpEx run rate is given a normalized turnover rate? If you can help us think through that.
Yeah, Rich, this is Sean. In terms of the first part of your question, I mean, turnover is down pretty broadly. I mean, if you look at our footprint on a quarterly basis year-over-year as well as the year-to-date numbers, turnover is down pretty material across all the markets with the exception of the greater New York, New Jersey region, which is pretty flat. The reductions are relatively meaningful, let's say, greater than 300 basis points across all those markets that are down. When you look at sort of the reasons for turnover, it's didn't really change a lot. I mean, relocation's up a little bit, rent increase is down a little bit. Just the overall volume of churn is down.
I think it's probably a function of a number of different factors, including certainly what's happening in the single-family business in terms of home sales and production and things like that being relatively constrained in part due to the availability of labor, cost of materials, things like that in terms of actually producing new product as well as just inventory being down in terms of home sales. There's probably a number of different factors in there as it relates to turnover. But if you look at the cost side of it, REDAC is down, which shows up in the maintenance category. But in terms of moving the needle, it's not moving the needle in a material way, I would say.
If you looked at overall OpEx growth, you may be talking about 10, 15 basis points that might relate to what's happening on turnover and REDAC and things of that sort. Probably the more important factor is we're thinking about it more on the occupancy side in terms of reduced turnover. You don't have the vacant days associated with turning those homes. That tends to support a higher occupancy, which is certainly what we experienced in the first half of the year where our outperformance in revenue was to a significant degree due to greater occupancy. I'd probably be focused more on that side of the P&L as opposed to the OpEx side in terms of a material benefit.
All right. That's perfect. Thanks, Sean.
Yep.
Our next question comes from Drew Babin.
Good morning. There's good deal of information in the presentation about employment growth, obviously it exceeded your expectations so far this year. I was hoping you could talk about whether the improved employment growth outlook is kind of a pass-through of what happened in the first half of the year or better expectations for the second half of the year. I guess kind of bolting onto that, how has wage growth trended year to date relative to your expectations, kind of outside of the Bay Area where it's obviously very strong?
Yeah. Happy to talk about that, Drew. This is Sean. In terms of job growth, what I'd say is across the footprint, the majority of the markets are producing jobs at a greater rate than what we expected. The exceptions are sort of in the greater New England area, but it's a pretty modest number in terms of softness there in job growth, a little bit in Southern California. Out-performance in New York, the Mid-Atlantic, Pacific Northwest, Northern California in terms of jobs has been healthy. Certainly, we would expect that to bleed through into the second half of the year. As I mentioned as it relates to the last question, the first half of the year, we benefited from greater occupancy.
That has allowed us to push rates a little bit harder, we expect to benefit from that in the second half and let it bleed through across the footprint. If you're looking for the impact we certainly realized in terms of occupancy, we're realizing it in terms of rate growth. You'll see more probably on the rate growth side than occupancy in the second half of the year. As it relates to wage growth across the various markets, we have seen pretty healthy wage growth. I mentioned what's happening in Northern California, but we're seeing across some of the major markets, north of 5% wage growth. Not wage growth, but median household income of new residents relative to new residents that moved in the same period last year.
If you think about it from that perspective, I think we're somewhat of a proxy for our market and the profile of the customers within our buildings. It's been pretty healthy wage growth, has actually driven rent-to-income ratios down close to 20%, whereas they peaked the cycle closer to 22% or so. Wage growth has been healthy across the portfolio, probably most pronounced in the tech markets. Healthy just about everywhere.
Okay. I guess if you could help kind of marry the comments about economic prosperity in the near term and kind of using the term late cycle and saying that things have obviously decelerated from where they were a few years ago. With this pickup in employment, is that sort of saying that, yes, things are a little better than expectations, but employment growth is likely to kind of return more to trend levels over time, wage growth is likely to return to trend over time? I guess. How do you kind of marry the short term versus the long term in the way you've phrased it?
Well, if you just listen to economists, I think the general consensus is that the combination of stimulus and the rollback of regulatory requirements is creating a bit of a stimulus effect here that may not be long-lasting. We think it's probably going to last for 2018 and maybe 2019. In some sense, you may be pulling some demand forward. I'm not sure that either the economist community or we believe at this point that it's just structural in nature that's going to sort of put us on meaningfully different trajectories for a longer term, if you will. Certainly, corporations are just starting to get the benefit of the tax cuts, right? Most companies are just starting to enter their planning and capital cycles right now.
You would expect to see some of the impact carried forward in 2019 based upon that alone.
Okay. That's all from me. Thank you.
Our next question comes from Juan Sanabria.
Hi. Just hoping you could comment a little bit on supply. You talked about some slippage in deliveries, seeing 5% less deliveries than you expected for 2018 to start the year. If you could just help us frame your views as you see 2019 now, which markets are up and which are down, and how you're thinking about the relative growth in the portfolio as a result of that.
Juan, this is Sean. Happy to take that, and then [inaudible] can chime in as needed. Yes, as Tim mentioned in his prepared remarks, supply, consistent with the last several years, is beginning to slip a little bit from one year to the next. It's in the kind of 5%-6% range in terms of the deliveries that we anticipated for 2018 that are probably going to be pushed into 2019. It's spread across a variety of markets. It's probably most concentrated in Southern California, I'd say, where based on what we see, upwards of 20%, 25% of the deliveries that were expected this year could be pushed into 2019. There's some in Northern California, the Mid-Atlantic, et cetera, it's sort of everywhere.
I'd expect that based on what we're seeing in terms of trends in the construction market, that as we get towards year-end, we'll see additional slippage in terms of deliveries. I think the sort of the macro way to think about this is last year, deliveries were about 2.2% of inventory. Based on what we know today for 2018, it's going to be about 2.3%. 2019 is forecast at 2.1%, I'd say 2018 and 2019 are probably going to be pretty similar in terms of the volume of deliveries. You really have to double-click through at the market or the regional level to find where the variations are.
As you look at 2019 relative to 2018 in terms of any meaningful changes, there's three markets where we're likely to see an increase in deliveries, and that's in D.C. proper, the district itself, the East Bay, and San Jose, all on the order of magnitude of 2,000-2,200 additional units in 2019 relative to 2018. The markets with a more meaningful reduction in deliveries currently are expected to be New York City, which is pretty meaningful. It's a reduction of about 6,000 units as compared to deliveries that are somewhere in the 12,000-unit range this year. Northern New Jersey, a couple thousand units. Baltimore, about 2,500 units. We expect to benefit from given some stuff we have under construction up there. We think that'll be good timing for us.
In Orange County and San Diego, down about 3,000 units in Orange County, about 2,500 in San Diego. Orange County performance has been a little bit soft this year, they should benefit that market next year. I mean, those are the markets that, given the current level of job creation and assume that that bleeds through into 2019, tagging along with some of the things that Tim talked about from a macroeconomic perspective, these markets with changes in supply, you'd expect to see either an uplift or potentially a modest softening, all else being equal. That's probably how I'd describe that in terms of next year.
Great. Just with regards to your developments, you brought down your uses. You talked about some delays or starts maybe a little bit later than you'd anticipated. It didn't look like any of your completions moved, other than maybe Public Market in California. Do you see any risk from your development perspective on delivery delays or slippage, given what we've just discussed?
Tim here. No. In fact, our updated outlook basically is aligned with our original budget. We're basically tracking plan at this point with respect to deliveries, occupancies, and rate as it relates to the development portfolio.
Thank you.
Our next question comes from Austin Wurschmidt.
Hi, good morning. Just have a question around the guidance. You beat in the second quarter by $0.04, which was attributed to better core fundamentals. I'm just curious if this was occupancy related. I think you mentioned a little bit of rate you expect to show up in the back half of the year, but would've thought there'd be some carry-through to the balance of the year, particularly with the backdrop of better demand and lower supply you talked about. Can you just walk us through why we're not seeing any flow-through?
Yeah, this is Sean. Why don't I let Kevin kind of roadmap the earnings piece for you, and then I'm happy to talk about the bleed-through on revenue specifically.
Sure. Austin Wurschmidt, in terms of, as you identified, in terms of our outlook, we are expecting from a core FFO point of view, a $0.04 increase in 2018 versus our initial outlook to $8.97 versus $8.93. As we have in the table in the earnings release, as you double-click through that, essentially on a net basis, $0.04 is really coming through the same-store and redevelopment portfolios with essentially of that $0.04, really kind of on a net basis, $0.03 coming through from same-store revenue, if you will. The other $0.01 coming through essentially accelerated occupancies in the redevelopment portfolio. As Tim Naughton pointed out, it could be opening the adjustments in the capital markets and expectations in the overhead line items kind of being awash.
In terms of kind of the cadence of that, if you look out in the balance of the year, our implied guidance for core FFO in 3Q and what you might sort of back into for the fourth quarter, much of the sequential uplift in core FFO as you pace through the balance of the year is really going to be driven primarily from same-store NOI, if you will, and to a lesser degree, but still to a positive degree from lease-up activity in the development portfolio.
Austin Wurschmidt, as it relates to thinking about how revenue growth bleeds through, as I indicated, the first half of the year, we outperformed our expectations overall in the neighborhood of 25 basis points or so. The majority of that was on the occupancy side, around 20 basis points. The other handful of basis points through rate and other rental revenue. As we move through the second half of the year, as I mentioned earlier, we expect more of that performance to come through on the rate side than the occupancy side. We had budgeted to be at a higher level of occupancy in the second half versus the first half. That is how I would think about seeing the components of performance shift in the same-store basket as we move through the balance of the year.
Does the revised guidance in the back half of the year assume the inflection that you talked about in July, and also for August and September renewals?
Yes.
Okay. Appreciate that. Previously in the Mid-Atlantic, you talked about that market was tracking a little bit softer early in the year. We saw an acceleration here. What do you attribute that acceleration to? Has it benefited from better demand, or did you see supply get pushed out a bit in that market specifically?
Yeah, Austin, it's Sean. It is on the demand side. Job growth outlook for 2018 based on what we produced in the first half and sort of the expected pace in the second half, given some of the macroeconomic things that Tim talked about. We're talking about the beginning of the year, we expected job growth to be closer to 1.1%, roughly 1%. Right now, it's tracking at a pace that's probably closer to 1.6%, so that's a pretty meaningful increase. Supply has not changed materially, I would say, at this point. When you look at the delays in that market, we're talking an insignificant number of units. It's like 800 units or so in D.C. that's been pushed out. Really nothing in suburban Maryland and Virginia. There's a little bit in Baltimore, but we don't have a big same-store basket there.
It's primarily on the demand side when you look at the Mid-Atlantic. In terms of where we're seeing the best performance right now is in the Northern Virginia sub-market of the three major components of the metro area.
Great. Thanks for the time.
Yep.
Our next question comes from John Pawlowski. Pawlowski.
Thanks. Tim, regarding dispositions and doing something more opportunistic, am I interpreting your comments right that if you did do something opportunistic, that proceeds will be funneled towards development and acquisitions?
Perhaps. Obviously, it's part of the whole capital allocation process. Largely to fund, we don't really have any debt to retire. We don't really have any debt rolling, but it's largely to fund development and perhaps to some extent, redeploy into potentially, particularly the expansion markets of Southeast Florida and Denver. Some of that may be in development, by the way, as well as acquisitions.
Okay. Curious the thought process, just in terms of deploying capital in a very competitive private market. If construction costs keep outpacing rent growth by a wide margin, your cost of equity remains impaired, and the private vehicles keep raising more money than God, and people are going to Denver and South Florida. My question is, do the odds of you guys doing a special dividend or share repurchases increase in 2019 and 2020 if you're having trouble deploying capital?
Yeah, John, this is Kevin. We understand kind of where you're getting at. It's sort of a hypothetical in the first instance about whether we transact opportunistically. Then another hypothetical in terms of what do we decide at that point in time based on future capital market and real estate conditions about the second choice of how to deploy that capital. That's a lot of speculation for something that hasn't yet happened. I guess, to try to be responsive, we do think about all those questions. If cash shows up in hand and there's not an immediate compelling use, then certainly issues such as a special dividend, buyback, all get part of the management discussion.
As we talked about before, there are a number of different hurdles and complicating factors that relate to each of those things, particularly as a tax-paying entity with obligations to make a dividend over time. It's premature for us to try to answer that question in a concrete way or to kind of lay out with specificity what the framework would be. We certainly look at all those things in those circumstances should they arise.
Okay. Thank you.
Our next question comes from John Kim.
Good morning. On your development rights slide 11 of your presentation, you have a bar of $400 million, which includes asset densification on the West Coast. I'm assuming this includes your joint venture with GGP in Seattle, I was wondering if there were any other retail developments as part of this figure and how many joint ventures you may have on densification efforts.
Yeah. Hi, John, it's Matt. I can speak to that one. Actually, no, the potential joint venture with GGP in Seattle is not currently in our development rights pipeline. We don't technically recognize a development right till it's cleared due diligence, and cleared our investment committee for kind of the initial screen. We've been working on that for a long time, and it is what I'd call a likely future development right. That's not in there. In terms of how much of the current development rights pipeline is retailed joint ventures, none of it. Again, we are talking to various folks. We do have a number of development rights, which are partnerships with retail owners, where ultimately we will own the residential, and they will own the retail. We have a site in Woburn, Mass.
It's in the development rights pipeline that fits that description, which is a partnership with EDENS. We have a number of development communities currently underway, like our deal in Towson with RPAI that would fit that description, or the Avalon Public Market site. The only development joint venture, true joint venture we have right now is one that's wrapping up, which is NorthPoint in Cambridge.
In this figure of asset densification, those are densification efforts on your assets?
Yes. There's a couple assets that we own that we bought through Archstone. One of which is in Mountain View, which we've talked about a little bit in the past, one of which is in San Jose. There's actually a third one in Redmond, which is not on the list yet, but which will join the development rights pipeline in the third quarter. These are older garden communities with surface parking, where the jurisdictions recognize there's a need for more housing, as part of just an overall housing shortage in those markets, and are willing to work with us to try and modify the entitlements to add density, usually through replacing parking, or replacing surface parking with parking deck. In some cases, just reducing the parking ratio because times have changed, and there's not quite as much demand for parking.
Got it. Okay. Then a second question on development returns. This quarter, you had 170 basis point spread in development yields between high-rise and garden developments, I was wondering if you had seen a noticeable difference among development unlevered IRRs between high-rise, mid-rise, and garden projects based on your history of developing and recycling assets.
Yeah, it's an interesting question. Generally, I think we did. The last time we looked at that by product type, I think it was pretty consistent across the three baskets. High-rises will generally tend to trade at a lower cap rate. In some cases, we developed high-rises in urban sub-markets that were transitioning where we got in early, like you think about Chrystie Place. We were very early there in the Valley or our Riverview assets. In Long Island City. Sometimes that plays a part in it as well. I would say probably in terms of risk-adjusted returns, high-rises are riskier in our experience, both on the cost side and just the timing it takes. It takes a long time to put the asset into production. You might argue that if gardens are getting the same IRRs on a risk-adjusted basis, it's probably even a little better.
That's probably over the last 10 or 15 years. I don't know, I'm guessing maybe a third of our development in terms of capital has been high-rise. Probably two-thirds has been mid-rise.
Okay, great. Thank you.
Our next question comes from John Guinee.
Hello?
Yes.
Hello?
Yes.
Oh, hey. If I'm looking at page 17, your development rights, are you at liberty to talk about where the numbers make sense? I'm assuming you've got some low basis in some of your land positions or your development rights, which help the yield on cost. Where do the numbers pencil out and where don't they in this day and age?
Do you mean geographically or by-
Yeah. Geographically.
Geographically-
You're talking about putting a lot of this into play, I think.
Well, as Kevin went over on the slide, some of these are going to take quite a while to play out, and others would be ready in the next year or two. The ones where the economics are holding better tend to be the more suburban deals, where the entitlement process takes longer. As you point out, in some of those cases, those are land deals that are four or five years old, and maybe there's been a little bit less cost inflation pressure. Some of the deals we have in suburban Boston or suburban New Jersey, those are deals that are less sensitive to changes in the cycle. That's where you see, frankly, when you look at our development rights pipeline, it is a little overweight in the Northeast partially because of that.
In terms of the $3.5 billion that's there, the allocation of what makes economic sense is probably consistent with just the total allocation that you see on that chart.
Great. Second question, have you seen any sign that the merchant builders are perhaps laying off people or slowing down, or are they still locked and loaded and aggressively trying to build new product?
Yeah, this is Matt Birenbaum again. We have not seen many signs of them slowing down yet. I would say, I don't know that they're increasing capacity, but I would say they're still pretty full up. They still have pretty deep pipelines. In fact, one of the ways we've tried to play it out a little bit is, as Tim Naughton mentioned, we are, particularly in the expansion markets, looking to, in addition to doing our own ground-up development, partnering with some folks that might have sites ready to go. The Doral asset we started this past quarter is a good example of that, where that's a deal that Trammell Crow Residential, the local Trammell Crow Residential office is the development sponsor. We're providing the capital, and then at the end of the day, we will buy out their position and wind up as a wholly-owned asset.
They took the entitlement risk. They're taking the construction risk. We're taking the lease-up risk. We like that kind of business. We haven't done a lot of it in the past, but particularly in these expansion markets where there are some deals ready to go, where the economics still do look good, that's a good way to get some volume there.
Yeah, John, maybe just to add to that quickly. The public's have pulled back, which is interesting, and I agree with Matt Birenbaum. My sense is the merchant guys haven't necessarily increased, but haven't necessarily pulled back at all. I think the other trend you've seen, you just had some new entrants that probably made up or offset some with the amount the public have pulled back. Overall, we're seeing pretty level volume of supply, and that's kind of what's in our projections over the next couple of years.
Great. Yeah, I think I'd probably add to that is the multi-family-focused public guys have pulled back, but the multiple product-type REITs-
Yeah
maybe haven't.
Yeah.
Thanks.
Yeah. Good point.
Thank you.
Our next question comes from Dennis McGill.
I have a question, guys. Just want to tie together a couple things you noted with, on the turnover side, turnover being down substantially, and you mentioned that being really across the portfolio, wage growth similarly accelerating across the portfolio. Both would be pretty notable tailwinds to the rent growth side. It's been fairly stable over the last year. When you guys look at that, is that simply just supply overwhelming both of those factors, or have you just been more cautious on the renewals for more defensive purposes?
Yeah, Dennis, it's Sean. Good point on the tailwind factors, all else being equal, would result in better performance. I think that's what's reflected in the revised outlook is we are seeing better performance in the first half, really driven by occupancy, a little bit of rate. In the second half, a little more on the rate side. It is bleeding through in terms of better performance. Really, you've got better job growth, reduced turnover, good wage growth. All those are positive benefits. Still a meaningful amount of supply, but the supply was known. It is bleeding through for us in terms of better performance in the first half and what we're expecting in the second half, and that led to the revised outlook. If that's the heart of your question.
Yeah, I think that makes sense. Essentially, there's a lag effect that you're seeing through the business. If we look at the blended rent growth in the second quarter, I think it was equal to or lower than a year ago in all the regions except for Northern California. You've noted that flipped positively for the overall portfolio. Can you give some color at the regional level as well as to how broad-based that is as far as the reversal of being positive year-over-year?
Sure. I am happy to do a little bit of that. As I mentioned, when we look at Q2 2018, it is 2.8. Q2 2017 was 2.9. Kind of rounding here and there, it is pretty much similar. In my comments, I mentioned that July is running 3.25, which is about 50 basis points greater than what we had expected. A meaningful portion I mentioned in Southern California. The rest of the markets, when you look through it, in terms of July, what we are experiencing is a modest lift in certain markets like the Mid-Atlantic, modest lift in Boston. Southern California is at par. New York is a little bit weaker. I do not have that number right off the top of my head. What I would say is it is relatively broad-based with the exception of a couple of regions. The order of magnitudes are different.
The order of magnitude is more significant in Northern California and Boston, as compared to the other markets. I would describe it more generally. If you want specific data points without going through all the markets, we can try to talk to you offline.
Okay, perfect. That is helpful for now. Then just one final one. On the dispositions in the quarter and anything that you might be marketing, can you just talk a little bit about the types of bidders that you are seeing and how those assets price relative to your initial expectations?
Sure, Dennis. This is Matt. It has been a pretty deep field, I would have to say. Pretty robust. Pricing has exceeded our initial expectations, probably by maybe 10 basis points on the cap rate from where we expected it to be, maybe a little more. We are marketing a couple of West Coast assets now, one of which was out of one of our fund vehicles where it exceeded by more than that. We sold an asset to Blackstone's multifamily private REIT. We have sold to some private buyers that we have dealt with in the past. There have been some foreign capital buyers pursuing some of these assets that we have not seen before necessarily on some of the larger assets that are in the mix. I would say the field, if anything, is probably a little deeper than it was maybe a year or two ago.
Perfect. That's helpful. Thanks, Matt. Thank you, guys.
The next question comes from Wes Golladay.
Hi, guys. I just want to go back to that comment about the accelerated rent growth. I just want to get your opinion on what is potential drivers of that. You talked about the improving demand, but I was also wondering about the impact of having less concessions in the market. Is that a big factor at all?
Yeah, Wes, it's Sean. For the most part, across our markets, for most of the major public REITs and major private players, concessions aren't used a lot on existing assets. They're more used in lease-up communities. For the most part, that's really concentrated in New York, given some of the rent regulations there, where lease-ups could offer anywhere from one to three months of concessions, depending on the lease term, to establish a relatively high legal rent, and then they build their rent increases off of that. In terms of concessions, they're pretty de minimis overall. Concessions are certainly down for us and I suspect many others, which is helpful as it relates to revenue growth. It's not a meaningful number relative to occupancy gains or rate gains overall.
I wouldn't attribute it to that in a meaningful way, except for maybe what you would be looking for in terms of performance in New York City specifically.
Yeah. Okay. I was looking at more so like maybe having some private developers being maybe more rational this year, not pressuring the public REITs on new and renewal leasing. Maybe if I could parlay that into another question, I guess with supply moving out of peak leasing season, some of it's moving to 2019, do you see any markets where there'd be heavy supply in the second half of the year, maybe in a lower-demand season?
Yeah. The numbers don't move around a lot from quarter to quarter when you look at it. It's a little bit heavier in Q3 as compared to Q2 across our footprint for 2018. Q4 is up a little bit from Q3. For us, the volume of lease expirations during those periods, particularly Q4, is down quite a bit, so it doesn't have much of an impact on the rent roll and the revenue stream, given it's 20% of lease expirations. What you've been through for the first three quarters kind of bakes 80% of the year. Even if there's some additional softness in certain pockets where there's heavier supply, markets like the District come to mind for me as an example, or maybe parts of downtown Brooklyn, it shouldn't have a meaningful impact on us in that period.
Okay, thanks a lot.
Yeah.
Our next question comes from Richard Hill.
Okay. You got Ronald Kamdem on the line for Richard. Just going back to the expansion markets. How should we think about when you're looking at the deals at whether it's Denver or Southern Florida? Could you just provide some color of some of the deals you may be looking at? What are the cap rates? Is it more deals than you thought, less deals than you thought, so on and so forth?
Sure, Ron, this is Matt. We are certainly looking at both acquisitions in the expansion markets, future development, and then as I mentioned also, in some cases, looking at development that others might have ready to go where we could capitalize it. It's been very active, and if anything, I would say cap rates are probably down a little bit in both of those markets. What we're finding in Denver, we're probably more interested right now in some of the assets that are a little bit more suburban, where, kind of like in our portfolio in our other markets, there's a little bit less supply and the risk-adjusted return at this particular moment looks more attractive in the long run. We'll look to have a diversified portfolio in both of those markets.
Right now, stuff that is kind of high profile, sexy, downtown, or in a walkable-type Denver location is probably a 4.25% to maybe a 4.5% cap. In many cases, the assets coming out of lease-up are not really stabilized yet, or it may be hard to tell because the lease-up pace may not be what really would sustain the rents that they're getting. Our view on what that cap rate truly is might be a little lower than some other market participants. In the more suburban locations in Denver, it's probably more like 5.25% cap rates. In Southeast Florida, probably similar, a little bit less in the market. Not as much trade in Southeast Florida as in Denver, but still an active market. Kind of similarly there, we're being somewhat focused in terms of select sub-markets, those that are less exposed to supply right now.
On the development side, we think, the yields there are probably comparable to in our markets. If we do a deal like this deal we're doing in Doral, where we're partnering with a local developer, they're taking the construction risk. For us, we're solving for a yield there that's kind of halfway between a development and acquisition yield, because from a risk point of view, that's kind of an appropriate allocation of the risk.
Got it. That's helpful. If I could just go back to Mid-Atlantic region for a second. You talked about it a little bit on the supply side, but maybe if you could touch on just the jobs outlook, not just this year, but sort of into 2019 and 2020, that'd be great.
Oh, yeah, Ron, it's Sean. The data we have best available right now really reflects what's happened in the first half and projects for the second half, given the effect of stimulus and things like that Tim addressed earlier, which is job growth being sort of in the 1.6% range for the full year 2018 as compared to the beginning of the year, which is 1.1%. How long that plays out in terms of stimulus through tax cuts, regulatory reform, blah, blah, all the various factors out there, it's hard to play out. There's certainly a lag effect. Probably spills over into 2019, but it'd be too premature to speculate on what specific job growth would be in either 2019 or 2020 at this point.
Yeah, this is Matt. I guess the one thing I would add to that is, as it relates to the D.C. metro specifically, certainly, the recent budget deal should lead to an increase in local procurement, which is generally a pretty big driver of the D.C. metro economy. I'm not sure we've seen that impact yet, but there's certainly a lot of talk now. There could be another government shutdown. That could change. On the current place we're at, there does appear to be, from what we've read, kind of a backlog of spending and contracts to be let that could provide a little juice for Northern Virginia and D.C. Followed, obviously, the devil's in the details.
Got it. Helpful. Thank you so much.
Our next question comes from Daniel Santos.
Hi, thanks. My question, just two quick ones for me. I was wondering, I am sorry if you have answered this question already, if you could give us some background on the Miami development, how you chose this site and the partner. I was wondering if you could give us an update specifically on Boston supply.
Sure. I could speak about the Doral deal. I know Sean, you may want to talk about Boston supply a little bit. Again, as I mentioned, we have been looking at sites that are ready to go where somebody else, a local developer. It really starts with the sponsor, the quality of the sponsor, and we have known the folks at TTR for many years and obviously share a common heritage if you go back a long, long time. Have a lot of respect for what they do. This is a site, it is in Doral, which is one of the fastest-growing sub-markets of suburban Miami. There is a grocery-anchored shopping center, which is part of the project, which is developed by another developer, which will be right at the front door. It has got some marketability. It is a seven-story, eight-story mid-rise wrap product with structured parking.
It's a sub-market that we like long-term, and a sponsor that we think highly of. That is, again, we'll be looking to do more of that kind of business. It's different than what we've done in the past, and it's different also in the sense that it doesn't really show up in our pipeline until the deal is ready to go, because we're not funding those pursuit costs early. We're not taking that risk. We've been working on it for probably six months. We didn't commit to it and close until it was all ready to go. There's a third-party general contractor, but again, the local developer is providing the completion guarantees to us.
Yeah. As it relates to supply, Daniel, happy to take that as it relates to Boston. For 2018, supply currently is expected to be about where we thought it would be when we started the year, which is around 6,200, 6,300 units, something like that. It's down about 20% from what was delivered last year. A good percentage of that reduction in deliveries is in sort of the urban markets of Boston, a little bit in the suburbs. As it relates to the outlook for 2019, supply should be running, based on what we see today, at a pretty similar level to 2018, again, around 6,200, 6,300 units. Relatively stable supply outlook in Boston, kind of moving from sub-market to sub-market.
In terms of total deliveries, down in 2018 relative to last year, it looks pretty steady for the next 12 to 18 months in terms of pace of deliveries.
Do a couple.
Okay, this is your last chance to enter the queue. If you would like to ask a question, please press star one now. Our next question comes from Rick Anderson.
Hey, good afternoon now. Tim, early on in the call, you talked a little bit about what might be a short-term economic stimulus from all the things that have gone on, maybe perhaps into 2019 or through 2019. With that in mind, if this is an inflection point in terms of fundamentals for your business, do you feel a little bit less sort of sanguine towards it because of that short-term perspective you have, and maybe it's prompting you guys to do things before the music stops? Or are you equally as optimistic about things relative to past cycles that you've seen as a manager of this company?
Yeah, Rick, I think that's a good question. I think you captured it well. I guess we'd say we're less sanguine at this point, sort of as late in the cycle as we think we are. You're starting to see areas in the economy where there just isn't much slack. You look at the labor markets, which can be contingent upon labor force participation rates, when you're seeing unemployment at 4%, and then for college grads, it's almost zero. It's literally in the low twos. There's not much slack in the labor markets to continue to sort of drive household formation. I think there is some opportunity still as it relates to household formation as the millennials age. The most recent print on household formation was the strongest we've seen in a while. I think you've got to take that with a grain of salt.
It kind of moves all around. I think it came in at 1.7 on a year-over-year basis, the strongest we've seen. I think that is a bit of the number of young adults that are living at home, as you would expect to go down, as the leading edge of that age cohort starts to migrate towards their mid-30s and late 30s. When you think about some of the inflationary pressures, you look at our business, the construction cost pressures are pretty acute. I don't see them necessarily abating because you've got both the labor side and the material side, and they're both not being helped by policy right now as it relates to tariffs and potentially immigration and the impact on skilled labor.
I think there's a lot of reasons to be cautious as it relates to being aggressive in terms of deploying capital in this market, and we probably are a bit more cautious than we would be in other points that may be showing some inflection.
Would you say that some amount of your kind of declining development, or I should say, elevated development risk management process is tied to that shorter-term economic perspective as well, beyond the construction costs this year? Maybe it's all just related to each other?
I think it's related. I think it's something that's been going on really.
Yeah
Two or three years. We were much more willing probably through about 2015 to consider taking land inventory on the balance sheet that we felt we could get in production over the next year. Today, I'd tell you, we're not that willing, and we're pretty surgical about it. We had one deal in L.A. that we were willing to do that with because we felt like maybe that market had a little bit more legs than maybe some of our other regions. Fundamentally, we don't think land markets have adjusted yet. Yeah.
Okay. Good enough. Thank you.
All right. Very good.
Our next question comes from Tayo Okusanya.
Yes, good afternoon. I hope you haven't addressed this yet, but I got onto the call late. Have you talked at all about just views on Costa-Hawkins and kind of progress being made in regards to that in California?
Tayo, we haven't talked about it on the call. Do you have specific questions around it in terms of-
Yeah. Just kind of how you're thinking about some of the momentum behind it, about possibly being on the ballot in November, and kind of what are you hearing locally from lobbyists about that and-
Yeah
what the potential implications could be.
Yeah. No, happy to address that. People have been asking about that through other means as well, but particularly around the likelihood of it passing and things of that sort. Trying to give you a specific probability about it passing would be pure speculation on my part and anyone else, I think, that would be doing out there. In fact, there are polls out there that offer a wide range of answers. What I'd say is that based on what we know, that if you simply ask voters in the state of California if they would support rent control as it relates to controlling housing costs in the state, more than a majority would likely say yes. Based on what we know, to the extent that you educate voters about what a repeal of Costa-Hawkins specifically means. The outcome could be quite different.
There's a number of issues associated with Costa-Hawkins that voters are being educated about, including the impact on homeowners, which represents about 60% of likely voters, and putting single-family homes at risk regarding rent restrictions and potential reductions in the value of their home if the kind of single-family rental market and those buyers, the investor buyer, starts to go away because of concern about rent restrictions, as an example. The fiscal impacts, the nonpartisan LAO issued a report recently talking that a repeal could be detrimental to local government funding, particularly in terms of lost revenue from property taxes associated with single-family and cost of administration and all kinds of other things like that.
Other issues that are out there relate to the conversion of rentals to for-sale product, which happened in San Francisco after the adoption of rent control, and there's a number of studies out there related to that topic. There's a lot of different issues that people need to understand as it relates to what Costa-Hawkins means, what protections exist today that would potentially go away with a repeal. What I'd say is the messages are being delivered to voters and probably will be much more so over the next few months here in terms of what the repeal means, and those are the issues that will ultimately drive the potential outcome when we get to Election Day.
Gotcha. All right. Again, if it does happen, have you guys done any kind of analysis around what kind of impact it could potentially have on your portfolio?
It's very much speculative in terms of what local jurisdictions will do. All we know is based on what's in place today, for us, one asset would be impacted by rent control that currently isn't today. Other than that, it's trying to handicap every jurisdiction and which way they're going to vote in terms of putting a rent control measure on the ballot. Is that done through some kind of voter referendum or other means? That's all purely speculation that is really hard to comment on or quantify at this point.
Gotcha. Okay. Thank you.
Yep.
Final question comes from John Pawlowski.
Thanks, Sean. I apologize if I missed some of these components. Could you just quickly run through 2Q new and renewal growth rates as well as early 3Q new renewal and occupancy?
John, why don't I give you the Q2 numbers at the regional level. A lot of that stuff, that's a fair amount of detail, so why don't I have Jason follow up with you on that. The Q2 blended rates were included in the supplemental, as you may know, by market in a row, so you can see that. As it relates to the difference between move-in, renewal, and blended for the quarter, I can tell you New England move-in.
Sorry.
Total portfolio would be fine. Total portfolio.
Total portfolio?
Yeah, total portfolio for Q2 is included in the supplemental, which is 2.8 blended, 3.9 on renewals, and 1.4 on move-ins, if that's what you're looking for specifically. Then July, I mentioned 3.25 blended, which is roughly 4% on renewals and about 2.5 on move-ins.
Occupancy today?
Occupancy today is still running in the low 96% range.
Thanks a lot.
Yep.
I would like to turn the call back over to Tim Naughton.
Cool. Thank you, Travis, and thank all of you for being on the call today. I hope you all enjoy the rest of your summer, and we'll see you sometime in the fall. Take care.
Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.