The Vice President of Investor Relations, Jason Reilley, welcomed participants to the AvalonBay Communities Second Quarter 2023 Earnings Conference Call and noted that forward-looking statements may be made during the discussion. He then introduced Ben Schall, CEO and President of AvalonBay Communities, who will provide an overview of their outperformance in Q2, their limited new supply in their markets compared to other markets, and additional color on their guidance raise. Sean will then discuss the underlying market fundamentals and progress they are making on bad debt.

In the second quarter, the company achieved core FFO of $2.66 per share, which is a 9.5% growth from last year and $0.07 higher than the Q2 guidance. This outperformance was primarily revenue-driven with same-store revenue growing 6.3%, lease rates and other rental revenue being modestly favorable, and underlying bad debt being successful in getting back and re-leasing apartments. In the future, the company expects to benefit from significantly less competitive new supply in their established regions than in the Sunbelt.

The activity of increasing apartment deliveries in the Sunbelt is expected to create a meaningful differential in the stock of existing apartments, compared to the established regions. The company has raised their full year guidance for core FFO to $10.56 per share, which is a 7.9% increase from 2022. This increase is attributed to outperformance in Q1 and Q2, as well as improved expectations for bad debt and lower payroll costs. The increase from $10.31 to $10.41 and now to $10.56 per share is primarily due to same-store NOI, and the company has adjusted their capital allocation approach to reflect the changing external environment.

Ben discussed the development and transaction sides of the business, noting that they have reduced their expected level of starts in 2023 to 775 million from 875 million and will be net sellers of assets this year with expected dispositions exceeding acquisitions by roughly $200 million. Sean then discussed the steady improvement in underlying bad debt due to nonpaying residents leaving their communities, which led to an increase in turnover and modest decline in physical occupancy. They expect a continued steady flow of move-outs associated with nonpaying residents over the next few quarters, which will further reduce underlying bad debt.

The Q2 rate of 2.3% suggests that revenue growth in future quarters will be strong. The midpoint of the same-store residential revenue growth outlook has been increased to 6%, which is supported by better-than-expected bad debt, higher-than-projected average rental rate, and increased contribution from innovation efforts. Economic occupancy is expected to be modestly below original expectations, and all established regions are projected to perform at or above the high end of the original revenue growth estimate. Additionally, the East Coast portfolio is projected to outperform the West Coast portfolio by 200 basis points for the full year 2023. The reimagined operating model is expected to bring an incremental NOI benefit of $16 million in 2023, which is $4.8 million higher than the original objective.

The material drivers of the positive variance in the company's results include faster deployment and adoption of technology services, as well as increased efficiency from digitalizing customer-related processes. The company's lease-up communities are delivering outstanding results, with rents 18% higher than initial underwriting and a yield of 6.6%, well above the 4% cost of capital. In the next six quarters, the company expects to deliver an additional 3,600 homes, which will drive incremental NOI growth and NAV creation on completion. The company has also seen success in the disposition market.

AvalonBay has closed on three asset sales in the past few months, but total sales volumes are still down 70% from 2022 levels. Cap rates on assets that are selling tend to be below prevailing debt rates, but some listings are not proceeding to closing due to a bid ask spread. AvalonBay is looking to redeploy a portion of the proceeds into limited acquisition activity and is on track to reach its 25% weighting goal in its expansion markets. They recently released a 12th annual ESG report and their key takeaways from the successful quarter are summarized on Slide 16.

Ben Schall and Matt Birenbaum discussed the legal update provided in Avalon's earnings release, as well as the dismissal of the class action lawsuit against Avalon. Additionally, Birenbaum discussed the development accretion that Avalon has seen in the past and expects to see in 2024, which will be double the pace of the last year or so.

Kevin O'Shea and Eric Wolfe discussed the level of accretion that can be expected from the volume of activity that is underway. Sean Breslin then went on to discuss the spreads between asking and take rates for renewals, which typically range from 150 basis points or so.

Sean Breslin explains that the company pushed hard for rental rate growth in the first two quarters of the year, resulting in a 2.8% increase in new move-ins in July. He states that the revised rent growth assumption for the year is 70 basis points higher than originally anticipated.

Sean Breslin provided preliminary estimates for July in terms of rent change and other factors, but the July bad debt data has not yet been fully closed out. The underlying bad debt rate for the first half of the year was 2.7%, and the rate is expected to decrease for the second half to 2.2% in Q3 and 1.9% in Q4.

Occupancy is correlated with bad debt, and economic occupancy is expected to average around 95.5% in the second half of the year due to the return of non-paying resident units. The deceleration in term effective rent change seen in July is likely due to the expiration of the eviction moratorium in March, which led to more availability in the portfolio, prompting a decrease in rates to encourage more leasing velocity.

Ben Schall discussed the expected bad debt rate of 2% for the second half of the year, which does not include rent relief funds. He expects this rate to continue until at least the first half of 2024. He also mentioned that they are expecting lower property taxes in the second half of the year, with Washington state being one of the markets driving the lower taxes.

Sean Breslin states that they are halfway through their plan of achieving $15 million in incremental NOI by 2023 and that there is another $25 million to come in 2024 and 2025 from automation, AI, and other initiatives. Alan Peterson appreciates the information.

Matt Birenbaum explains that there has been a decrease of $100 million in development starts due to one project, where the returns were too tight in comparison to capital costs and asset values. He does not believe that this should be read as a sign for next year.

Ben Schall discussed the discipline the company has had in terms of adjusting their capital allocation approaches and maintaining spreads between underlying market cap rates and stabilized development yields. Sanket Agrawal asked if they had seen private merchant builders pull back on development teams, to which Matt Birenbaum answered that they had not been in that position and had had a relatively measured pace of start activity for the last few years.

Ben Schall discusses the outperformance of the northeast markets and suburban markets in recent years, and how the supply dynamics in these markets will continue to be a factor into 2025. He explains that if demand remains flat or softens, these markets will face a softening operating environment. He is confident in the demand and supply dynamics of the suburban coastal markets in the northeast.

Jamie and Sean discuss the economic advantages of renting versus owning in the northeast, citing the high rent-to-own spreads, difficulty in building single family supply, and lack of run-up in the housing market in the region. They provide the example of Boston, where the predominantly suburban portfolio is protected from supply, and New Jersey, which is seeing development for the first time in 30 years.

Matt Birenbaum explains that the SIP business is not a distressed business, but that the amount of proceeds of the first construction loan are lower than they would have been in the past, so they are lending from 50-75% cost instead of 60-85%. He gives an example of a suburban garden community in Charlotte that they recently closed on, which is near the DFP deal they started construction on in the first quarter.

Matt Birenbaum discussed the success of their DFP deal, which has yielded around 13%, and is representative of the type of business they are looking for. Despite the success, developers are finding it difficult to put their capital stack together, slowing start activity. The company has their pick of the litter in terms of quality sites and sponsors, but they are not willing to bend on the quality of the underlying collateral. The long-term goal is to have a $300 million to $500 million book of business. Currently, they are at less than $100 million in commitments.

Ben Schall explains that the company has shifted to selling assets in the market due to uncertainty and wants to lock in cost to capital before deciding how to reinvest. Josh Dennerlein then asks for guidance on new lease rate growth in the back half of the year, to which Sean Breslin responds that they expect to see solid rate growth in the first half, followed by a modest deceleration in the back half.

Ben Schall clarified that there are no other litigations related to RealPage that the company is aware of and has not been dismissed from. Matt Birenbaum explained that the outperformance of their developments is due to the rents running up significantly over the last two years, rather than the land price being baked in. This is a unique moment in time as they quote yields based on today's NOI and cost, and remarket once they have leased roughly 20%.

Matt Birenbaum discusses how the hard costs of the deals they bought were good, allowing them to enjoy a yield of 5.9%. He further explains that the deals they are starting to lease up should have a significant lift due to the rent growth, and that when thinking about future deals, they are looking for mid-6 yields given the cost of capital.

The speaker is discussing the current state of hard costs in different markets. He notes that in some regions, such as the Northeast, costs have fallen by 5-10%, resulting in buyout savings for recent starts. However, in other areas such as Austin, Denver, and Seattle, hard costs have not yet fallen. He also mentions that two-thirds of the increase in turnover in the second quarter was driven by recapturing delinquent homes, with the remaining one-third being attributed to other, unspecified factors.

Ben Schall reaffirms the goal to move 25% of their portfolio to expansion regions over a period of five or six years. This is due to the knowledge-based worker being in more dispersed markets and the desire to take their operations and development to new markets in order to create value for shareholders.

Sean Breslin discusses the opportunities for acquisitions and development in the current market, where there is softening in operations and limited institutional capital. He explains that they are focusing on lower density, lower price point assets with limited supply, and that they have seen some deals come back at 30-40% of what they traded for a year ago. He also mentions that there have been no unusual trends in terms of how tenants and consumers are reacting to suburban versus urban regions.

Sean Breslin states that New York is the slowest market in terms of processing cases, followed by D.C. and L.A. When a tenant skips or is evicted, they are not eligible for a new market rate apartment.

Sean Breslin and Anthony Powell discussed the current trends in the apartment industry, such as screening criteria and the number of tenants doubling up. Breslin reported that there has not been a significant trend of tenants doubling up during the COVID-19 pandemic. The call concluded with Ben Schall thanking everyone for joining and looking forward to speaking with them soon.

This summary was generated with AI and may contain some inaccuracies.