The operator welcomes participants to the AvalonBay Communities Third Quarter 2023 Earnings Conference Call. The host, Jason Reilley, introduces the company's CEO and President, Ben Schall, who will provide opening remarks. The company has posted a presentation to accompany the earnings release and will also hear from other executives on the company's operating performance, revenue building blocks, and development projects. There is a reminder to refer to the company's website for additional information on non-GAAP financial measures and terms.

The speaker begins by expressing gratitude to the AvalonBay team and associates for their strong financial performance. They credit their success to their operating model transformation and portfolio positioning in suburban coastal markets. They then mention that they exceeded expectations for core FFO growth in Q3, primarily due to strong revenue growth. They have raised $855 million in capital this year at a low cost and have completed three development projects with high yields. They also mention two new projects starting in Princeton, New Jersey and South Miami.

In the third quarter, the company made $50 million in commitments through its structured investment program, generating a 13% return. This has contributed to the company exceeding and raising its guidance three times this year. The company now expects core FFO to grow 8.6% in 2023, with same-store revenue growth expectations up 130 basis points. Sean, the company's CEO, then discusses favorable demand and supply drivers in their markets and shares initial thoughts on macro factors that will support the portfolio's performance in 2024. He also highlights the portfolio's rental affordability in comparison to other regions and single-family homes for sale.

The cost of owning a home has increased compared to renting, making apartment living a more attractive option. This has resulted in a decline in home sales and a decrease in move-outs to purchase a home. The company's portfolio is insulated from new supply and they expect strong revenue growth in all market cycles. Four building blocks for revenue growth in 2024 are highlighted, including embedded growth from executed leases, current loss to lease, and operating model initiatives.

The company's Avalon Connect offering saw a significant increase in revenue in September, with a projected continued growth in the last two months of 2023 and throughout 2024. The normalization of bad debt is also expected to contribute to healthy revenue growth in the upcoming year, partially offset by the loss of rent relief recognized in 2023. The company's lease-up activity has been successful, with five developments leasing at rents 17% above initial underwriting, driving a 90 basis point increase in yield. The structured investment program also saw two new investments in the last quarter, totaling $52 million at an average interest rate of 13%.

The company is discussing their three to five-year investments in merchant builders, which they expect to grow to $400 million over the next few years. They are able to underwrite most of this business in today's restrictive environment and have strong financial strength and flexibility. Their balance sheet shows low leverage, high interest coverage ratio and unencumbered NOI percentage, and well-laddered debt maturities. They also have a high level of excess liquidity, with $1.5 billion available for development and structured investment products.

The company has maintained a strong balance sheet and is well prepared for the current economic environment. They have adjusted their capital sourcing and allocation activities to respond to changes in the market. They have also raised their return requirements for new development projects and expect to have a lower number of development starts in the coming quarters.

The company is focused on maintaining a strong balance sheet and believes they are well positioned to take advantage of market opportunities. They have raised their development yields to mid to high 6s and are aiming for a spread of 100 to 150 basis points between cap rates and development yields. They estimate that a significant portion of their future development pipeline will meet this criteria.

The company is guessing that cap rates are in the mid-5s, which translates to development yields in the mid to high 6s to maintain a spread. It's hard to say what percentage of the current book meets this threshold due to fluctuating costs. Some deals are meeting the hurdle, while others may fall short but could potentially meet it with value engineering and changes in costs. The company is still working on determining market rent growth for next year.

The company has a macro view and a grassroots approach to forecasting demand. They anticipate a deceleration in demand in 2024 due to slower job and wage growth and other potential headwinds. They use consensus forecasts and on-the-ground data to estimate market rent growth. In the near-term, they have seen a moderation in lease rate growth as they work to fill vacancies.

The company has been successful in building occupancy in the third quarter, but there are still pockets of softness in certain markets, particularly in Northern California. The development pipeline is expected to continue creating value and earnings, with a ramp-up in activity in 2024 and 2025. However, the company may not see the same level of outperformance as in the previous year.

The speaker discusses the decision-making process for new development and the need for a sufficient profit margin in relation to market cap rates. They mention the availability of opportunities in both new development and acquisitions, giving the example of buying assets below replacement cost in Dallas. They emphasize the importance of flexibility in their approach and adapting to market conditions and cost of capital. The questioner asks about leasing trends in Northern California and Seattle, and the speaker explains that there are multiple factors at play, but there has been a difference in lease growth rates in these two markets due to varying demand.

The speaker is discussing the recent trends in the rental market in various regions, specifically Seattle, the Mid-Atlantic, and Denver. They note that there has been a step-up in rent change in these regions, but there has been a softening in Northern California, particularly in San Francisco. This is likely due to a lack of demand, as there is no compelling reason for people to return to the office. However, Seattle has not seen the same level of weakness, and this, combined with the easier year-over-year comparison, has resulted in an uptick in rent change. The speaker also mentions that there was a lot of short-term leasing activity in 2023, which put pressure on rates at the end of Q3 and Q4, but this was not present in 2023.

In this paragraph, the speaker discusses two questions related to the company's earnings and performance. The first question is about the improvement in bad debt, which the speaker estimates to be around 100 basis points from the beginning of the year to the present. They mention that Florida is the only region where there has not been significant improvement. The second question is about the impact of resident relief funds on earnings in 2024, and the speaker explains that while there will still be some improvement, it may not be as high as in 2023 due to the loss of rent relief funds.

The speaker discusses the building blocks of bad debt and how it has been elevated in Miami and Fort Lauderdale. Lease renewals for November and December are at 6%, and the percentage of move-outs to buy a home is below 10%. The speaker declines to give a specific time frame or number for the progression of bad debt.

The speaker discusses the recovery path to pre-COVID levels and whether it is achievable. They mention that the industry expectation is to reach 70-80 basis points, but it is uncertain. They also predict that it will take until 2025 to reach full stabilization and mention the progress seen in Southern California. In regards to delinquent tenants, there may be an increase in repair and maintenance costs due to the backlog and evictions.

The speaker discusses the company's recent acquisitions and the state of the market. They sold $445 million worth of assets this year and will close their last dispo next week. The speaker also mentions the distressed state of the sellers and the pricing of the assets.

The company bought and sold several assets throughout the year, with the earlier sales achieving better pricing than the later ones. They bought three assets in the last 60 days for a total of $275 million, with cap rates in the mid-4s. These purchases were not distressed sales and one involved assuming debt. The company also sold assets for a net total of $230 million, with a focus on portfolio allocation. The assets they sold were older and located outside of their established regions, while the assets they bought were in Dallas and the Greater Charlotte area, where they can add value through their operating platform. The overall yield on the purchased assets is closer to 5% due to value-add opportunities and economies of scale.

The three assets that the company acquired are on average seven years old, with an average cost of $245,000 per unit and an average rent of $1,700. This is below today's replacement cost and is seen as a more affordable price point with better growth potential. The company is not currently seeing any distress in their expansion markets, but expects some dislocation in the future. They are looking to add density to their portfolio and potentially acquire deals with lease-up or near-term loan maturities.

The speaker discusses opportunities for borrowers and lenders to extend loans and leases, as well as opportunities in land development and providing capital to third-party developers. They expect less competition in the current capital environment and have a target of building up to $300 million to $500 million in the SIP program over the next few years.

The speaker discusses the company's selective approach to deals and their focus on achieving a 13% return. They plan to gradually build their book over the next few years. In response to a question, they mention that customer behavior has remained consistent, with a low percentage of people looking to move out to buy homes. They also note that the market has slowed and renting is seen as a more affordable and less risky option.

The speaker discusses the current and expected trends in rent change and property taxes for the company. They mention an easier year-over-year comparison in Q4 and anticipate rent change stabilizing in November and December. They also expect an elevated year of tax pressure in 2024 due to the expiration of tax abatement programs and anticipate more pressure in expansion regions compared to established regions.

The operator introduces a question from Joshua Dennerlein of Bank of America regarding the company's two new product starts and their impact on lease-up projects. However, there is technical difficulty on the call and Dennerlein is asked to call back. The next question comes from Steve Sakwa of Evercore who asks about the company's plans for development starts in the fourth quarter and in 2024, to which Matt Birenbaum responds that there may be a start in the fourth quarter and that 2024 starts may be more back half weighted depending on capital market conditions.

The company is experiencing a decrease in starts this year, which is lower than expected. This has led to a modest level of starts volume compared to their long-term capacity. Expenses have come in better than expected, but are still elevated and are expected to remain so in 2024 due to factors such as property taxes, pilot burden, utilities, and insurance.

The company is trying to mitigate pressure through the use of captive and other strategies to offset market growth rates, but expenses may still be elevated. The repairs and maintenance and legal costs are due to nonpaying residents and will be offset by payroll initiatives. Expenses may be in the same ballpark for next year, but elevated compared to history. The company is seeing some relief in certain areas, but the AvalonConnect offering is still profitable. The company is looking at distressed deals and the underwriting process for those deals compared to internal underwriting.

The speaker explains that the company underwrites all projects in a similar manner, using their own data and projections. They are cautious in their lending and have a margin of safety in case they need to step in and take over the project. They also have a screening process to ensure they wouldn't want to own the project at any price. This approach applies to both the SIP program and other acquisitions and developments.

The speaker discusses how they formulate a view on the worth of a deal and make an offer. They also mention applying market-based underwriting and not factoring in the benefits of their operating platform when evaluating the value of an asset. In response to a question, they clarify that the improved earnings outlook is driven by both developments and operations, with a breakdown provided in the earnings release. Another question is asked about the negative newly spread reported in October.

The speaker is unsure if there is a normal trend for rent growth in October, but generally there is a seasonal bell curve with rents increasing from January to July or August before decelerating. This year, rent growth has been around 2.5% on average, with slightly less seasonality in most markets except for Northern California. Hard costs have decreased by 5-10% in some areas, but not yet in others, and it is expected to continue in certain regions.

The company is staying flexible and taking a methodical approach to expanding into new markets. They would prefer to do it perfectly all at once, but are committed to their long-term goal of moving 25% of their portfolio to expansion markets. They believe this is necessary because their core customer, the knowledge-based worker, is located in a more dispersed set of markets. The performance of the Sunbelt market is not meeting expectations, but it is still a key focus for the company.

The company plans to expand into new markets and take advantage of potential opportunities in the current market conditions. They have already started buying assets and are open to larger opportunities in the future. The company also discusses their target leverage and potential ways to reach it, such as debt assumption.

The speaker explains that the company's current leverage ratio is 4.1 times, which is lower than their target range of five to six times. This is due to their capital decisions over the last few years, including paying off debt and bringing in new equity. This has given the company financial flexibility and leverage capacity to take advantage of investment opportunities in their established and expansion markets.

The speaker did not provide specific expectations for new move-in lease rates in Q4, but did mention that renewal offers went out in the 6% range and are expected to settle around 4-4.25%. The speaker also noted that comparisons get easier in November and December, resulting in an uptick in rent change in certain markets. Overall, the speaker expects a relatively stable glide path for lease rates through the end of the year.

The speaker is discussing the earn-in and loss of lease in the company's portfolio. They mention that the earn-in may soften slightly by the end of the year, but have not determined by how much. They also provide an update on the loss of lease, with the East Coast markets having the highest percentage. The speaker also mentions that the Northern California market has been softening. The expansion region's loss of lease is 70 basis points, which is better than expected. The speaker is asked about the possibility of space markets being a positive attributor to same-store revenue growth next year.

The speaker explains that the company's projected rental income for new properties is lower than the actual income they are currently achieving. This could be due to either rent growth or other factors, and they do not adjust their projections based on trends.

The speaker discusses how their company has been conservative in their initial underwriting, which has resulted in outperforming their competitors. They mention potential reasons for this, such as hard cost savings and rent growth, and state that they tend to outperform by 20 to 30 basis points in the long run. They also mention their current economic occupancy rate and thank the participants for joining the call.

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