AvalonBay Communities, Inc.

Good morning, ladies and gentlemen, and welcome to Avalon Bay Community's second quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. Following remarks by the company, we will conduct a question and answer session. You may enter the question and answer queue at any time during this call by pressing star 1. If your question has been answered or you wish to remove yourself from the queue, 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 please have your cell phone turned off during the question and answer session. Your host for today's conference is Mr. Jason Reilly, Vice President of Investor Relations. Mr. Reilly, you may begin your conference.

Thank you, Matt, and welcome to Avalon Bay Community's second quarter 2020 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements, and actual results may differ materially. There 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, followed 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 forward slash earnings, And we encourage you to refer to this information during the review of our operating results and financial performance. And with that, I'll turn the call over to Tim Hutton, Chairman and CEO of Avalon Bakery, for his remarks. Tim? Thanks, Jason, and welcome to the Q2 call. With me today are Kevin O'Shea, Sean Breslin, and Matt Bierenbaum. Sean, Kevin, and I will provide commentary on the slides that we posted last night, and then all of us will be available for questions. Q&A afterwards. Our comments will focus on providing summary Q2 results, an update on operations, and some perspective on development in the balance sheet now that we've entered an economic recession. But before getting started on the deck, I thought I'd offer a few general comments about the environment we're currently facing. To say things that have changed over the last four months is certainly an understatement. We are in the middle of the largest global health care crisis in a century. The economic downturn is the most severe we've seen since the Great Depression and on the heels of the longest expansion on record. And social unrest is at a level we haven't experienced since Vietnam and the Civil Rights Movement over 50 years ago. It's been said, but these are indeed unprecedented times. And these events aren't just having an unprecedented impact on economic activity, but also on income and wealth distribution across industries in the broader population. For those companies and workers leveraged to the virtual economy, they're actually doing quite well, and some are even thriving. For those companies and workers that operate in a real economy of bricks and mortar like ADB, we're certainly feeling the normal effects and then some of a downturn. And then for those companies and workers in the travel, leisure, and entertainment sectors, among others, they are basically in shutdown mode. These sectors, as well as others, will undoubtedly need to be restructured over the next few years. Many companies will not survive, and their employees, if even temporarily furloughed for now, will join the ranks of the permanently unemployed over the next several quarters. And unfortunately, those impacted by these events, or most impacted by these events, are those in lower-paying service jobs and minority populations. As a result, this downturn carries not just the normal economic risk of prior recessions, but also profound health, social, and political risks that are likely to shape the length and of the economic recovery. So while this was a sudden and quick downturn, the timing and shape of the recovery is hard to project, and that presents a unique challenge in managing our business and communicating our expectations to you, our shareholders. Having said that, we'll do our best to be as transparent and direct as possible as we all try to understand and gauge how the current environment will play out in our business in the months and quarters ahead. Now let's turn to the results for the quarter starting on slide four. As expected, Q2 was a challenging quarter. Core FFO growth was down almost 2%, driven by same-store revenue decline of almost 3%, or 2.2% of retail is excluded. And on a sequential basis, from Q1, same-store revenue was down 4.5%, or 3.9%, excluding retail. We had no development completions or new development starts this quarter, and we've had no starts so far year-to-date. And lastly, we raised over $700 million in capital this quarter at an average initial cost of 2.8%, with most of that coming from a $600 million long 10-year bond deal at a rate of around 2.5%. As Kevin will share in his remarks, our liquidity, balance sheet, and credit metrics are very well-positioned, heavy-duty. heading into this downturn. Turning to slide five, I wanted to drill down a bit more on the decline in same-store residential revenues this past quarter. As this slide demonstrates, the decline was primarily attributable to a loss of occupancy and uncollectible lease revenue or bad debt. Economic occupancy was down 120 basis points, while bad debt was 200 pips higher than normal. Higher than normal bag debt is likely to continue, given the breadth and depth of the downturn, coupled with eviction moratorium in many of the markets in which we operate. We also experience higher concessions in the quarter and lower other income as we weigh various fees this past quarter for our residents, including late payments, common area amenity, and credit card convenience fees. Average lease rate for our same-store portfolio in QQ is actually up. 1.8 percent over Q2 of 2019, reflecting embedded rent growth from leases entered into in 2019 through Q1 of this year. Turning to slide six, as I mentioned in my opening remarks, this downturn poses a unique risk relative to other recessions. In addition to the household contraction and consolidation that occurs due to job losses in any downturn, The pandemic is driving other trends that are impacting rental demand. These include work-from-home flexibility that is shifting some of the demand from higher-cost and urban infill markets. Many renters are relocating, perhaps only temporarily, to lower-cost markets or submarkets, leisure areas, or even back home with their parents. Second, record low mortgage rates and the desire for space is accelerating demand for single-family homes. Many homebuilders reported strong orders in sales this past quarter, particularly towards the back half of the quarter. And home ownership rate is on the rise. And lastly, we're seeing reduced demand from two important segments around us, corporate and students. As most temporary corporate assignments have been canceled, while higher education is adopting remote learning models and limiting on-campus activities for the fall. These factors will likely weigh on performance until the public health crisis is abated. On the other hand, they'll also likely contribute to a more robust recovery once employees begin to return to the workplace. With that, I'll turn it over to Sean to discuss operations and portfolio performance in more detail. Sean. All right. Thanks, Tim. Turning to slide seven, the factors Tim highlighted on the previous slide impacted leasing volume throughout the quarter. which is down roughly 10% year over year. Turnover for the quarter fell about 5%, so the volume of resident notices to leave our communities exceeded leasing velocity, most particularly in May when we experienced about a 25% increase in lease breaks for a variety of reasons, including corporate apartment operators shutting down operations in certain markets. As a result, move outs exceeded move-ins for the quarter. As of yesterday, net lease volume for July is roughly on pace with the volume of notices to vacate our communities, which should help stabilize occupancy as we move into August. Moving to slide eight, we experienced 120 basis point decline in physical occupancy from April to June, with most of it occurring in May as a result of the lease break volume I mentioned a few moments ago. Chart two on slide eight depicts both lease and effective rent change for the quarter. As detailed in our earnings release, blended lease rent change was down 40 basis points in Q2, while effective rent change was down 3.1%. Rent change for July has improved slightly from June, but the nature of the health crisis and economic environment will dictate the ongoing demand for rental housing, and our pricing power has moved through the balance of the year. Turning to slide 9, you can see the regional distribution of both lease and effective rent change for Q2. Northern and Southern California were the most challenging regions for a variety of reasons, while the Pacific Northwest performed the best. Moving to slide 10 to look at performance metrics by sub-market type, urban sub-markets deteriorated more materially during Q2 as compared to suburban sub-markets. From an occupancy standpoint, urban sub-markets declined by 270 basis points from April to June, while suburban sub-markets fell by only 50 basis points. And from a rent change perspective, urban submarkets trailed suburban by roughly 200 basis points. While the weakness in urban environments is pretty broad-based across our portfolios, most pronounced in San Francisco, Boston, and parts of L.A. Unfortunately, demand in urban submarkets is suffering from a variety of factors, several of which Tim mentioned in his prepared remarks, including a desire for more affordable price points, extended work-from-home policies across corporate America, a lack of short-term and corporate demand, uncertainty regarding on-campus learning at urban universities, and a general concern about population density. Shifting to slide 11 to discuss our development portfolio, construction delays at the beginning of the pandemic weighed on both deliveries and occupancies during the second quarter. As noted in chart 1 on slide 12, Deliveries and occupancies for the first half of the year fell short of our expectations by roughly 450 and 650 units, respectively, which translated into an NOI shortfall of approximately 2 million. Fortunately, following some initial shutdowns at about one-third of our construction sites for a short period of time, all our jobs are currently underway, albeit with a slower pace of deliveries expected across certain assets. I'll now turn it over to Kevin to further address development parts, funding, and a balance sheet. Kevin? Thanks, John. Turning to slide 12, in response to the current environment, we have chosen not to start any new construction projects so far this year, despite having initially guided in the beginning of the year to about $900 million in new construction starts for 2020. Looking ahead, we expect lower construction costs will benefit many of our future planned starts, and we are prepared to wait for the success of correction and hard costs before breaking ground so that we can lock in a lower basis on these investments. Although real-time construction cost data are difficult to come by, initial indications suggest we are beginning to see a softer labor market and a reduction in overall construction activity make their way into subcontractor pricing. As for development that is currently under construction, as you can see on slide 13, we are in a remarkably strong position from a financial point of view. Development under construction is already 95% match-funded with long-term capital, which not only mitigates the financial risk of development, but also means that we have locked in the investment spread profit on these developments by having maxed the long-term expected returns on the price of equity and debt price when we were selling these projects. Finally, as shown on slide 14, we continue to enjoy an exceptionally strong financial position today. This is particularly evident when comparing our key credit metrics today to those from the fourth quarter of 2008 when we entered the last recession. Specifically, since late 2008, our NASDAQ to EBITDA ratio has improved 4.9 times from 6.5 times. Our interest coverage ratio has increased to 6.9 times from 4.5 times. Our unencumbered NOI percentage has increased to 94% from 77%, and our credit rating has improved. to A3, A- from BAA1 to BBB+. This strong balance sheet position provides us with great flexibility to pursue attractive investment opportunities that may emerge as this downturn unfolds. And with that, I'll turn it back to Tim. Thanks, Devin. Just turning the last slide and offering a few summary comments. Q2 was a challenging quarter, driven by the suddenness of the pandemic and the depth of the downturn. So far, the impact on same-store performance has been driven by lower occupancy and elevated debt. Contributions from NOI and new development lead subs were less than expected due to construction delays and weak consorption. We have curtailed that new development dramatically and have not started any new community so far this year. Despite the strength in the Purcell market, we do expect construction costs to fall over the next few quarters. And we'll incorporate that into our capital allocation plans. And then lastly, the balance sheet is very well positioned in both an absolute sense and relative to prior downturns, which is evident that it just gives us plenty of financial flexibility to address challenges or opportunities as they arise. And so with that, Matt, we'll open the call for questions.

Thank you. And as a quick reminder for those on the phone, it is star 1 if you'd like to enter the queue. Our first question will come from Nick Joseph with Citi. Thanks. I appreciate the color and the rationale behind pausing new starts. I'm just curious how long you think the delay will be until you actually start new projects again, and then what signals are you looking at before actually making that decision to proceed?