AvalonBay Communities, Inc.

Ladies and gentlemen, good morning and welcome to Avalon Bay Community's third 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 making your or sorry, 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 Riley, Vice President of Investor Relations. Mr. Riley, you may begin your conference.

Thank you, Abby, and welcome to Avalon Bay Community's third 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 410 and 410 problems with the administration. As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures, 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. With that, I'll turn the call over to Tim Naughton, Chairman and CEO of Avalon Bay Communities, for his remarks. Tim?

Yeah, thanks, Jason. With me today are Kevin O'Shea, Sean Breslin, and Matt Bierenbaum. Sean, Matt, and I will provide comments on the slides that we posted last night. and all of this will be available for Q&A afterward. Our comments will focus on providing a summary Q3 results, an update on operations, and some perspective on the transaction market and our financial position. Maybe just a few comments before turning to the deck. Several of the trends unique to this downturn and pandemic that we discussed last quarter played out in our performance in Q3. The appeal of urban living is, for the time being, diminished due to health concerns of living in dense environments, the shutdown's effect on retail, entertainment, and cultural venues that have long been the draw for urban centers, and a civil unrest that occurred in many of our cities over the summer and early fall. Work-from-home flexibility has been extended through year-end by many, if not most, employers, particularly those heavily weighted to knowledge-based jobs like many businesses in our coastal markets. We've experienced a significant reduction in student and corporate demand as remote learning modalities are being deployed at many urban universities and business travel has dropped off substantially. And finally, historically low interest rates are stimulating demand for existing and new home purchases, particularly for young age cohorts where homeownership rates have begun to climb. All these factors have resulted in an unprecedented reduction in apartment demand, particularly in urban centers, beyond what we typically experience in an economic downturn. And while we believe the reduction in demand is mostly temporary in nature, we also believe that it won't be restored until we substantially resolve the public health crisis from the pandemic. A meaningful recovery in our business will not occur until employers believe that they could safely bring their workers back to the workplace. Until then, business leaders are likely to err on the side of caution before reopening their workplaces, which is ultimately what will need to happen before many of their employees return to apartment living. I suppose if there's any silver lining in any of this, it's that our nation's struggle to respond effectively to the pandemic could ultimately lead to improvements in our response to future public health crises. Much like we saw in the aftermath of 9-11 and the great financial crisis, when our national response led to building a more resilient system to address the threat of terrorism and financial market dislocation respectively. We hope then that in the future, our nation and our cities will be better prepared to deal with the public health crisis in a more resilient and less disruptive way. But for now, we need to play the hand we've been dealt, and we'll endeavor to provide as much transparency and disclosure as to the actions that we're taking in response and their ultimate impact on the business. So with that, let's turn to the results for the quarter, starting on slide four. Q3 certainly proved to be a challenging quarter. Core FFO growth was down by 12%, driven by same-store revenue decline of just over 6%. On a sequential basis from Q2, same-store revenue was down 2.2%, or about half the sequential decline we saw in Q2 as bad debt in Q3 leveled off relative to Q2 after the big increase we saw in Q2 during the early months of the pandemic. In terms of capital allocation for the year, through the end of Q3, we've raised $1.7 billion through new debt issuance and dispositions and repurchased about 140 million of shares. We started only one development so far this year, and that was through a joint venture in Opportunity Zone in the Arts District of L.A., where we earned just 25% of the venture. Importantly, our liquidity, balance sheet, and credit metrics remain in great shape as we manage through the current downturn. Turning to slide five, like we saw in Q2, the decline in year-over-year same-store revenue and Q3 was primarily attributable to a loss of occupancy and uncollectible lease revenue or bad debt. These two factors drove about 80% of the drop in same-store revenue in Q3. Over the next two to three quarters, we expect to see continued declines in same-store revenue, but increasingly, the decline will be driven by pressure on rental rates, as we saw effective rental rates fall by almost 6% this past quarter. These declines will have a more pronounced impact on revenue over the next few quarters as those leases begin to roll through the portfolio. And as Sean will share in his remarks, the decline in effective rental rates have been greatest in high-cost and urban markets like San Francisco, New York, and San Jose. And with that, I'll turn it over to Sean. He'll discuss operations and portfolio performance in more detail. Sean. Sean Esterly All right. Thanks, Tim. Turning to slide six, We experienced a year-over-year increase in prospect visits to our community each month of the quarter. In total, visit volume was up about 20% year-over-year during Q3, which led to a roughly 10% increase in net volume. As you can see from chart two on slide six, the most significant increase in net lease volume occurred in September, which was up about 35% year-over-year. And as of yesterday, traffic and leasing volume for October was up roughly 25% and 20%, respectively. Moving to slide seven, for the first time in more than four years, resident notices to vacate our communities increased by a meaningful amount on a year-over-year basis. During Q3, notices increased by roughly 17%, primarily as a result of a spike in lease terminations in urban submarkets, which is depicted by the hash bars on chart one of slide seven and a topic I'll touch on in a minute. Our leasing volume exceeded the pace of notices, however, starting in August and has continued through October. As a result, if you turn to slide eight, you can see that beginning in September, move-ins exceeded move-outs and physical occupancy has increased from the low point at 93.1% in September to 93.5% for October and stands at 93.9% today. Moving to slide nine, Our suburban portfolio continues to perform substantially better than our urban assets. Charts one and two at the top of slide nine reflect notices to vacate our communities and lease terminations by sub-market type. Notices to vacate our urban communities increased by roughly 40% during the quarter, driven by an approximately 70% increase in lease terminations, and led to a 340 basis point decline in physical occupancy from Q2 to 90.2%, and double-digit decline in rent change. For our suburban portfolio, the increase in notices to vacate was more modest, supporting better physical occupancy and rent change. The performance of our urban portfolio has been impacted by a variety of factors, including those mentioned by Tim in his prepared remarks. I'd highlight the combination of extended work-from-home policies and the civil unrest that occurred during the summer months, which impacted the quality of urban environments as key factors driving residents to break leases during Q3 and leave urban centers for housing options in other geographies. Shifting to slide 10 to address regional performance, increased turnover in Northern California, the Mid-Atlantic, and New York, New Jersey impacted physical occupancy more than in other regions. In the New York, New Jersey region, the increase in turnover was primarily a function of elevated turnover in New York City, which was 87% on an annualized basis during the quarter. For the Mid-Atlantic, we experienced increased turnover in the District of Columbia and other urban or quasi-urban sub-markets, like the Roslyn, Ballston, and Tysons Corner sub-markets in Northern Virginia. In Northern California, annualized turnover during Q3 was 85%, driven by elevated turnover across all three markets, San Francisco, San Jose, and the East Bay, but was most pronounced in San Francisco, and in Mountain View, where Google is headquartered. On a positive note, turnover was relatively flat in New England, which is a testament to our primarily suburban Boston portfolio, and was down in both Pacific Northwest and Southern California. Physical occupancy in all three regions exceeded the portfolio average. And moving lastly to slide 11, same-store light-term lease rent change was down 3.3%, and effective rent change was down 5.8%. Metro New York, New Jersey, and Northern California, two of the regions I identified on the last slide with elevated turnover and therefore available inventory to lease, produced the weakest rent change during the quarter. Rent change in New England held up the best, again supported by our suburban Boston portfolio, which in many cases offers differentiated products, including larger unit sizes, to those departing urban environments. So with that, I'll turn it over to Matt to address our development portfolio. All right, great. Thanks, John. Turning to slide 12, we are starting to see a remarkable recovery in the transaction market. Ultra-low interest rates have started to bring buyers back into the investment sales market for properties that can support reasonable levels of debt service, primarily suburban assets where operating results have been less impacted by the pandemic. To take advantage of this shift in buyer sentiment, we increased our disposition plan over the summer and brought several communities to market in the past two months. As of today, six of these communities are currently under contract or letter of intent at very attractive pricing with cap rates averaging 4.4%. This compares to four communities that we sold earlier in the year at an average cap rate of 4.7%, putting us on track to complete nearly $700 million in dispositions for the year. Turning to our development portfolio, slide 13 shows the rents we are achieving at the nine communities currently in lease-up. For the past several years, we have shifted our development focus to more suburban locations, and we're starting to see some of the benefits of this strategy now, as our lease-up rents are only about $45 per month below our initial underwriting, allowing for continued value creation on these assets as they are completed and stabilized. We have highlighted three of our lower-density northeastern communities on the slide, which feature rental townhomes, and which are showing a nice increase in rents compared to pro forma. This product, which features larger floor plans, private garages, and direct entry with no common corridors, is particularly appealing in the current environment and serves as a good substitute for single-family rentals, which are enjoying very strong fundamentals. On slide 14, we show the future earnings potential of our development portfolio. At current projected rents and yields, we expect to generate nearly $140 million in annual stabilized NOI, with only 14 million of that reflected in our Q3 results. And with more than 90% of the capital needed to complete those assets already funded, these developments should contribute significant incremental cash flow over the next several years. And for that, I'll turn it back to Tim for some closing remarks. Well, thanks, Matt. I'm going to turn it to the last slide, slide 50. It was another challenging quarter, driven by the suddenness and continued strength of the pandemic. Weak same-store performance is being driven mostly by our urban core, which Sean mentioned, particularly in the high-end areas of San Francisco and New York. Suburban communities with larger units have performed much better. While pricing pressure continues to impact rental rates, occupancy has begun to modestly improve and stabilize in the 93% to 94% range. The transaction market, as Matt mentioned, has picked up dramatically after having been frozen earlier in the year. For those assets being taken to market, values are generally holding up at levels close to pre-COVID valuations. We continue to be cautious in deploying new capital, particularly for new development, where economics are challenging and construction costs have not abated in any material way. And lastly, the balance sheet is very well positioned and is much stronger than prior downturns, which would give us plenty of financial flexibility to address the challenges posed by the current downturn. And so with that, Abby, we'd like to open the call for questions.