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spk02: Good morning, ladies and gentlemen, and welcome to the Avalon Bay Community's first quarter 2023 earnings conference call. At this time, all participants are in a listen-only mode. Following remarks by the company, we will be conducting 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're using speaker equipment, 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 Riley, Vice President of Investor Relations. Mr. Riley, you may begin your conference.
spk03: Thank you, Doug, and welcome to Avalon Bay Community's first quarter 2023 earnings conference call. As a reminder, this call may contain forward-looking statements, and actual results may differ materially. There's a discussion of these risks and uncertainties in yesterday's afternoon's press release, as well as in the company's Form 10-K and Form 10-Q filed with the SEC. I'll now turn the call over to Ben Shaw, Chairman and CEO and President of Avalon Bay, for his remarks.
spk04: Thanks, Jason. In terms of key themes for this quarter, I will start by reviewing our strong start to the year and describe why we believe our suburban coastal portfolio is particularly well positioned. Sean will discuss our operating performance and relative strength as we enter the peak leasing season. Matt will comment on the evolving development market and detail the differentiated earning stream that our developments currently underway are set to provide. And Kevin will review our strong financial position and highlight the advancements at our industry-leading centralized service center we utilize to drive revenue and operating efficiencies. Turning to our presentation, starting on page four, we continue to meaningfully grow earnings in Q1, with core FFO increasing 13.7%. A significant part of this uplift is related to the roll-through of leases signed last year. We also continue to grow rents during Q1, with light-term effective rent change of 4.1%. For the quarter, we exceeded core FFO guidance by 5 cents, with the one cent of revenue primarily attributable to better than expected collection rates from residents, three cents due to lower operating expenses, and one cent related to interest income and other items. In early April, we drew down the proceeds of our equity forward, which we entered into about a year ago at the spot price of $255 per share. A couple of items to highlight here. First, the initial cost of this $500 million of capital is in the low 4% range. As was originally intended, we've allocated this capital to development projects underway, which are projected to generate development yields of 6% or more. So when we talk about funding our underway development at yesterday's capital cost, this almost 200 basis point spread is what we're referring to and leads to significant value creation for shareholders as these projects stabilize. The second aspect of the drawdown of the equity forward is unique to the current environment in which we can earn outsized returns on cash. We weren't originally planning to draw down the equity forward until Q4 of this year, but we executed it now and have invested the cash at 5% plus interest rates with extremely strong banking partners. On a net basis, the incremental income on this cash is projected to increase 2023 core FFO by approximately 3 cents per share after factoring in the incremental shares outstanding. We in turn increased our full year core FFO guidance by 10 cents to $10.41 per share at the midpoint. The breakdown is as follows. Two cents in revenue, with the one cent from Q1, and then an additional one cent in Q2, based on slightly better rental rates. There's an assumed two cent improvement for operating expenses for the full year, which includes the three cents from Q1, partially offset by one cent higher off X in the second half of the year. And then six cents of additional core FFO, primarily from the interest income on the equity forward proceeds, as well as other cash management and slightly updated assumptions related to transaction timing. We did not adjust our same store guidance ranges at this point, and we'll reevaluate those as part of our more fulsome mid-year re-forecast. Turning to page five regarding market fundamentals, occupancy and rent trends in our established regions are experiencing less volatility than in the Sunbelt regions. Part of this is a reversion to long-term trend lines. There are also underlying demand factors providing greater stability in our established regions, and two are worth noting. First, rent to income ratios are generally in line with traditional levels. As noted in chart three, effective market rents in our established regions have grown about 10% over the past three years, with income levels more than keeping pace with rent growth. And second, with limited single-family home inventory and higher interest costs, the economics of renting are considerably more favorable than buying a home in our markets. The near-term supply picture also bodes well for the performance of our suburban coastal portfolio. As shown on page six, our established regions have meaningfully less new supply coming online this year, estimated at 1.6% of stock, as compared to Sunbelt markets at 3.6%. And as shown on the right-hand side of this page, when we look at supply that is directly competing with our portfolio, levels are even lower, at 1.4% of stock overall, and only 1.2% of stock in our suburban markets, which comprises roughly two-thirds of our portfolio. In terms of our portfolio allocation objectives, we do still want to shift 25% of our portfolio to our expansion regions over time in order to diversify and optimize our longer-term growth profile. So that has not changed. And in the nearer term, the relative trade of selling assets in our established regions to acquire assets in the expansion regions could be more attractive to us than it has been, allowing us to more profitably reposition our portfolio for future growth. And with that, I'll turn to Sean for more specifics on the operating backdrop.
spk09: All right, thanks, Ben. Continuing with slide seven to address market trends, effective rents in the East and West are up about 10% from pre-COVID levels, but took very different paths to get to the same point. Rents on the West Coast, which have historically been more volatile than the East, declined sharply in 2020, escalated significantly in 2021 and the first half of 2022, and then softened consistent with seasonal norms in the back half of 2022. Rents on the East Coast experienced a more modest decline through COVID and have grown steadily since Q1 2021, with very modest seasonality in the back half of 2022. And consistent with historical norms, both coasts posted positive sequential monthly rent growth during the first quarter. From a year-over-year growth rate perspective, the West Coast continued to decelerate during Q1, while the East Coast showed signs of stabilization bolstered by slightly better growth in absolute rent levels since the beginning of the year. Moving to slide eight to address trends in our same-store portfolio, key performance indicators were healthy during Q1 and remained so heading into the prime leasing season. Our availability was in the low 5% range during the quarter. Turnover, which was relatively stable during the quarter, was lower than Q4 2022 as the volume of residents leaving our communities to purchase a home declined by roughly 25% sequentially and about a third year over year. Occupancy increased about 30 basis points from Q4, and as noted in chart 4 on slide 8 and also in our earnings release, rent change improved from 3.7% in January to 4.9% in April. Additionally, our portfolio average asking rent has increased about 3.5% since the beginning of the year, up 4% on the east and about 3% on the west, and is slightly ahead of our original expectation. Also, renewal offers from May and June went out at roughly 7%. I'll turn it over to Matt to address development now. Matt? All right, great. Thanks, Sean. Turning to slide nine, our lease-ups continue to deliver outstanding results. laying the foundation for strong future growth in both earnings and NAB. We currently have four development communities that had active leasing in Q1, all of which started construction early in the pandemic before rents had started to rise meaningfully. As a general rule, we do not update our projected rents on lease-ups until we open for business and start to gain leasing velocity, at which point we mark those rents to current market levels. For these four deals, we have seen an increase of $485 per month or 17% above our initial underwriting. This in turn is driving a 70 basis points increase in the yield on these investments to 6.7%, well above current cap rates and even further above the cost of the capital we sourced to fund these deals back when they broke ground consistent with our match funding approach. Looking ahead, we expect to start leasing on an additional seven communities before the end of the year. We have not yet marked the rents on these projects to current market, but in general, The locations in which they're located have seen similar increases in market rent since we started construction, providing a great opportunity for further lift in their results as well. As shown on slide 10, with most of our communities, development communities still early in lease up or yet to open, we realized just 10 million of the total projected 142 million in NOI from the entire development book in Q1. This leaves over 130 million of incremental NOI to come as these assets complete construction and stabilize. And as per the prior slide, that total NOI figure is also likely understated given only four of those 18 total projects have been marked to market today. Turning to slide 11, as we look to future development starts, we are certainly starting to see shifts in the development market in response to the Fed tightening of the past several quarters. Among our competitors, many planned projects are being postponed or abandoned as third-party financing becomes scarce, and some of these dropped land contracts are starting to come back to the market with much lower pricing expectations. We've already been able to take advantage of several of these situations with recent additions to our development rights pipeline, and we do expect to see more as the market adjusts. The slowdown in starts, in turn, is starting to impact the construction market, where we are finally starting to see some retraction in subcontractor trade pricing after three years of outsized increases. An environment where capital is scarce and certainty of execution becomes more critical, both to land sellers and subcontractors, plays well to our strengths as both the developer and the general contractor. And we have traditionally seen some of our most profitable investment opportunities when these more challenging cyclical conditions have prevailed. And with that, I'll turn it over to Kevin for an update on the balance sheet and the CCC.
spk10: Thanks, Matt. Turning to slide 12. As we look ahead, our balance sheet remains exceptionally well positioned to provide financial strength and stability while also giving us the flexibility to continue funding attractive growth opportunities across our investment platforms. In this regard, we enjoy low leverage with net debt to EBITDA 4.6 times, which is below our target range of five times to six times. Our interest coverage ratio and unencumbered NOI percentage are at near record levels at 6.9 times and 95% respectively. and our debt maturities are well-laddered, weighted average years to maturity of about eight years. In addition, as disclosed in our release, we also enjoy tremendous liquidity of about $2.8 billion today, with no borrowings under our $2.25 billion unsecured credit facility and an additional half billion dollars from just having settled our equity forward that we originated a year ago. As a result, we don't need to tap the capital markets for an extended time, And we are well positioned to lean into our balance sheet to take advantage of future investment opportunities that may emerge in our markets over time. On slide 13, we highlight our recently announced agreement to provide back office financial administrative support to Gables Residential's portfolio of 25,000 apartment homes from our centralized customer care center, which we established in 2007 to create operating and scale efficiencies in supporting our own portfolio while enhancing our resident customer experience. At the outset, I want to acknowledge the efforts of the entire Avalon Bay team that brought this business relationship to Gables across the finish line. We highlight this achievement for several reasons. First, because we were genuinely excited to be able to extend these services to a highly respected multifamily company such as Gables and to its residents. Second, because this agreement demonstrates the appeal of the innovative capabilities that we've created in the 16 years since we established the CCC. And third, because we have embarked on extending those capabilities in a way that allows us to create additional value for Avalon Bay shareholders by offering these support services to other institutional multifamily owners now and in the future. As a reminder, we are not offering property management services under agreement with Gables, nor do we intend to do so, as all business and operational decisions related to Avalon Bays and Gables portfolios will continue to be managed separately by each company. Rather, we are providing back office financial administrative support to Gables. And finally, from an economic and guidance perspective, while we are not disclosing the specific terms of our agreement for confidentiality reasons, the near-term earnings accretion from this agreement is relatively modest and was included in our initial outlook given back in February 2023. With that, I'll turn it back to Ben for closing comments.
spk04: All right. Thanks, Kevin. Page 14 summarizes our key takeaways and focus areas. We're pleased with our start to the year, expect our portfolio to outperform as we look ahead, and are also mindful that these are the types of environments, particularly an environment in which capital is generally less abundant in the industry, to selectively take advantage of opportunities in order to create value for shareholders. With that, I'll now ask the operator to open the line for questions.
spk02: Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. If you'd like to ask a question, you may press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Eric Wolf with Citi. Please proceed with your question.
spk08: Thanks. It's actually Nick Joseph here with Eric. Kevin, you mentioned the agreement announced last week with Gables. I recognize you can't talk too much on the specific terms of that, but you know, if you could talk more broadly about, you know, is this a one-off deal? Are you looking to scale this business? What sort of margin and economics could you derive from it? You know, and then I know this isn't a third-party management contract, but would that be of interest as well for other property owners?
spk10: Sure. Thanks, Nick. I'll start, and others, Ben or Sean may want to chime in. You know, in terms of the go-forwards, view of this. We're certainly excited to have this agreement in place. And without getting into the specifics of the economics, I mean, the impact is at the moment fairly modest if you just think about the relative size of our business and our main value creators outside of operations and development and so forth. But we are excited to have it in place. It is accretive. There are, you know, from a contribution point of view, healthy margins for sure that make this worth the while. As to the future potential, we're certainly hopeful and inspired to do more business like this, but we're not proactively looking for that new business right now. We've just completed this transaction, of course, with Gable. But we do hope, looking ahead, to be able to do more business like this over the time. And we think it does make sense for us to do it over time because it allows us to scale and more fully invest over time in an important capability that allows us to further differentiate ourselves from our peers. So there's a lot more I could go into there, but maybe I'll just pause there, and I don't know if Sean or Ben have anything else to add.
spk04: Yeah, I think that was well put. I'll add a couple of things, and thanks for the question, Nick. I would connect for you this step as the kind of next continued evolution of both of our operating model journey, but as well as the role that the CCC and centralized services are playing for us. And so part of the appeal, in addition to the revenue and profit opportunity with Gables, we are increasingly handling more services, at least in part, at a centralized way. And this relationship allows us to make continued investments think about technology, about process, people, that we think can then accrue to the larger platform here at Avalon Bay. So it's a nice next step in our overall operating model journey, and we're excited for this first step and potentially future clients going forward.
spk08: Hey, it's Eric. Maybe just to follow up there. You said that the initial sort of impact was including guidance and it wasn't, you know, frankly that large, I guess. how many units would you sort of have to manage before it would become a sort of more material part of your earning stream? And just to make sure that I understand the last part of your answer, I think you're effectively saying that you can sort of invest in your platform, invest in technology, and even though the financial contribution above that might not be that big, you're effectively allocating those costs to other parties. Is that the right way to think about it, or did I misunderstand that?
spk10: Eric, let me kind of take a stab at it a little bit. You know, I can't really give you, I mean, an answer of what number of units would have to be under this kind of an arrangement for it to be material. It partly depends on what you think is material, I guess, to some degree. I think the way we look at it is from a slightly different perspective, not the immediate financial impact, but it's kind of been alluded to what this sort of thing does for us to continue our journey to create the leading, you know, operating platform in the business. And so, You know, we're in our 17th year with this experience, and I think that we're pointing this out probably for two reasons. One, you know, to your question about what this can do, the more you do this for not only yourself but for others, the more you can reinvest in that business, create a better platform in and of itself over time. But even for our own sake, when we started, we weren't at, you know, our current size of whatever, 80,000 apartment homes. When we started this in 2007, we were quite a bit smaller. It has gotten better itself over time. We've really fine-tuned and honed the CCC so that it's substantially better than it was even back in 2007 and 2010. And it has done a number of things you can see on the slide here for us over time. I mean, one thing it did is when we had the Artstone transaction, we were able to add 20,000 units in 30 days. So that bespoke, that speaks to sort of the ability to scale quickly when you've got that capability centralized in-house. And the other reason why we think it's worth highlighting for you, apart from, you know, the fact that it is a relatively modest financial significance today, is the fact that, you know, a highly respected institutional multifamily owner such as Gables, you know, by entering into agreement with us after its own due diligence to us and our center, does provide external validation of the strength and the economic value of the capabilities we've created at the CCC over the past 16 years. And we think that's something that's worth emphasizing today. to our investors, given the increasing importance of generating alpha in our operating platform through innovation, which we're continuing to do across the entire business at this point.
spk19: All right. Thanks for all the detail. Our next question comes from the line of Steve Sackwell with Evercore. Please proceed with your question. they were pretty back and loaded for you guys this year.
spk12: I'm just curious, given Matt's comments about costs starting to come down, but the economy's potentially weakening and rent growth is slowing, you know, how those potential starts are kind of shaping up for you. And, you know, what, I guess, are you looking for higher hurdle rates today and maybe in the back half of the year than you were say six months ago?
spk09: Sure. Hey Steve, it's Matt. Um, uh yeah so our target yield or going in initial return on new development has been rising really over the last year as we saw you know cap rates rise and cost of capital rise both debt and equity so um you know our target yields were probably in the mid fives mid to high fives last year and now they're they're kind of in the mid sixes low to mid sixes depending on the geography and the risk associated with the deal so um you know our start activity for the year is it is probably a little more back half weighted just by the way these deals tend to pace out. And also we do think that as time goes by, we're going to see more buyout savings on our hard costs. So that probably pays to our advantage a little bit. And we can play that a little more aggressively given that we act as our own general contractor, 90% of our development, which is a little different than I think many others. So, you know, But when I look at our development starts that are slated for this year, that's about where the yields are. They're probably in the low sixes. And you have to kind of look at the geographic mix and the risk profile of those deals to kind of weigh the profitability of each one, which is what we do. But again, we've been pretty consistent in saying we're continuing to look for that 100 to 150 basis point spread on new starts. And frankly, the stuff that we started last year and the year before, the spreads are well wider than that, which was kind of highlighted on the slide.
spk12: Yeah, I guess maybe to ask it maybe a little differently, I guess what risk or what probability would you put that you don't hit the starts number for a host of reasons, or do you feel reasonably confident that costs are coming your way, and even if rent growth slows a little bit, that you're still able to kind of achieve the returns you need to kind of put those starts into the ground?
spk09: I think I'm pretty confident about it. When I look at the starts for the year, We started one in the first quarter. We have one that we've just started that will be a second quarter start, a third one where we have all of our final budgets, and it's been approved through our investment committee. So that's, you know, three of the seven rates start to be planned for the year. And when I look out at the other ones, I'm feeling pretty confident that we should track that unless something very unexpected happens.
spk04: Steve, maybe a little bit more to your question about, you know, how is our development approach changing? And we do have a fairly fulsome development rights pipeline. And Matt's talking about our nearer term starts, which are fairly big at this point. But the next set of deals in that pipeline over the next couple of years, part of what we're going through right now is very proactively, effectively we're reworking those deals to reflect today's environment. And given what's happening with some of our competitors, some of the formerly active developers there, sellers are starting to increasingly acknowledge that the environment has changed. And so that's leading to land repricing. That's leading to more attractive terms. It's allowing us to control high-quality real estate, relatively limited upfront costs. So all those dynamics continue to run in our direction.
spk12: Okay, great. And maybe just one question for Sean. You talked about, I guess, the renewals going out around 7%. I know you don't provide a split between new and renewals, and you kind of just provide the blend. And, you know, April was a nice uptick. I guess given that we're going into spring leasing season, you know, how – I guess how much confidence do you have that, you know, kind of the May and June numbers might look like April? Could they be better? And I guess what markets are you seeing the most strength and weakness?
spk09: Yeah, Steve, good questions. Maybe I'll provide a little high-level commentary as it relates to renewals versus new move-ins and a little bit about trends. But in the first quarter, what I'd say is if you look at the blend there, renewals were kind of in the high fives and new move-ins were sort of in the mid-2% range. And then in April, renewals were sort of in the mid-fives, but new move-ins, just given the seasonality of rents, have kind of moved up. into the mid-fours, just to give you some perspective there. And our expectation is that, you know, consistent with what we talked about on the first quarter call, that we would see the best rent change kind of in the first quarter, and then it would begin to decelerate. But, you know, that's dependent upon what happens with growth and asking rents as we move through the year. So our expectation is still consistent with what we communicated in Q1, is that we would see Q1 perform well, and then we would start to see some moderation. both in rent change and in overall rental revenue growth. And that's still the expectation. And part of that you're going to have to keep in mind is, you know, on a year-over-year basis, you know, the headwind associated with the reduction in rent relief becomes more material as you get into the second and third quarter. And that will create some moderation from a rental revenue growth perspective. But as it relates to rent change, based on what we know today, I would say as you get further into the second quarter, you know, we would expect that to begin to moderate more so than what obviously we saw in the first quarter.
spk19: Great. Thanks. That's it for me. Our next question comes from the line of Austin Worsham with KeyBank.
spk02: Please proceed with your question.
spk17: Great. Thanks, everybody. Going back to Gables for a minute, I guess I'm curious what sort of precipitated the discussions with Gables and whether or not you pursued any other potential portfolios to add to the CCC platform. And while understanding you're not handling the property management, could we see these partnerships lead to a feeder for future acquisitions?
spk04: Austin, on the first piece, short version of it, there were some existing relationships across the firms, which sort of started the conversations. We then went through a pilot with Gables on a smaller portion of this portfolio to test it, both for them and for us. And on the heels of that, we both decided to proceed, given the benefits that were being realized And then to your last piece, no, this is not an acquisition type of approach or angle here. This is much more focused on operational benefits.
spk17: Understood. And then going back to development, I recall some tables you provided over time showing kind of IRRs on development, and certainly recall coming out of the GFC, there were some really attractive returns over time. So given what's going on with the availability of bank financing, the more attractive land and input costs, I guess it seems like a unique opportunity today. So how are you thinking about ramping development as quickly as you can to maybe capitalize on what's going on today?
spk09: Hey Austin, it's Matt. I can speak to that a little bit and then Ben may want to as well. The good news is we're controlling a lot of really good real estate right now for very modest upfront investment. So we've kind of been operating the platform in anticipation of a potential opportunity emerging like this really for the last couple of years. And we've added quite a lot to our pipeline over the last year or two. We're controlling, I think, 40 or 41 potential deals with, you know, pretty modest land on our balance sheet. I think it was $180 million. At the end of the quarter, the total investment, including capitalized pursuit costs, is only around $235 or $240 million. So, you know, we have, and a lot of those options, you know, are not yet at the point where we have to make a decision about, are we going to close? Are we going to, as Ben mentioned, there are some conversations going on with some sellers about these deals were struck in a different environment um so i think we're well positioned um i wouldn't say it's quite there yet um it's not like development economics are screaming you know uh value yet you know we kind of have to see where asset values settle out and that's the other side of this is what's going on the transaction market um which is still you know pretty muted deal deal volumes but we do have the ability uh you know to ramp it up if we see that uh emerging kind of later this year, particularly when we look to next year. The other thing is, as I mentioned, we are starting to see the moderation in hard costs, particularly in some markets where start volume has come down. There are other markets where that's coming, but it's not here quite yet. So we're watching that very closely every day. And that's the other opportunity that we will see. There's some markets where we think it's going to come down more. There's other markets where it's going to take a little more time. But over particularly the next four or five months as we have more deals out in the market actively bidding, you know, we'll have a much better sense for where hard costs are going. Because what we're finding today is if you have a job that you're going to start in a year and you're showing preliminary drawings, you're not getting particularly attractive pricing. But if you have a job that's truly ready to go, you've got a permanent hand, subcontractors can see some early site work, and they have a hole in their production schedule, that's when you're seeing, you know, the more aggressive bids.
spk04: Two areas that emphasize, you know, one, just on the point of, you know, our relatively limited land holdings, you look across our peer set, you know, our land holding numbers is below a number of our peers, you know, despite kind of our ability to execute at higher development levels, you know, throughout cycles. So we've got, you know, some room in there. The second part is In the environment right now, we recognize we need to be selective about that. But in places, you know, it could be markets we know really well, have nearby operating communities, places where we can bring our platform into. We're finding opportunities there in our expansion markets for some high-quality land, deals that are falling out of contract, ability to step in. And, you know, there have been a couple of situations where land is getting repriced at, you know, 30% to 35% where it was priced nine months ago. If we can step in and control that land with relatively limited cost, we can look at a couple of years and we think that will accrue some significant benefits.
spk19: Thanks for all the detail. Our next question comes from the line of Adam Kramer with Morgan Stanley.
spk02: Please proceed with your question.
spk13: Hey, guys. Thanks for the question. I just wanted to ask about bad debt. It looks like 500 basis points on kind of a gross basis in the quarter. I'm just wondering, you know, I know you're going to give a really helpful kind of market by market breakdown there. So I'm just wondering kind of how you're thinking about gross bad debt over the next few quarters. And is there a chance this could be kind of a, you know, some sort of tailwind going into next year if this does return to, maybe doesn't even return all the way to kind of normal pre-COVID levels, right? But just, you know, you get some year over year improvements on that number.
spk09: Sure, Adam. This is Sean. Just a couple comments on that. First, as it relates to bad debt during the quarter, the sort of uncollectible portion from our residents, as we think about it, sort of underlying bad debt, you know, came in around 3%, which is about 22 basis points better than what we anticipated. And that's the penny that Ben basically spoke about in terms of what we picked up in the first quarter. Moving forward, For the balance of the year, we're expecting Q2 through Q4 to average roughly 2.7%, starting at about 3% in Q2 and then sort of trending down throughout the year in terms of that underlying sort of bad debt percentage. So that's how the sort of trajectory looks as you move forward. You know, different markets are doing different things. We saw some nice improvement in New York. the greater New York region in the first quarter. It was responsible for about half the variance in the quarter, about a third in Southern Cal, and then kind of sprinkled across the other markets as well. So overall, we were pleased with what we saw in the first quarter, but, you know, doesn't necessarily make for a trend just yet. And we'll be able to revisit that mid-year once we have a better sense for how things are playing out as we move through the second quarter as well.
spk13: great that's really helpful i'm going to appreciate the the clarification there on the 300 basis points i was wrong on my uh my higher number there appreciate that um just just as a follow-up um is there is there a chance you can kind of have a i guess kind of more of a one-time one-time in nature but but uh you know kind of a benefit from residents who who kind of true up right who not only kind of get current on rent but also pay prior periods that they hadn't that you know that they were delinquent on and hadn't paid um is it possible you can kind of see a 110 benefit from that um adam what i say is anything's possible uh i don't think that is probable based on the resident behavior we have seen thus far um so i would not anticipate that to the extent that we
spk09: all of a sudden, you know, cash started raining in from people who haven't paid, you know, that's not necessarily what we've expected in our guidance. It would be a bump. But I would not expect that as a likely outcome.
spk19: Got it. Really helpful, guys. Thanks for the time. Yep.
spk02: Our next question comes from the line of Channey Luthra with Goldman Sachs. Please proceed with your questions.
spk11: hi thank you for taking my question could you talk about concessions you know what are you seeing across your markets particularly on the west coast and perhaps even on your expansion markets and how has the trend been in the last uh 19 days you know have things gone worse uh thanks um sure shandy this is sean happy to answer that um first in terms of q1 activity
spk09: Across all the leases we signed in the quarter, which was about 16,000 leases, the average concession was less than 200 bucks. So very, very modest. Obviously, you know, more concentrated in certain places. What I would tell you is about 30% of the concession volume that we experienced in the quarter in terms of leases that were captured were spread across Seattle and the Bay Area, particularly in San Francisco. So that's where most of the volume is, frankly. But if you look at concessions over the last few weeks, just to give you a little more recent data, you know, less than 10% of the transactions that we're executing are seeing a concession. And again, it's more concentrated in those two areas, San Francisco and the Pacific Northwest, where in those markets, you know, you're 30, 40, 45% of leases spending on sub-market are getting some type of a concession. Those are the two places where we're focused on it the most in terms of moving volume, but it's not a significant issue elsewhere.
spk11: Noted. And then, you know, as a follow-up, last quarter you laid out cap rates in the mid to high-force range. What are you seeing right now, and, you know, at what levels would you think that it would become appealing enough for you to dive in?
spk09: Yeah, hey, this is Matt. I guess I'll speak to that one. So what we've said, cap rates and then our own trading activity, I think what we're seeing is that there's a bifurcated market. There are a lot of assets that are not trading. Those that are, I've kind of put them into two buckets, kind of the haves and the have-nots. The haves, which is highly desirable assets in locations, either markets or sub-markets that, you know, are on a lot of investors' lists for growth, you know, those assets are still trading in the mid-fours cap rates. I think, in fact, I would have, if you'd asked me 90 days ago, I probably would have said high fours, but, and we do have some assets actively in the market today that hopefully will close here in Q2. And, you know, we have at least one that's in that, you know, halves category, I would say that's, you know, probably more of a mid-fours cap rate. Now, when I say cap rate, I'm not necessarily talking about the yield. I'm talking about kind of the market convention, the way they record a cap rate, which includes a management fee and a CapEx allowance and the buyer's property taxes. The other side of the equation is the assets that maybe have a little bit less of interest that have a less deep pool of bidders. And there, you know, the have-nots, you might have one or two that are seriously interested. And there, I'd say cap rates are probably more like low fives. And, you know, so call that range anywhere from four and a half to five and a quarter. And we may have an asset or two that's in that latter category as well that's currently working in the market. As it relates to our own asset trading activity, you know, our plan for the year was to be net neutral, but to really we started last year saying we were going to sell first and buy second so that to the extent we're trading out of assets in our established regions into our expansion regions we would know what the cap rate and pricing was on the asset that we were selling, which in turn would inform our appetite on the buy side. So now we do have a couple of dispositions that are in process. And so we are going to be looking here over the next quarter or two to reinvest that capital into potentially some acquisitions in the expansion region. So hopefully, you know, we would expect, I don't know if anything's going to close on the acquisition side in Q2, but it is our plan to kind of resume that forward trading.
spk11: Appreciate all the color. Thank you.
spk19: Our next question comes from the line of John Palowski with Green Street.
spk02: Please visit with your question.
spk07: Thanks for the time. I just want to follow up on the conversation around the state of the development market and the bullets you lay out on page 11 of the investor deck. Ben, I know you threw out like a 30% to 35% reduction in land value comps. Is that representative of the market right now? And, like, is the volume of these broken sites meaningful right now, or we're just getting started on the repricing?
spk04: I think we are still early. There are more sellers than less who are effectively willing to give – current contracts sort of time, right, extend out and see where it heads. But we are, you know, starting to see some situations where deals are breaking. And the two situations I was referring to, you know, had buyers who were relatively motivated. And when they're looking out on the landscape, this goes to Matt's comments, you know, about our ability to execute that we don't need to rely on construction financing to execute projects today, those buyers are going to, on the margin, look to somebody like Avalon Day to contract with. So I'd say that's kind of the general environment. Our expectation is that there's more to come. Starts, we're expecting to be down substantially this year. And a big part of underlying all this is you look out at the private market environment and the merchant builders who have been very prolific, their ability to get capital for new construction deals is just very challenging. And the cost of that capital is also expanded out significantly. on a relative basis, this is one of the parts that we're starting to see. While our cost of capital has gone up, and our cost of debt borrowing has obviously gone up from the 2% range to 5% range, the private market players, if they can get construction financing, those senior mortgages are at 7.5% to 8.5% now. And that's before putting on some preferred equity or MES, and that's before getting to equity. So our relative advantage In a period like this, we think we're relatively well positioned. And so selectively, we're going to start stepping into some of these types of opportunities.
spk07: Okay. On that point, I'm just curious if you guys have any internal theories of why we haven't seen a more precipitous fall off in permanent and start activity. I mean, the credit market's been volatile for a while, and they've been tightening for a while. And I know they're down a little bit more in your markets, but I'm just curious if If you have any internal views on why we haven't seen the relief yet in the permanent starts data.
spk19: Yeah, John, it's Matt.
spk09: I ask Craig Thomas, our head of market research, that question every month when the permit numbers come out. It is a little bit of a head scratcher. I mean, I think in the fourth quarter, a lot of that was probably capital that was committed and had been lined up. And then a lot of the start, a lot of the permit and even start activity I've come to learn is not kind of what we would think of as our product. As much of half of it is other things. Affordable housing production is actually running pretty high right now. There was a lot of one-time money through some of the COVID relief funds, which has gotten out there. So that could be inflating it a bit. And in some cases, people may be pulling permits and then getting bids and not liking the numbers they're seeing. But it is a little bit of a head scratcher, I would agree with you.
spk19: Okay. Thanks for the time.
spk02: Our next question comes from the line of Jamie Feldman with Wells Fargo. Please proceed with your question.
spk16: Great. Thank you. I guess as you think about potential acquisition opportunities, do you think there could be some portfolios or platforms out there for acquisition, or do you think it will be kind of singles and doubles on the land side or on the asset side?
spk09: Hey Jamie, it's Matt. I would expect it's probably more the latter. You know, usually portfolio transactions, unless somebody has some kind of, unless they bought a portfolio and put a lot of short-term debt on it all, which, you know, would be pretty unusual. Our portfolio, usually sellers selling portfolios, it's more opportunistic and, you know, those things happen when, you know, there's an abundance of capital and, you know, go back three, four years, there was a kind of a portfolio premium. I don't, you know, today we talked about, I think on the last call, there's a portfolio discount just given, you know, given the capital markets. So we haven't heard of anything like that. And I guess I'd be a little surprised.
spk16: Okay. Thank you. And then as you think about the suburban versus urban assets, you know, whether it's the April data or your views on what's to come in spring leasing, Any thoughts on how they're performing versus each other versus your expectations and what we can see going forward, expect going forward?
spk09: Yeah, Jamie, it's Sean. What I'd say is that generally, you know, things were in line. The rent change that we experienced in Q1, basically about 10 basis points better than what we anticipated. And if you double-click through that and look at urban and suburban, again, very, very nominal variances. Certainly as we move forward, particularly if we get into an environment that is weaker from an economic standpoint, we do feel very good about our suburban coastal portfolio, given the exposure to new supply is quite a bit less than what we're anticipating in urban environments. So I would say kind of as expected right now, but as you look forward, depending on how the environment unfolds, We'd probably pivot more towards suburban assets outperforming.
spk19: Suburban assets outperforming. Yes. Okay. All right. Great. Thank you. Our next question comes from the line of John Kim with BMO Capital Markets.
spk02: Please proceed with your question.
spk18: Hi. Thank you. I know you talked a little bit about Gables already, but I was wondering how big you think this revenue opportunity could be as far as offering these kind of back office support functions for other operators.
spk04: John, we haven't sized it yet at this point. We went through the pilot, as I described, wanted to get our first third-party client fully implemented. We get a little bit further out, we'll start thinking about the profile of additional clients and even further down the road, thinking about where it could come, but we're not at that stage yet.
spk18: Okay. And where do you see the most attractive opportunities, whether it's the broken deals that you talked about in the presentation versus MES or other ground-up developments?
spk04: Yeah, I'll bet maybe on three areas, and Matt can add in because he and his teams are living and breathing this. First is the development side, which we've talked about. Second is on acquisitions. And this gets into, we do think our relative trade selling out of the established regions and into expansion regions is more attractive today. We've got a couple assets now that hopefully we will sell over the next couple of months. And so when we look to deploy that capital, you know, types of situations we can be looking at are, could be deals in lease up, right? Which are harder to finance for most buyers today could be, a place where we can bring our platform to bear for a particular reason, a nearby asset. But generally in this type of environment where we're not doing a ton of buying and selling, on the buy side we're going to be looking for places where we can add and create some incremental yield on those acquisitions over the first couple of years. And then the third category that I'd highlight goes broadly to the theme in a world where capital is less abundant, We believe opportunities will present themselves to us, but it also makes our capital more attractive, right? So you think about our programs, the developer funding program, our structured investment program, and we look at over that book of business, and we think we'll have the ability, stronger sponsors, stronger quality real estate, better returns. So that's another place where we can selectively put capital to create value.
spk19: Very helpful. Thank you.
spk02: Our next question comes from the line of Josh Dennerlein with Bank of America. Please proceed with your question.
spk06: Yeah. Hey, everyone. Thanks for the question. I'm going to go back to the opening remarks about the development pipeline and how you don't mark to market the yield until they're impacted lease up. Is that – imply that the potential uplift from those seven projects that haven't gone into lease up yet, but we'll go into it later this year, not included in the guidance range?
spk09: Yeah, this is Matt. Guidance for the most of those deals are going to really impact earnings in 24 and 25 because they're not going to start leasing until later this year. So we do have lease up budgets on those deals, which is reflected in the guidance, which does reflect
spk06: higher rents than you know kind of what's shown on the on the development attachment but the real list there isn't 23 it's 24. okay that's super helpful and then one follow-up to that the 70 basis uplift for the for these sub projects you have um currently with updated projections is that a fair uplift at this point for those seven projects
spk09: I would say that, you know, that was kind of the point of including the slide. Yeah, that, you know, if the 17% uplift in rent is, you know, roughly comparable to what we've seen across our entire same-store book over that time, you know, if those seven lease-ups experienced similar kind of rent growth to kind of what we've seen broadly over that time period, then, yeah, I mean, we would be expecting to see yields on those deals rise by, like, you know, roughly similar amounts.
spk06: Okay. And then you mentioned like if you could start a project today, you're seeing good construction pricing bids versus like if you had something that might not start for a year, you're not seeing that. What's driving that dynamic?
spk09: I think it's just certainty. I mean, you know, when you ask somebody to give you a price on a deal, you're not going to start for a year. It's just, you know, they're just giving you an estimate number. It's not, you know, you can't take that number to the bank. Anyway, you don't even, you know, you don't have final construction drawing. So, you know, you're not contracting at that number. It's more of an allowance. And so it's natural for people to say, well, you know, here's where I did the last job at. When you have a job that's ready to go and it's like, I need your guys on site in 90 days. That's when some subcontractors are busy and don't need the business. and we'll not give you a number that's any better than the number they would have given you 90 days ago. But there are others where, as I said, maybe they were working on five jobs. They only see two coming up. They have availability, and they're essentially willing to lean into their margins, which got very inflated over the last couple of years when all these subcontractors were stretched beyond their capacity.
spk19: Okay. Thank you.
spk02: Our next question comes from the line of Handel St. Just with Mizuho. Please proceed with your question.
spk15: Hey, good afternoon. A couple quick ones from me. I guess first a question on the equity that you pulled from your forward investment with the bank at the 5%. How much is that? Can you request a withdrawal at any time at your option? And what's the longer-term plan for that capital? Is it ultimately earmarked for development funding, or would you also consider acquisitions or other – Yeah, sure.
spk10: Handel, this is Kevin. Well, the amount that we pulled down the equity for was $490 million. And so, roughly speaking, that's the amount that we incrementally invested, and we did so in latter time deposits with banking partners that are very highly rated, known to us, part of our credit facility syndicate. And the latter time deposits are essentially mapped to when we think we will be pulling that capital down or need the cash in order to reinvest into development. So that's how we've structured that set of cash investment activities so far. And we retain liquidity to fund development from that source as well as liquidity in our line of credit of $20.25 billion where there's nothing drawn. So we have plenty of ability to respond to new opportunities that may justify an earlier deployment of cash, either from the cash we've invested or from our line of credit.
spk15: Got it. Thanks, Kevin. That's helpful. Ben, maybe one for you. For those of us who followed Avalon Bay for some time, the recent changes you've made entering the MES lending business, delving deeper into third-party services, and even a more proactive cash management strategy, capitalizing on the environment to generate some incremental FFO that you outlined, I guess I'm curious, how should we be interpreting these changes in what they suggest for Avalon's longer term strategy as you evolve the platform? Curious what else you're considering, what else is top of mind as you navigate the company forward? And then how did you think about the trade-offs for perhaps growing the revenue, but maybe adding a bit of complexity and maybe a lower multiple as well? Thank you.
spk04: Yeah, I appreciate that. I'd start by emphasizing, I mean, this is about this executive team, right? So, you know, we're the ones setting the course for this business over the coming years, and we're looking for ways to continue to drive earnings, profit, and ways to differentiate that we think can lead to long-term value creation. A number of the recent announcements, including the DFP and SIP, there have been versions of this that have existed, elements that we were working on, and so we've decided as a team in certain areas where we think we can accelerate that activity, and so you've seen that come In terms of our strategic focus areas, we've communicated this externally and continue to emphasize it internally. First is our operating model transformation and driving margin and value to customers through that. Second is optimizing our portfolio as we grow, and part of that is our movement to the expansion markets and also looking to prune assets out of our established regions. Third is leveraging our development DNA in new ways. And so that gets into our programs like our DFP and our SIP. We don't talk a lot on this call, but particularly for certain investors, it matters. And for associates and increasing our residents, our leadership in ESG. And then the fifth one, we always drive home. And this is what's special about here is people and culture. So those are what are driving us as we look ahead and I believe will create outperformance for us.
spk19: Appreciate the thoughts. Thank you. Our next question comes from the line of Alexander Goldfarb with Piper Sandler.
spk02: Please proceed with your question.
spk05: Hey, good afternoon. So two questions here. First, on the expansion market, can you just remind us where you're targeting, urban versus suburban, just from some of your peers who have spoken and then speaking to the private operators in the Sunbelt It definitely seems like the supply competition is much more concentrated in the urban areas, whereas those out in the suburbs tend to be less impacted. So just sort of curious, as you look at the Sun Belt, how you're framing out your exposure.
spk19: Hey, Alex.
spk09: It's Matt. So we don't necessarily start with a kind of goal in mind really what we're looking for is the best risk-adjusted return and we are taking it as an opportunity expansion regions to construct a portfolio from the ground up and what we found over the last couple years as we've started our investment as we felt like the supply-demand fundamentals and the pricing of the assets was just more attractive the suburbs so if you look at our Denver portfolio the assets we bought there they've all been suburban assets and We did develop the one deal in Rhino to a very high development yield. So we're going to supplement and ultimately have a diversified portfolio. But we tend to be finding better value in the suburbs, not just better supply-demand fundamentals, but also better pricing. Until recently, probably higher cap rates as well. So same thing in Southeast Florida. If you look at where we bought in Southeast Florida, it has tended to be more, you know, we bought in Boca, we bought in Margate, we just recently bought a couple of different assets in Broward County. We tended to find better value there, and we are very mindful of that as we invest. We may develop a little bit in urban areas if we find a really strong opportunity, but a lot of our development pipeline is also suburban. Right now in Denver, we have the One Deal under construction in Westminster, and then we have One Deal in Governor's Park, which is more of an urban sub-market. you know these summed up markets in the first place there's not as much they're not as urban in the first place so i don't i don't know that there is an urban sub market in all of raleigh durham for example maybe downtown raleigh and you know we're not looking there so um and uh you know in charlotte uh all of our development has been in the suburbs we did buy the portfolio in the south which is kind of the one urban sub market there that uh is very very dynamic so i'd say that's the exception But generally speaking, you're right, it is maybe a little bit of a different strategy than the way some others have pursued it. And it's also kind of just more the way the lifestyle is in a lot of these Sunbelt metros. They don't necessarily have the same transit orientation. They don't have the concentration of employment. And a lot of the reason people are moving there is, frankly, to have more space and have more of that suburban lifestyle.
spk05: Okay. The second question is, just given what's going on in the insurance market, are you seeing more I don't want to say opportunity, but are you seeing that it's financially better for you to take on more self-insuring your portfolio to reduce the cost or maybe especially as you partner with developers where you guys are self-insuring more to try and mitigate some of the pretty sizable premium jumps or the ability or inability to get certain carriers or reinsurers
spk10: Alice, this is Kevin. Maybe I'll just respond strictly to the insurance aspects of this. Ben or Matt may want to respond to the development implications, but you're spot on with respect to highlighting the self-insurance aspects and really the relative strength of well-capitalized REITs and particularly residential REITs that absorb this risk as opposed to passing it on to commercial tenants. You know, having that capability of self-insure has been a helpful thing in recent years as the insurance market has become increasingly challenging. I'm not going to get too specific about what's going on with our property renewal right now because we renew on May 15th, so we're actually in the market for that. But we have in the past, I'd say, seven or eight years used our wholly-owned regulated captive insurance company in order to be strategic in these property renewals to mitigate bearing the full impact of market increases in property insurance premiums to the extent individual insurers have become inefficient in their pricing. And so that has helped keep our insurance costs in the property program to a far lower than market rate of growth. And so, for example, Last year, total insurance costs, which properties are the biggest piece, grew down by 4% or 5% last year. We do expect a higher level of growth this year in the property program, but as we look at this year's renewal, we're likely to be willing to take on more self-retained risk through our captive in order to mitigate inefficient pricing from some of the market participants should that be necessary.
spk19: Okay. Thank you.
spk02: As a reminder, it's Star 1 to ask your question. Our next question comes from the line of Amy Progrant with UBS. Please proceed with your question.
spk14: Hi. So turnover was up from the 2022 lows, but remains low on a historic basis. I'm wondering, over the next couple of years, do you think we trend back toward a more historic level, or has demand shifted in a way where turnover could remain below the historic level?
spk09: Good question. Obviously somewhat speculative in nature in terms of what happens. I mean, the one thing I would say is that we continue to remain in a relatively tight housing market overall. If you look at the sort of aggregation of multifamily, single family, et cetera, and the ability for people to access the kind of inventory they want, maybe more limited, particularly on the single-family side, maybe condos, townhomes, et cetera, for the last couple of years. That does not seem to be likely to correct. So I'd say that's probably the one macro factor that may put some cap on sort of churn. And people, you know, that would typically 13%, 14%, 15% that might go buy a home. This past quarter, that was less than 10%. And that's not likely to get better in the near term given the financing market, but also just the production in terms of what's actually being put on the ground. So that's one factor that may kind of keep a lid on things here for the next several quarters.
spk14: Okay, great. And then another quick one. How do yields on the projects in the developer funding program compare with Avalon Bay development yields?
spk09: Hey, this is Matt. The way we think about that program is basically we're allocating the risk differently than on our own development. And so consequently, the target returns are also allocated differently. Our target is for the yield to be roughly halfway between an acquisition and a development. What we've found so far, and a few we've done, is that it's been higher than that. So the way I would think about it is the yield on those deals is probably going to be 30, 40 basis points less than the yield on if we'd done the development ourself, but still probably at least 50, 60 basis points north of where an acquisition yield would be, if not more.
spk14: Great. Thanks.
spk02: Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.
spk01: Hi. Good afternoon. Broader question, I guess on the governor of New York's housing proposal that is stalled now in the Senate and the House there, that would have expanded zoning for multifamily in the suburbs. Was that an opportunity for you to develop or was that more supply? And how do you view those kinds of, I guess, initiatives nationwide going forward?
spk09: This is Matt, I think, and then Sean may want to weigh in as well. You know, it's really interesting to see these states try to engage in that dialogue about one of the things that has really led to the supply constraints that have in turn led to really an underproduction of housing has been local control. And that is a bit of a third rail politically in California and New York and other states. It's interesting to see the state legislatures try to chip away at it. I think you're right, it's both, right? It would be an opportunity for us as a developer you know, if it was really effective in the long run, it might lower the long-term rent growth trajectory of some of those markets. Frankly, from a public policy point of view, that kind of would be the point of it. What we've seen so far, at least in California, has been every time there's been something that in theory would have opened up more sites to development, there's been something else on the other side that's come with it that has made it a bit of a poison pill. So it has been very difficult to actually effectuate They say they'll allow multifamily near transit, but then they're saying it has to be prevailing wage, construction costs, which is a 20, 30% premium, and so economically it doesn't work. Or they'll open it up in certain sites, but they need 20, 25% affordable. And again, you can't afford the going price for land and make that economics work. So the one place we've seen it truly be effective so far has been with this smaller program in California, the ADU, Accessory Dwelling Unit. We actually have over 100 of those currently in our pipeline where we can just add two, three, four, five, six, seven apartments in kind of underutilized storage or parking areas that exist in communities and not have to go through a zoning process. So that's not going to move the needle kind of on the prominent macro level, but that's one small program we have been able to take advantage of.
spk04: And then maybe just to end kind of at a higher level, regulatory dynamics are influencing our portfolio allocation decisions. It's been a part of the reason why over the last number of years we've been moving more and more to a suburban oriented portfolio. And if you see where we're allocating capital, we're two-thirds suburban today, probably headed towards three-quarters there. It's influenced our move to the expansion regions at a minimum to diversify away from regulatory environments. And then the reality is at a more local level, based on some of the steps of certain municipalities. Effectively, the bar is higher for allocating new capital there, and it's playing into how we're shifting capital around our portfolio and within our regions.
spk19: All right. That's it for me. Thank you. If there are no further questions in the queue, I'd like to hand the call back to Ben Scholl for closing remarks.
spk04: Thank you. Thanks, everyone, for joining us today. We appreciate your support and look forward to speaking with you soon.
spk02: Ladies and gentlemen this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.
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