Operator:

Good morning, ladies and gentlemen, and welcome to AvalonBay Communities Second Quarter 2024 Earnings Conference Call. [Operator Instructions] Your host for today's conference is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference call.

Benjamin Schall:

Thanks, Jason, and thank you, everyone, for joining us today. I'm here with Kevin O'Shea, our Chief Financial Officer; Sean Breslin, our Chief Operating Officer; and Matt Birenbaum, our Chief Investment Officer. I will start by emphasizing a number of key themes that are top of mind and that we believe are important drivers of our continued outperformance and then turn it to Kevin, Sean and Matt to go deeper. . As usual, we will reference our investor presentation, starting on Page 4 as we proceed through our prepared remarks. Our operating momentum continued in the second quarter with us exceeding revenue expectations and also successfully managing operating expenses lower. Based on this momentum, we further raised our guidance for the year and are projecting sector-leading full year core FFO and same-store revenue growth among our closest peers. Our operating momentum through the first half of the year has been driven by better-than-expected demand with our core renter, the knowledge-based worker in a relatively strong position right now. Sectors of the economy that encompass our core customer are at effectively full employment with stable job and income prospects. We also continue to benefit from customers' strong tilt towards renting versus buying a home, given the lack of for-sale inventory and unaffordability. And finally, as expected, we continue to benefit from the low levels of new supply in our suburban coastal markets, a dynamic that should continue to benefit our portfolio versus most of the rest of the sector for another 12 to 18 months at least. Our strong internal growth is also being fueled by our continued progress with our operating model transformation. As we detailed at our Investor Day last November, our collective set of initiatives, from investment -- from our investments in technology and centralization to our reimagined operating neighborhoods are driving meaningful operating efficiencies and allowing us to drive healthy increases in ancillary revenue streams. We're on track with these operating initiatives for 2024 with a strong runway of future earnings growth ahead of us. Importantly, we're also increasingly tapping these operating capabilities to drive outsized yields and returns on new developments and acquisitions. Further to that point, our platform is uniquely positioned to continue to drive incremental earnings growth and value creation from our external investment activity. Our developments underway continue to outperform. During the quarter, we completed 3 new development communities at an impressive initial stabilized yield of 7.7% as noted on Slide 5. We are also incrementally more optimistic about new development adding 2 new -- adding 2 additional developments to this year's starts for a total just north of $1 billion. We're underwriting mid-6% yields on this set of new projects well within our strike zone of having 100 to 150 basis points of spread relative to market cap rates and our cost of borrowing. And as the final differentiator that I'll highlight upfront, we continue to actively reposition our portfolio for superior longer-term growth, heading from 70% suburban to 80% and 8% of our portfolio in our expansion regions to 25%. We believe we are now moving into a more attractive environment to execute on this repositioning, particularly with the froth in rents and cap rates off in our Sun Belt expansion regions. We're also tailing our portfolio in our expansion markets with lower density and lower price point assets at an attractive basis. At the bottom of Page 5, $500 million of the $900 million of capital raised year-to-date has been from asset sales at an average cap rate of 5.1%, which we are then reallocating into acquisitions in our expansion markets. The remaining $400 million was our prior unsecured debt deal with an effective rate of 5.05%, including the benefits of swaps we had in place, highlighting our relative cost of capital advantage. Before turning it to Kevin to discuss our updated guidance, let me touch on a couple of the details of our Q2 results. Page 6 provides the detail of our $0.09 core FFO outperformance in Q2, broken down by category. And please take note that $0.02 of this $0.09 outperformance was timing-related and costs we expect to incur in the second half of the year. Slide 7 Zoom's closer in on our Q2 revenue outperformance with better-than-expected outcomes on lease rates, occupancy and other rental revenue, partially offset by bad debt staying more elevated than we had hoped. Other than bad debt, our revenue momentum was strong, which is a nice segue to Kevin to discuss our updated and increased guidance for the year. Kevin?

Sean Breslin:

All right. Thanks, Kevin. Turning to Slide 10. Key portfolio indicators were strong during Q2, and we're off to a good start in Q3. In Chart 1, turnover remains well below historical norms in part supported by a lower level of move-outs to purchase a home. In Q2 specifically, turnover was down 600 basis points year-over-year or roughly 12% and was lower than last year in every region. Lower turnover supported relatively stable occupancy and drove higher rent change as we move through the quarter. Effective rent change increased from 3.2% in April to 4% in June before moderating into the high 3% range during July. As expected, our East Coast regions delivered the strongest rent change in Q2 of 4.2% and with our Mid-Atlantic portfolio leading the way of roughly 5.5%. Our Northern Virginia and suburban Maryland assets continue to demonstrate strong momentum, but the District of Columbia is still lagging due to weaker demand which is in part due to the federal government's return to the office policies and ongoing supply, which is projected to be roughly 4% of existing inventory this year before declining to approximately 2.5% in 2025. Our Boston portfolio, which represents high-quality assets and predominantly supply protected suburban submarkets produced rent change in the high 4s during the quarter. New supply in Boston has declined from the low 2% range a year ago to roughly 1.5% this year and is expected to decline to just above 1% next year for the urban supply projected to be substantially higher than suburban supply. Assuming a relatively static demand environment, the outlook for our suburban Boston portfolio remains quite positive. The Metro New York, New Jersey portfolio 2/3 of which is diversified across various suburban submarkets in Westchester, Long Island and Central and Northern New Jersey, delivered 4% rent change during the quarter. Recently, the strongest growth has occurred across the various submarkets in New York City, Northern New Jersey and Long Island. Some of the more distant locations in Central New Jersey have lag as employees increase their in-office Workday requirements in the city. The West Coast established regions produced rent change in the 3% range our Sudattle portfolio, which is primarily located in east side and north-end submarkets, led the way with 6% rent change during the quarter. While there are some pockets of new supply in select suburban submarkets, most notably Redmond, most of the new inventory is concentrated in urban submarkets and is not competitive with our portfolio. On the demand front, major employers like Microsoft and Amazon require more in-person work has supported the increased demand we've experienced throughout the first half of the year. Northern and Southern California lags Seattle with rent change in the mid-2% range. In Northern California, we had better momentum in San Francisco and San Jose, with 3.2% and 4% rent change, respectively, during Q2. However, the East Bay remains soft with the rent change of 50 basis points during the quarter. Given the supply is projected to be below 1% of stock across the major markets in Northern California for this year and next year. trends could continue to improve in the near future to the extent we realize a modestly stronger level of demand. Moving down to Southern California. Orange County produced the strongest rent change at 4.2%, followed by San Diego roughly 3% and L.A. in the 2% range. Orange County and San Diego have been healthy markets year-to-date, but performance across the various submarkets in L.A. has been choppy and highly correlated with the volume of inventory returning to the submarket from nonpaying residents. As it relates to bad debt, which is depicted in Chart 4 on Slide 10, while we're encouraged with the year-to-date trends in underlying bad debt across our same-store portfolio, results were choppy during the second quarter. We're still expecting bad debt to average roughly 1.7% for the full year 2024 at approximately 60 basis point improvement from 2023. As we've stated previously, prepandemic bad debt for our portfolio was 50 to 70 basis points. So to the extent we reach that level, we realized an incremental $25 million in revenue or more over the next several quarters. Transitioning to Slide 11 to address our updated revenue outlook for the year. We now expect same-store revenue growth of 3.5% for 2024, an increase of 40 basis points from our most recent outlook. The increased outlook is primarily driven by stronger lease rates as lower turnover and stronger occupancy in the first half of the year allowed us to achieve higher rental rates than originally anticipated, a trend we expect to continue. We now expect like term effective rent change in the 3% range for the full year 2024, up roughly 100 basis points from the 2% level we expected at the beginning of the year. We realized 3% rent change in the first half of the year and expect to produce similar performance in the second half. We've seen rent change begin to moderate to start the third quarter and consistent with seasonal norms expected to decelerate through the back half of the year. We expect renewals in the mid-4% range for the balance of the year, while new move-ins averaged roughly 1.5%. The near-term outlook for lease renewals remains healthy with offers in the low 6% range for August and September. Moving to Slide 12. You can see where we're projecting stronger revenue performance relative to our prior outlook. In our established regions, we're expecting substantially stronger growth in New England, the Mid-Atlantic and Pacific Northwest. We we're expecting modestly better growth in New York, New Jersey and almost no change in Northern and Southern California. In our expansion regions, Denver and Southeast Florida are expected to perform slightly better than we originally anticipated, but our other expansion regions of Dallas and Charlotte are expected to be weaker primarily as a result of the continued challenging levels of new supply in those markets. And then finishing on Slide 13, we're on track to realize roughly $10 million of incremental NOI from our operating initiatives in 2024. You can see those results in our same-store portfolio in 2 areas

Benjamin Schall:

Thanks, Matt. I'll wrap up on Slide 17 with the highlights from our recent ESG report. Our efforts on sustainability are led by Katie Rotenberg and her team but it is a full commitment across the entire organization that enables us to continue to make meaningful progress on these collective initiatives, from reducing our operating costs and environmental impact to making ABB more inclusive and diverse and to all of the time invested via volunteering by our local teams, a huge thanks to all AvalonBay associates. And with that, I'll turn the call to the operator to facilitate questions. .

Eric Wolfe:

You mentioned in your remarks the strong growth you're seeing in the fourth quarter, specifically I was just wondering if that's a good run rate for us to think about as you go into 2025 or if there's something in that number that wouldn't maybe carry over like lower seasonal costs. Just because you brought up the remarks, I don't know if you were trying to signal something about not your earnings growth going forward.

Eric Wolfe:

Got it. That's helpful. And then in the presentation, you had some [indiscernible] about the sort of unevenness in buyback. Can you talk about what you're seeing there, why you're seeing it, and what you're seeing sort of suggests that it might be harder to eventually get back to that normal long-term average that you typically run at?

Operator:

Our next question is from Austin Wurschmidt with KeyBanc Capital Markets.

Sean Breslin:

Yes, Austin, it's Sean. Given where we sit here with kind of half the year left to go, it wouldn't be appropriate to make comments as it relates to what we think the earnings going to be in January. But you can sort of do some math based on rent change last year versus this year and try to reach your own conclusion on that.

Sean Breslin:

Yes. I think for the most part, Austin, if you think back to Q4 of last year, we have a little bit softer comps when we get to Q4 of this year and that is in part producing the expectation for a slightly better revenue growth in Q4 as well as the continued activity in a couple of areas. One, from an operating initiative standpoint, continue to drive other rental revenue. We continue to push that and see that increasing sequentially as we move quarter-to-quarter. And then consistent with my last comment, we do expect bad debt in the second half of the year, potentially by Q4 to be a little bit better as compared to where we've been. So there's a few things that are contributing to it. But I would say the softer comp from last year is really the primary reason.

John Kim:

Kevin, you mentioned that you expect same-store expense to rise, I think, in the third quarter to 6% before moderating back down again in the fourth quarter. Can you just explain that dynamic?

John Kim:

And then I wanted to ask about build to rent. It looks like you have a new project in this category in Dallas. I was wondering how you look at this opportunity going forward and how you anticipate margins in the build-to-rent format versus multifamily?

John Kim:

But as far as yields and operating margins, do you find it similar to multifamily?

Operator:

Our next question is from Jamie Feldman with Wells Fargo.

Sean Breslin:

Yes. Jim, it's Sean. Why don't I take your second question first. Just from a macro perspective, I think we feel generally pretty good about the outlook that we provided. And I would say, just relative to last year, I mean, different things happening in terms of the general outlook, but I would say overall, each time we present our forecast, presumable we think is our realistic case for that forecast and the environment sort of dictates that. So I wouldn't say we're more or less confident this year than last year, per se, there's a lot of things that are happening out there that you could point to that you create concerns or you can create optimism, we try not to get caught up in that. As it relates to the outlook for the market, I'll try to keep it at a high level as opposed to going through all the regions, but we do expect continued outperformance across our established East Coast regions in the second half of the year relative to the Sunbelt and relative to the West Coast regions, generally speaking, with 1 exception potentially to be in Seattle, which has surprised -- I think most of us to the upside in the first half of the year and expect a solid growth in Seattle in the back half of the year. So without going through every region, I would think of it as East established, West established, followed by the expansion regions in terms of the latter of performance.

Benjamin Schall:

Jamie, what I would call out as different going forward is we have, to a certain degree, institutionalized our programs are providing capital to third-party developers. And we think about that as additive to the external investment activity that we make through our own teams. As we look out over the next number of months and number of quarters, you can hear from us, we are incrementally more positive in and around the prospects on development. And we're excited for the DFP program because it potentially allows us to accelerate external investment activity, call it earlier in that development cycle.

Operator:

Our next question is from Adam Kramer with Morgan Stanley.

Sean Breslin:

Yes, Adam, it's Sean. We've mentioned that for August and September, renewals went out in the low 6s, which is the visibility that we have today.

Sean Breslin:

Yes, Adam, it's Sean again. I mean I think the way it lays out is pretty consistent with historical seasonal patterns where you think about where you start the year in January, asking rents typically rise up through kind of early July, spending in the market, I'm kind of picking the average here, 6%, 7%, then you see a decelerate in the back half of the year, also consistent with seasonal norms. And so the acceleration that we saw was a combination of 2 things. One, the seasonal approach or seasonal factors. Second is just our overall revenue management approach. And what we saw early in the first quarter was better than anticipated occupancy, lower turnover. We hit the gas pretty hard as it related to asking rents. You saw that manifest itself in both renewals and new move-ins as we move through Q2. But as you see the seasonal peak in rents, and you try to make sure that you're maintaining stable occupancy, you start to see it begin to decelerate July, August time frame for the balance of the year. And so as you look at what happened, for example, from June to July, some markets were up a little bit, some markets were down a little bit. Overall, it was net down slightly 30 basis points from June to July, but it's not material in the whole scheme of things. But we would expect to see continued seasonal deceleration as we move through August all the way through the balance of the year.

John Pawlowski:

Matt, a question for you on -- just to get a sense for how the economics of the development rights pipeline compared to the starts this year. So [indiscernible] and started an additional $1 billion of starts, how would yield compared to the 6.4% you're expecting for 2024 starts?

John Pawlowski:

Okay, that's helpful. But there's nothing unique or maybe a stale land basis that you've seen the 6.4% yield on 2024 starts. Is there anything unique that's inflating the expected yields on this year starts?

John Pawlowski:

Okay. Great. Last question on acquisitions. Could you share the average cap rate on the 3 deals you acquired in recent months? And what's a reasonable base case of acquisition volume we should expect this year?

Operator:

Our next question is from Josh Dennerlein with Bank of America Merrill Lynch.

Benjamin Schall:

On the second part, Josh, that's a separate bucket of activity. So that's not in the operating model, $80 million target. It's part of an NOI enhancing pool that also has the sustainability benefits associated with it. And so when we talked at the Investor Day around our increased menu and opportunity set to be investing back into the portfolio in the 10% to 14% type of range. Those solar projects were a component of that.

Sean Breslin:

I wouldn't -- I'm not sure anything to watch out for going forward. I mean, typically, and Kevin went through this earlier, but in terms of the sequence of OpEx, you do see a spike in the third quarter historically. And as Kevin noted, for this year, that spike from Q2 to Q3, about 1/3 of that's in utilities based on seasonal increases in energy and water and sewer and things like that, about 1/3 is in R&M seasonal increase in turnover, which is historically the case and some projects from the first half to the second half and then kind of nits and nats and then things slow down as you get into the fourth quarter. So I think that's normal. I think the pattern has changed materially. . What you should see going forward that would be different, and we have explained before, is that as it relates to the absolute level of OpEx growth, we have a number of things happening that will begin to dissipate in terms of the impact on the portfolio in 2025. So our OpEx guidance for the full year is the [indiscernible] that we identified, but there's about 160 basis points of unusual activity embedded in that, about 80 basis points from the burn off of various pilots, mainly for 21 days and then the net impact of the operating initiatives, primarily in utilities category with both telecom, Internet, things of that sort. So kind of the organic run rate is closer to 320 basis points for this year. And some of those elevated activities that I just mentioned will begin to dissipate as you get into 2025. So without providing specific guidance, there's a little bit more of a tailwind as we get into '25 related to those various categories, but the seasonal patterns won't really change if you think about it from quarter-to-quarter.

Michael Goldsmith:

Are you seeing any changes in resident behavior across markets? Or any sort of price sensitivity among your tenants?

Michael Goldsmith:

Got it. And my follow-up question is, it seems as though there's been a push for more supply in New Jersey, suburban markets. Is there a risk that similar supply growth could pop up in some of your other suburban markets?

Operator:

Our next question is from Alexander Goldfarb with Piper Sandler.

Sean Breslin:

Yes, Alex, this is Sean. Happy to take that one. In terms of trying to compare bad debt across companies, one, I'd say it's probably a little bit challenging just because we don't know everyone's policies and -- what I mean by that is everyone bills different amounts for different things. So when someone doesn't pay us, for example, we bill them for everything. We bill them for the rent, we bill them for the late fees, billing for utilities, there's lease break fees, there's legal cost. There are a lot of things that we bill for and through our customer care center, [indiscernible] we track it very carefully. So I don't know if everyone is the same or not, but differences in policies can impact what the level of bad debt is. So I don't know if there was the same or not, but no differences and policies can unpack. What's the level of bad debt side? it's hard to comment on specifically different customers. As it relates to the markets that you mentioned, yes, New York, New Jersey is an example. It's only 23% of the outstanding accounts that we have. but it punches way above its weight in terms of dollar value. So it's about 1/3 of the outstanding receivables that we have that we're trying to chase down. And the main issue there as you may know, from being there, is just the pace at which the courts are moving. It is the slowest jurisdiction by far in the country. And so we have almost 400 accounts out there in the greater New York Metro area, and a lot of them have been sitting out there for more than a year in terms of their current time sort of in the eviction process, which continues. So we continue to see faster movement in primarily in New York City, but it does extend to places like Long Island and Westchester. And then in the Mid-Atlantic, a lot of that is tied to accounts in the District of Columbia and Montgomery County, 2 areas that have also been slow and also have taken steps to try to give renters more time through free legal advice, delays in court cases and things of that sort. So there's sort of a combination of factors that have led to it where New York, New Jersey, the Mid-Atlantic and Southern [indiscernible] are kind of all in the general same range. And what we've seen some movement, we need to see faster processing and sort of the relaxation of some of these other supportive benefits to prospective extreme cases kind of dissipate to allow the process to continue to move So that's just because like John?

Matthew Birenbaum:

Yes. Alex, it's Matt. No, it is -- we are almost complete with exiting the Connected market completely. You're right. If you go back, I think we probably sold 15 assets in Connecticut in the last 6 or 7 years. And once you're on that path to have a couple becomes very operationally inefficient. So you're right. I mean those -- the ones that [indiscernible] was among kind of the absolute most desirable of our Connecticut portfolio, but we've kind of made the decision that we're exiting that market. And so when you only have 2 or 3 assets left, it's kind of not worth it. .

Omotayo Okusanya:

I just wanted to ask a question on the regulatory front as you're kind of heading into the election cycle, if you're hearing anything at the state level and maybe some thoughts regarding the Biden proposal to have national rent control?

Omotayo Okusanya:

That's helpful. And then if I may ask one more. In your expansion markets, are you seeing anything different just in regards to how the competition is kind of behaving in light of kind of supply deliveries. And I know we have kind of had the classic use of concessions, but anything unusual in regards to this business practices to kind of shore up their financials that you may be seeing?

Operator:

Our next question is from Rich Anderson with Wedbush.

Benjamin Schall:

Rich, this is Ben. I'll handle the first part, and Matt can talk to the seller dynamics. On the first part, and we think it is an opportune time to effectuate the trade. And Matt talked to earlier, sort of the upfront dilution has gotten pretty narrow as we think about selling older, slower growth assets out of our established regions and then reallocating that capital. The other part that comes to mind is I'm not a believer that, that window is closing. I think when you look at the supply dynamics that are going to continue to be a wait on operating fundamentals in a lot of those markets as well as that we're still a certain degree of the front wave of refinancing activity. I expect the window of opportunity to be with us for a while.

Richard Anderson:

But not your REIT [indiscernible] down there?

Richard Anderson:

Okay. Second question. I think the townhome model is interesting when you consider millennials, building families and so on. Is that -- does that model work better in the expansion markets in general? Or is it sort of across the board sort of thinking in terms of that -- building out that product?

Operator:

Thank you. There are no further questions at this time. I would like to hand the floor back over to Ben Schall for any closing remarks.

Operator:

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.

Operator:

Good morning, ladies and gentlemen, and welcome to AvalonBay Communities First Quarter 2024 Earnings Conference Call. [Operator Instructions] Your host for today's conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilly, you may begin your conference call.

Benjamin Schall:

Thanks, Jason, and good morning, everyone. I'm joined by Sean Breslin, our Chief Operating Officer; Matt Birenbaum, our Chief Investment Officer; and Kevin O'Shea, our Chief Financial Officer. Sean will speak to our operating outperformance year-to-date and our positive momentum as we enter the prime leasing season. Matt will discuss the continued outperformance of our developments and lease-up and how we are strategically deploying capital to generate value. And Kevin is here for questions and is more than happy to speak to our preeminent balance sheet and liquidity profile.

Matthew Birenbaum:

All right. Thank you, Sean. Turning to our development communities. Slide 15 details the continued impressive results being generated by our lease-ups. The 6 development communities that had active leasing in Q1 are delivering rents $295 per month or 10% above our initial underwriting, which is translating into a 40 basis point increase in yield.

Benjamin Schall:

Thanks, Matt. Our results to date have exceeded our expectations, and we're excited for the momentum we have heading into the peak leasing season. Demand is stronger than originally expected, and our suburban coastal portfolio faces meaningfully less supply than elsewhere in the country. And we're confident that we will find opportunities to put our balance sheet and strategic capabilities to work to generate shareholder value.

Operator:

[Operator Instructions] And our first question comes from Eric Wolfe with Citi.

Matthew Birenbaum:

Yes. Sure. Nick, it's Matt. I would say the discount replacement cost is obviously going to vary to some extent based on the age of the asset. I mean, in theory, assets that are 10, 20 years old should be trading below replacement cost because there is some depreciation there.

Matthew Birenbaum:

Yes. I mean, who knows? I would say that there is more volume coming. And if you talk to the brokers, they'll say they're pretty busy with [ BOVs ]. This is the seasonal time of the year when you start to see an uptick in transaction volume.

Benjamin Schall:

Nick, I'll add a couple of comments, guess it's well put by Matt. I generally see as our window of opportunity being open for a decent period of time and 2 primary reasons

Operator:

And our next question comes from Jamie Feldman with Wells Fargo.

Benjamin Schall:

Yes. Austin would also be at the top of that list. Just look at percentage of stock coming online. That would be high up on the list. Generally, in the Sunbelt markets, the more urban-oriented submarkets are generally seeing the highest levels of supply coming online. And that's one of the reasons we've been conscious as we've been growing our expansion market portfolio to really push ourselves out further into those marketplaces out of a submarket or 2 with lower density product, lower price point. That is competing less directly with new supply.

Benjamin Schall:

It is. Yes, that's been a very conscious choice of ours. And we also think about it as complementing what we're buying with what we're going to be building. And so even to make the point further, what we've been buying tends to be slightly older product, lower price point, lower density products. Recognizing that our development, while it still will be suburban, will tend to be mid-rise and a little bit higher price point, once it comes to market. So we think about that as just our overall -- we talk about at a portfolio level optimization, but we also very much focus on it in terms of a market and a submarket perspective.

Austin Wurschmidt:

Great. Matt, I just want to go back to the dispositions. You kind of highlighted the scarcity premium, but I'm curious if there was any specific factors related to the assets you sold sort of idiosyncratic factors that maybe benefited valuations you achieved? Or if you think that is reflective of valuations today? And then can you just share how deep the buyer pool was and whether or not there is financing contingencies?

Austin Wurschmidt:

That's helpful detail. Just switching over to operations. Just wanted to hit on sort of the Bay Area commentary. You mentioned, I think, that the underpinnings of positive momentum were there. What's it going to take for that to translate into outperformance and sort of a little bit better and maybe less volatile fundamental backdrop? The Bay Area and then any other West Coast submarkets as well?

Austin Wurschmidt:

And so just one quick follow-up there. I mean is that sort of sequential improvement, Seattle and Bay Area, are those -- given we weren't hearing you talk about this 3 to 6 months ago, I guess, is that year-to-date improvement in asking rents being driven by those West Coast markets specifically? Or is it just more broad and related to the lower turnover, et cetera, that you're seeing?

Operator:

Our next question comes from Steve Sakwa with Evercore ISI.

Sean Breslin:

Yes, Steve, it's Sean. It's really 2 factors. One is what you described. We've seen sort of a faster improvement in occupancy. We experienced that in Q1. That is quickly translating to rate acceleration, which actually puts a little bit of pressure on occupancy.

Steve Sakwa:

Okay. And maybe as a follow-up, I think I heard -- I think you said that you were expecting about 4% on renewal growth, if I wasn't mistaken, maybe for the balance of the year. I don't know if I heard you say where you were sending out renewal notices for kind of the May, June, July period. But are those going out at substantially better than 4%, and you're assuming some discounting? Or could there maybe be some upside to that 4% number?

Steve Sakwa:

Got it. And then just lastly on development, Matt. You guys are starting a couple of new projects here, I think, in the second quarter. Can just remind us, what are you targeting on new projects today? I know that there's been some upside on the things you're delivering, but what's kind of the new hurdle in light of today's new interest rate environment?

Adam Kramer:

Just wanted to ask about your expectations for West Coast markets. I think these are markets that lagged a little bit if I just look at your kind of market-by-market effective [indiscernible] growth in the supplemental. But they also have pretty high expectations for same-store revenue if I'm looking at your presentation correctly.

Sean Breslin:

Yes, Adam, it's Sean. Good question. And one of the factors to keep in mind is what's changing in underlying bad debt across the markets. If you think about it, it was like rent change is one component, but changes in occupancy, bad debt, et cetera. And particularly for the Southern California market, I would say that is a meaningful contributor to total revenue growth in 2024.

Adam Kramer:

Great. And just maybe as a follow-up. You guys provided a really helpful kind of expectations for new and renewal growth for the whole year. And apologies if you've talked about this already today, but maybe just walk us through kind of what the updated expectations would be.

Sean Breslin:

Yes. What I mentioned in my prepared remarks is that we expect like-term effective rent change kind of in the mid-2% range, which is about 50 basis points above our original outlook. What I indicated is that the second quarter should trend up probably in the low 3% range before decelerating in the back half of the year.

Operator:

Our next question comes from John Kim with BMO Capital Markets.

Kevin O'Shea:

Yes, John, this is Kevin. Really, the $0.02 from better-than-expected capital markets activity was primarily driven by a combination of favorable interest expense and interest income as well as slightly higher budgeted -- higher-than-budgeted capital interest expense. So it's really in those categories where most of the favorability was realized.

Kevin O'Shea:

Well, I was referring to Q1. We didn't have any transactions that closed in Q1. So transaction activity cap rates did not really have an impact. As you look at the full year guidance, we expect basically due to adjustments in a range of things that fall with the capital markets activity such as buying and selling assets and then movement of interest rates on existing debt and additional debt activity that we have anticipated.

John Kim:

Okay. My second question is on the SIP program, where you mentioned that you had a favorable vintage '22 and '23 originations. I was wondering when some of those '22 originations start to get paid off. And forward and reinvest some of the proceeds. What metrics do you look at or monitor whether it's exit cap rate or [ tenure ] or maybe supply that would make you more cautious on reinvesting in the program?

Joshua Dennerlein:

Ben, I just want to explore a big picture topic you mentioned. You were talking about the differential between owning and renting in your markets is really wide. Rents are benefiting from that. Is there any historical time period where we could kind of look back at where the delta was this wide? And if so, just like how did it play out on the rent growth front?

Sean Breslin:

Yes. I mean the forecast for this year reflected being a relatively stable level. Obviously, interest rates bounce around, prices bounce around. But in terms of the current year outlook sort of reflects generally where we are at this point in time have remained relatively stable.

Unknown Analyst:

I'm just wondering have you seen any examples of things beginning to get more aggressive with property tax assessments of apartments to help fill the hole in budgets left by suppressed commercial real estate values in other sectors?

Matthew Birenbaum:

Yes. Anne, it's Matt. So our asset preservation CapEx has been pretty consistent over the last -- well, between '23 and '24, around $1,600, $1,700 a unit, which is, I guess, roughly 6% or 7% of NOI, 7%. The NOI-enhancing CapEx, that's where we really increased our investment or we're looking to increase our investment volume quite a bit. I think we invested about $75 million, $80 million last year across the whole portfolio, most of which I guess was same store. We're looking to double that this year.

Operator:

Our next question comes from Brad Heffern with RBC Capital Markets.

Sean Breslin:

No, not really, Brad. I mean low 3%, 3.2%, 3.3%, somewhere in that ballpark. I mean we've seen asking rent growth kind of 5.5% or so through yesterday. That's played through just renewal offers that have already been made in terms of what our expectation is for rate growth. So it seems like somewhere in that range for the second quarter is reasonable. And then you will have to see how asking rent growth continues as we move through the second quarter.

Sean Breslin:

Yes. What I would say, first, in terms of the expansion regions is we have relatively small portfolios in our same-store basket in those regions. So as you think of the expansion markets in Texas, for example, we don't have anything in Austin. There's only 2 assets in Dallas. We have seen -- at least in Q1, we saw a year-over-year increase in concession volume in Dallas. In the previous year, it was about 1/3 of all leases. It was roughly about half in Q1.

Unknown Analyst:

This is [ Amy ] on with Michael. Looking back, there have been periodic supply cycles in the South. So clearly, we're seeing supply starting to slow heading into '26. But as rents recover, how fast can development start to pick back up in the Sunbelt? And is that concerning to you as you look to increase your exposure there?

Unknown Analyst:

Great. And then just a quick follow-up on that. What are you seeing in terms of land cost currently?

Unknown Analyst:

Right. To acquire land, if you were going to buy.

Operator:

Our next question comes from Alex Goldfarb with Piper Sandler.

Matthew Birenbaum:

Alex, it's Matt. I would say no. Our developer funding program is really focused on expanding our growth in our expansion regions. So we're not looking to grow our capital investment in New York.

Operator:

And our next question comes from Anthony Dowling with Barclays.

Sean Breslin:

Sure, Anthony, it's Sean. Sort of a combination of all those factors that you just laid out. And what I'd point to geographically, which might be a little bit of a surprise for people is most of the improvement was actually not in places like L.A., which have been sort of the poster child for this.

Anthony Powell:

Maybe going back to the New York law that was just passed. I guess you don't want to increase more capital to New York. Was that a comment on the office ready or just a broader comment? I wanted to see if you can maybe just close your views on both the rental provisions and also the development provisions in the [ wall ]?

Linda Yu Tsai:

In terms of the 7% moving out to buy a house, along those lines, wondering if you've seen any demographic shifts in the composition of your residents over the past year or so?

Linda Yu Tsai:

And then on the better job growth being concentrated in lower-income residents. Is there any kind of read through for AvalonBay in terms of resident demand?

James Feldman:

Just quickly, I just wanted to get your thoughts on your debt maturities in '24 and '25. Obviously, a much larger maturity pipeline in '25 with $825 million of unsecured. But what are your thoughts -- like maybe can you talk to us about what's in your guidance in terms of refinancing? And is there any chance you'd pull forward the '25 maturities? And might that have any impact on your outlook if you did that? Just kind of what are you thinking about the markets in general?

James Feldman:

Great. That's very helpful. And then for the next year, would you put a hedge on early? And when would you want to do that?

Operator:

Our next question comes from Michael Lewis with Truist Securities.

Michael Lewis:

Okay. So if 2.5% supply growth in the Sunbelt next year, is that -- I mean it sounds like you think things are going to kind of gradually get better. But I mean, is that a concerning number versus the 1.3% established regions? Or are those pretty -- you think fundamentals in those 2 parts of your portfolio might start to look pretty similar next year?

Sean Breslin:

And Mike, one thing, I think, to keep in mind here is I'd be a little careful about isolating years as being very unique in terms of the delivery cycle and the impact on fundamentals. As Ben was alluding to earlier, what you see on that chart in terms of deliveries for 2024, where it does peak in the back half of this year, people will be leasing up. Putting those units into the market 12 to 13 months beyond sort of the initial delivery dates in terms of how they're leasing them up.

Operator:

And there are no further questions at this time. I'll hand the floor back to Ben Schall for closing remarks.

Operator:

Thank you. That concludes our call for today. All parties may disconnect.

Operator:

Good morning, ladies and gentlemen, and welcome to AvalonBay Communities Fourth Quarter 2023 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. [Operator Instructions] Your host for today’s conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.

Ben Schall:

Thank you, Jason. I am joined today by Kevin O’Shea, our CFO; Matt Birenbaum, our Chief Investment Officer and Sean Breslin, our Chief Operating Officer. We'd like to start by thanking our 3,000 AvalonBay Associates for delivering exceptional results in 2023. Your efforts and dedication are what make it happen, and your commitment to our purpose and culture makes us who we are as an organization. Thank you. As a brief recap on last year, as shown on Slide four, we achieved 8.6% core FFO growth for the year, a testament to our ability to grow earnings through unique internal and external drivers. Through the proactive management of our assets, same-store revenue ended the year up 6.3%, and NOI increased by 6.2%. For external growth, our developments underway continue to outperform with $575 million of completions across six projects, delivering outside stabilized yields of 7.1%. We're particularly proud of the results from our operating model transformation, where we are delivering enhanced value to customers and driving meaningful efficiencies. As highlighted on Slide five, our operating initiatives exceeded expectations in 2023, delivering $19 million of incremental annual NOI to the bottom line, which was $7 million or almost 60% higher than anticipated. Moving to Slide six and capital allocation, remain nimble in 2023, having shifted to being a net seller during the year, with four dispositions from our established regions for $445 million, $275 million of which we'd redeployed into acquisitions in our expansion regions. We also started $800 million of profitable new development during the year, including $300 million of starts in the fourth quarter at an initial projected yield of 6.7%. We also continue to build our structured investment business this year, in which we provide preferred equity or mezzanine loans to third parties for new multifamily construction. We're well positioned to underwrite this business given our development and construction expertise and our live proprietary data and we're fortunate to be building this book of business in today's environment, reflecting today's rates and asset values. The commitments we made in 2022 and 2023, which now total $192 million, are set to deliver an uplift in earnings this year and going forward. Our balance sheet is as strong as it has ever been, with a key metric summarized on Slide seven, providing strength as we manage the business and flexibility as we consider creative opportunities that may arise during 2024. Among a set of peers with strong balance sheets, we continue to experience some of the tightest credit spreads among all REITs, providing a meaningful financial advantage. Slide eight highlights our strategic focus areas for 2024. These focus areas draw upon our foundational strengths as an organization, while also recognizing our commitment to continue to evolve and our areas we are confident will drive superior growth over a multi-year period. Front and center are the next steps in our operating model transformation. At our Investor Day, we raised our target for incremental annual NOI to come from our operating initiatives to $80 million, $55 million of NOI from Horizon 1, and $25 million from Horizon 2. Second, we will continue to drive differentiated growth from our development and construction leadership. The near-term focus is on execution of our projects underway, ensuring they deliver outsized value for shareholders and while new start economics are challenging in certain of our markets, this is the type of environment in which we've typically found some of our most attractive development opportunities. Third, as a continued multi-year approach, we have set a target of shifting 80% of the portfolio to the suburbs from 70% today, and set a target of having 25% of our portfolio in our expansion regions, up meaningfully from 8% today and given the cooling of fundamentals in the Sunbelt, we believe we can make this transition at a more attractive basis than we were able to a couple of years ago. We're also making significant and very creative investments in the existing portfolio this year, ranging from apartment renovations to the creation of new Accessory Dwelling Units, or ADUs in certain markets. Finally, and as a follow-up to my comments about our balance sheet, we are confident that there will be opportunities for us to both utilize our balance sheet capacity and bring our strategic capabilities to bear, be it operational, development, or by utilizing our scale to generate value for shareholders. As we assess the year ahead and moving to Slide nine, our baseline expectation is for a slowing economic environment this year. As we have in the past, we start with consensus estimates from the National Association for Business Economics, or NABE, which forecasts positive but very modest job growth in 2024 of 55,000 jobs per month. This muted growth tempers housing demand, while other factors such as rent versus own economics should serve as a balanced apartment demand, particularly in our established regions, where it is now $2,500 per month more expensive to buy than to rent. Nevertheless, given mixed signals and what we believe is higher uncertainty in the economy and capital markets, our approach is to remain nimble and be ready to proactively adjust based on how 2024 evolves. In an environment of uncertainty, one known factor is new multifamily supply. In our established regions, we expect new apartment deliveries of 1.6% of existing stock in 2024, and expect this figure to further decline to 1.4% in 2025. Importantly, these figures are in line with historical averages for these coastal markets, and this is quite a contrast with supply dynamics in the Sunbelt, which will have twice the level of supply and this elevated supply dynamic in the Sunbelt is expected to continue at least through 2025, simply a function of the reality that it generally takes two plus years to complete and stabilize a new development project and so as we assess 2024, we expect to be relatively well positioned given the stable demand and limited supply outlook in our established regions, but are forecasting a slower year of growth. I'll now turn it to Kevin to provide an overview of our guidance for the year and the building blocks of earnings growth.

Sean Breslin:

All right, thanks, Kevin. Turning to Slide 13, three primary drivers will support same-store revenue growth in 2024. First, embedded rent roll growth of 1%, down approximately 50 basis points from where it was at the end of Q3 2023, which is consistent with historical trends, plus incremental lease rate growth throughout the year. Second, an outsized contribution of roughly 80 basis points from the projected 13% increase in other rental revenue, which is derived from our operating initiatives and third, about a 60 basis point improvement in underlying bad debt from residents from 2.4% in 2023 to an expected 1.8% in 2024. The cumulative growth from those three primary drivers is expected to be partially offset by a 30 basis point headwind from the projected $6 million year-over-year reduction of rent relief and a modest drag from net concessions and economic occupancy. To provide a little more detail on underlying bad debt trends from residents, we're expecting a 60 basis point improvement year-over-year, our forecast reflects an underlying bad debt rate of roughly 1.6% at year-end 2024, which is still more than double our historical pre-COVID rate. Moving to Slide 14, we expect revenue growth in our established regions to be more than double that of our expansion regions, which is primarily a function of the substantially lower level of new supply in the established regions and within our established regions, we expect better demand supply fundamentals on the East Coast as compared to the West Coast. Southern California is expected to produce the strongest same-store revenue growth, which is primarily the result of a substantial improvement in underlying bad debt on a year-over-year basis. Transitioning to Slide 15 to address our operating model transformation, we're tremendously proud of our team's focus and efforts over the last couple years, which have produced approximately $27 million in incremental NOI. We expect to recognize another roughly $9 million benefit in our consolidated portfolio during 2024. The key drivers in 2024 include Avalon Connect, our bulk Internet and managed Wi-Fi deployments, along with smart access features. In addition, we expect an incremental benefit from our shift to a new organizational model, which reflects neighborhood staffing supported by centralized teams. While we have specific plans for 2024, our focus in these areas and others will continue to deliver additional value for associates, residents and shareholders for years to come. Turning to Slide 16 to address our same-store operating expense outlook, we expect roughly 340 basis points of organic expense growth, another approximately 140 basis points from profitable operating initiatives, and roughly 75 basis points from the expiration of various tax abatement programs in the portfolio, primarily in New York City. As it relates to our initiatives, the 140 basis point increase is driven by 170 basis points from our Avalon Connect offering, which I mentioned earlier, partially offset by reductions in payroll. As I've noted in the past, the deployment of our Avalon Connect offering, which will ultimately enhance portfolio NOI by more than $30 million, will pressure expense growth during the deployment period. We expect to be fully deployed by the end of 2024, so the operating expense impact will diminish materially as we move into 2025. So now I'll turn it over to Matt to address our capital allocation activity. Matt?

Operator:

Thank you. We will now be conducting our question-and-answer session. Our first question comes from the line of James Feldman with Wells Fargo. Please proceed with your question.

Sean Breslin:

Yeah, Jamie, this is Sean. Why don't I give you the sort of blended rent change we expect across the portfolio for the year, so that we can talk about all the individual regions. That's a lot of data. We might want to do that offline, but in terms of the broader portfolio, our expectation is to deliver rent change of roughly 2% in 2024, which would reflect renewals at roughly 4% and new move-ins at essentially flat and as it relates to the first half versus the second half, if you think back to 2023, where we achieved 3.4% rent change, a good portion of that rent change, a stronger portion was in the first half of the year. So we do expect to see some acceleration in rent change, all else being equal in the second half of 2024 relative to the first half, assuming that obviously the economic environment is consistent with our expectations.

Sean Breslin:

Yeah, no, good question. Taking them in the two pieces on the revenue side, obviously a significant driver is the macroeconomic environment and we provided and Ben referred to some of our assumptions. So we are expecting a slowdown given the roughly 2.7 million jobs that were produced in 2023 as compared to the current expectation for '24, being close to 700,000. So that's outside our control, but obviously we're well positioned to the extent things accelerate and we think we're also well positioned somewhat defensively given our portfolio if things deteriorate. So outside of that, I'd say what we would see is a more substantial improvement in bad debt would certainly be a tailwind. Over the last several months, bad debt rate from residents has sort of flattened out a bit and primarily as a result of what's been happening in the court system, residents that are behind getting free legal advice and things of that sort. So we started to see greater improvement in the court system in places like the greater New York region, parts of the mid Atlantic, etcetera, that would certainly give us a significant benefit outside of just the macroeconomic view and whether we were able to push rents harder or softer in the environment. On the expense side, a good portion of it is baked in terms of what we have. There's about two thirds of it are expected year-over-year increase is driven by number one utilities, which is really where our Avalon Connect offering comes through and that's a pretty embedded program we're on plan. We expect that to be where we thought it would be. Property taxes, there's a portion of that related to the pilots, but obviously to the extent assessments come in at different levels or rates throughout the portfolio during the year, that would certainly help us out. The rest of it is kind of ins and outs in different areas, and so I wouldn't expect a significant shift, but there are modest shifts from line item to line item that might move around with, payroll benefits and things like that.

Operator:

Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.

Matt Birenbaum:

Hey, sure, Adam. This is Matt. As it relates to the pace of development starts across the year, it is more back half loaded. I don't think that we maybe have any starts in Q1 or maybe one. So, we'll see how that develops across the course of the year. It really is idiosyncratic, though, based on the timing, permits, buyout of various projects. So, the things that might cause it to ramp up or down is really just changes to the deal economics. If rents accelerate or degrade more quickly than we expect in any particular submarket where we're planning to start a deal or if hard costs surprise us either to the good or the bad, that could cause us to either pull some deals forward and start more or conversely push some deals further out.

Adam Kramer:

Great. Thanks, guys and just on the January like term effective rent change, I guess the new rent specifically, and not asking you for kind of each of your markets individually, maybe just at a high level if you could display, I don't know if you want to kind of go through West Coast versus East Coast versus kind of Sunbelt, maybe just kind of general trends breaking down that January new lease number I think would be helpful.

Adam Kramer:

Great. Thanks, guys.

Austin Wurschmidt:

Great. Thanks. Good afternoon, everybody. Sean, appreciate the same-store revenue growth guidance breakout between the established and expansion markets. I think you referenced that that's primarily supply driving the delta between those two projections, but I guess if you remove some of the bad debt improvement, some of the other initiatives and just focus more so on that lease rate growth piece, how do those two regions stack up versus one another?

Austin Wurschmidt:

And then just, just focused on kind of the urban versus suburban, you continue to kind of talk about this strategic focus of shifting into more suburban markets and sort of a preferred incremental investment there. So what's sort of the expectation for lease rate growth when you look at those two, urban versus suburban, for the year? Thank you.

Austin Wurschmidt:

Do you think that 200 basis points in the fourth quarter is a decent proxy for what you see moving forward in the call it medium term?

Austin Wurschmidt:

Okay. It sounds like seasonality is a little bit of a factor. Thank you.

Eric Wolfe:

Hey, thanks. I think at your Investor Day you gave an estimate around 175 basis points of annual earnings contribution from your development pipeline. I was hoping you could just give an estimate for the contribution this year and if there's just anything that might be influencing more this year versus a typical year and if it's just going to kind of be maybe a bigger contribution in 2025 as you lease up the communities that are delivering.

Eric Wolfe:

Okay. That's helpful. And then I guess just a quick one on the capitalized interest guidance. It looks like based on your guidance, the construction progress or development balance is going down by like $200 million. I'm just taking, what the interest is divided by your weighted average interest rate to get to that. But is that the right way to think about it and then I guess why would that balance be going down if it seems like spending is set to accelerate a little bit this year?

Operator:

Thank you. Our next question comes from the line of Steve Sakwa with Evercore. Please proceed with your question.

Kevin O’Shea:

Yeah, that's pretty much it, Steve. If you think about it, a lot of our growth comes through the first nine months of the year, including short-term premiums and other activity that happens in Q2. Excuse me, Q2 and Q3 and then traditionally, it sort of decelerates as you go through Q4 and land in January.

Kevin O’Shea:

Yeah, Steve, I would say, and as I kind of mentioned in my prepared remarks, there may be less upside. Historically, if you look back over a long period of time, we tend to deliver yields that are 20 basis points to 30 basis points higher than what our initial underwriting is because we don't trend. Now, in the last two years, when rents were rising in double-digit rates in 2021 and 2022, that 20 basis points, 30 basis points was more like 70 basis points or 80 basis points, but that's why now when you look at, say, the deals leasing up this year, they'll have some of that wind at their back, but it's probably back to that kind of 20 basis points to 30 basis points that's more typical. And that's why we feel like there's an adequate margin of safety in there because we're starting them on today's economics with that 100 basis points to 150 basis points spread to current cap rates that Ben referenced. So the two deals we're talking about in expansion regions or the third of the starts this year in the plan happen to be in North Carolina. I think one is in Raleigh, Durham and one is in the Charlotte area and so you have seen rents, market rents in those markets decline a little bit in '23. So based on today's rents, there is more supply coming there. There's obviously strong demand too, and we're investing over the long term. These are 20-year investments, but I would say that margin of safety would suggest that if you start those next year, they're not going to be in lease up for a year and a half, two years after that. We feel pretty confident that we'll be able to hit our NOI numbers, if not still get a little bit of lift.

Steve Sakwa:

And just a quick clarification, the $870 million, is that mostly back halfway, did you think, in terms of start to the deliveries or kind of more late '25, maybe even into '26?

Operator:

Thank you. Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.

Ben Schall:

Yeah, John, I think it's footnoted on the slide, but just to be specific, when you start the year, it reflects essentially the rent roll or gross potential is a common term for the month of January relative to the average gross potential or rent roll that we had in place for 2023. So as I mentioned earlier in response to Steve's question, you tend to realize a substantial portion, if not all, of your rent roll growth in the first nine months of the year or so. It accelerates in the spring, peaks in the summer, and then starts to come down in the fall as a result of not only decelerating like-term rent change, but the mix from unlike-term rent change where you burn off short-term premiums and other things. So essentially, in Q4, you don't really see sequentially, if you think about it, any material growth occur during that period of time. So you might have eight months or nine months that you're up kind of an average of a point and a half, like as we were talking about, and the last two or three months is closer to zero and that's how you get closer to kind of the low ones. But we can certainly walk you through it in more detail offline if you like.

Ben Schall:

It's also probably a timing issue. We described the point and a half as kind of where we were spot basis at the end of Q3. I know some companies sort of estimate where they think they might be in January and provide that information on their calls. We tend to provide on a spot basis.

Ben Schall:

For Avalon Connect specifically, the costs associated with those programs are essentially 100% expensed.

Joshua Dennerlein:

Yeah. Hey, guys. Appreciate all the color on how the Avalon Connect flows to the same-store expenses this year. Could you remind us how it's going to flow through the revenue line item this year and what kind of ramp you're assuming?

Joshua Dennerlein:

So, I guess maybe on a quarterly basis, because it looks like one key of a big uptick, and then it kind of drops off. So, just kind of trying to figure out the quarterly cadence.

Joshua Dennerlein:

Okay. That's helpful. And then maybe just curious on a breakdown for expense growth, kind of like, do the subcomponents like utilities, R&M. Could you provide just like your underlying projections for that?

Operator:

Our next question comes from the line of Brad Heffern with RBC Capital Markets. Please proceed with your question.

Ben Schall:

Yeah, happy to take that one, Brad, pretty much consistent with what we've outlined in terms of our outlook. And I would say relative to historical norms for January growth, it's modestly below. Sort of if you look at the change in asking rent in the month of January, say, for the five years pre-COVID as compared to this January, asking rents are trending up just at a slightly lower growth rate.

Ben Schall:

Yeah, we're expecting average asking rent growth throughout the year to be sort of in that 2.25% to 2.5% range and actual rent change in the portfolio would be roughly 2%.

Michael Goldsmith:

Good afternoon. Thanks a lot for taking my question. You use a macro scenario from NAI [ph] of like about it seems like 1% GDP growth and 55,000 jobs per month. How sensitive is the rent growth to kind of your underlying macro forecast? Like said, another way, if the economy is better, how much more rent growth can you get in 2024? Thank you.

Michael Goldsmith:

Got it. That's helpful. And then just based on current conditions, how far along do you think that we are in post-COVID recovery in the Northern California and Seattle regions?

Operator:

Our next question comes from the line of Richard Anderson with Wedbush. Please proceed with your question.

Ben Schall:

Rich, we are not seeing significant distress in the system. You know, there obviously is the potential wave of maturities that's being highlighted by folks. For the most part, at least in our markets and the assets that we're spending time in and around, we're seeing lenders agree to extend out loans. We're seeing equity step in and put up more capital. Now, not all debt providers and equity providers are able to do that. So that does create the potential for some dislocation, but we're not necessarily seeing it of size. I'd say we're preparing to be ready to take advantage of it, but not seeing it at this point. Operationally, you know, the theme I would take you to is look back over, I don't know, this last cycle, last decade, world of capital being homogeneous. Capital is flowing to all types of players and generally is flowing at a similar cost to all types of players and so as we think about positioning going forward, there is an element of thinking about how we take advantage or step in opportunities for assets that are being operated by, less sophisticated players, players with less scale. And I'll kind of end on the theme of as we're thinking about the opportunity set out there, it is a combination of both places where we can bring our balance sheet to bear and bring our strategic capabilities to bear and we've spent a lot of time on our operating model transformation. It's got two impacts. It's one, it helps us drive internal growth, but we're also bringing those operational capabilities to our external growth.

Sean Breslin:

Yeah, Rich, this is Sean. But why don't we kind of parse the conversation into our portfolio versus the Sunbelt more broadly? What I indicated for our expansion regions in January is that blended rent change is essentially flat. If you were to parse that between move-ins and renewals, what you would see is that new move-ins are negative in the expansion regions down about 150 basis points as compared to kind of low to mid 3% sort of renewals. What I would tell you is that's primarily driven by some assets that we own in Charlotte in the South End, there are three assets that we acquired in that market a couple of years ago at a time where we loved the environment, great long-term neighbourhood, but we knew there was a fair amount of supply coming, sort of underwrote it that way. We're seeing the impact of that supply currently, as opposed to, say, Denver, where most of the pain and suffering is in the sort of urban core, much more significant pain and suffering given the volume of supply as compared to our broadly distributed portfolio across the suburban markets. So our portfolio, you kind of really, not a lot of assets. You really have to look region by region to understand it. What I would say more broadly about the Sunbelt, though, is certainly when you think about negative rent change playing through and what it does to revenue and NOI, the first thing that typically happens when you get into a much more competitive environment is people are starting to have weaker occupancy. We saw that happen in 2023 in terms of the leg down in occupancy, both in our established regions in the Sunbelt, but much more significant in the Sunbelt. That starts translating to much heavier discounting in terms of where people are marking their rents to try and occupy those units because some rent's better than none. That's what we've started to see in the last few months here and we'd expect that to continue as you roll through 2024 as those leases expire. So the most significant impact on both revenue and NOI would likely be, all else being equal, 2025 as you roll all those leases through the rent roll to that lower market rent. That's probably when you're going to see the most pronounced impact would be our view.

Alexander Goldfarb:

Hey, good afternoon. Two questions. First, maybe just continuing on with Rich's line of questioning, as you guys look to the Sunbelt, it looks like most of your product, I think, is more suburban. So is that is basically as you assess opportunities in the expansion markets, are you really just looking only at suburban or are you looking at urban and what I mean by that is it seems that a number of the urban markets in the Sunbelt have the same issues that we have in the urban coastal cities, meaning people don't necessarily need to live right next to the office or there may be life quality issues, etcetera. Whereas in the suburbs, it seems more fit for Avalon's development model and also closer to recreation and sort of a quote unquote, easier lifestyle, if you will. So just sort of curious how you're shaping out your Sunbelt strategy of urban versus suburban.

Alexander Goldfarb:

Okay, and the second question is in the fourth quarter, it looks like you guys wrote off four development deals for $9 million in aggregate, but nothing changed in the pipeline that is the projects that are underway. So maybe just a little bit more color on it sounds like these deals were really in their infancy, but just maybe some color around what caused you to scotch these deals and where they may have been located.

Operator:

[Operator instructions] And our next question comes from the line of Linda Sye [ph] with Jefferies. Please proceed with your question.

Ben Schall:

Yeah, good question. What I would say is seasonally, rents start to pick up in January. Rent growth typically accelerates asking rent growth, this is as you move through the spring and into the summer. So typically what you would see is this would be sort of the low point of the year, kind of December, January, and then things would improve from here. So certainly, I mentioned, we're talking about basically getting flat for the year. So, we've got several months here where it will continue to improve, flatten out and then probably as we get to Q4, you would see it come back down and go slightly negative again, which is not uncommon in this kind of an environment. So you start to see sort of positive numbers as you get into Q2 and Q3.

Ben Schall:

Yeah, we're not providing any guidance as it relates to 2025 at this point. I did indicate what it was for 2024 as it relates to revenue and the impact on OpEx in my comments, my prepared remarks.

Haendel St. Juste:

Hey there, good afternoon. Two questions for me. First is a follow up on your comments earlier in San Fran, Seattle. Can you outline what your blended rent expectations for the two markets are this year? It seems like your client Seattle is creeping over into the east side and Bellevue, where you have more relative exposure while demand and pricing power still seems pretty evasive in San Fran and maybe some color on the level of concession you're offering as well as what you're seeing competitors offer in those markets. Thanks.

Haendel St. Juste:

Any color on the impact of supply in Bellevue and any color on the concessions?

Haendel St. Juste:

I got it. Thank you for that. And last one, just speaking overall on the transaction market, I'm curious, how do you characterize your conversation of late with potential sellers and their cap rate IRR expectations with some hopeful distinction between coastal and the Sunbelt? I was at National Multihousing this week as well, and it seemed to be still a fairly wide bid ask spread with buyers sticking to their guns and some waiting to sell in the back of this year and hoping that lower interest rates would drive lower cap rates. So curious kind of how those conversations are going. Cap rate IRR expectations in any color on coastal versus Sunbelt. Thanks.

Operator:

And we have reached the end of our question-and-answer session. I'll now turn the call back over to Ben Schall for closing remarks.

Operator:

Thank you for your participation. This does conclude today's conference. You may disconnect your lines at this time.

Operator:

Welcome, ladies and gentlemen, and welcome to AvalonBay Communities Third Quarter 2023 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. [Operator Instructions] Your host for today’s conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.

Ben Schall:

Thank you, Jason, and thank you, everyone, for joining us. In keeping with our custom, we posted a presentation last night to accompany our earnings release. In addition to my opening comments, you will hear from Sean on our operating performance and revenue building blocks for 2024; from Matt on the significant earnings being generated by our development projects and lease-up; and from Kevin on the strength of our balance sheet. I want to start with my thanks to the AvalonBay team and our 3000-plus associates for delivering another strong quarter of financial performance and operating results. Particularly in the current environment of higher interest rates and uncertain cap rates, we are laser-focused on driving cash flow growth from our portfolio. The bottom line results from our operating model transformation led by our on-site and centralized teams and powered by our technology, revenue management and data science teams and proprietary systems continue to outpace expectations. Our strong operating performance also speaks to our portfolio positioning, which is 70% suburban and primarily in suburban coastal markets, which continue to benefit from a combination of steady demand and limited new supply. Turning to Slide 4 in the presentation. We grew core FFO by 6.4% in Q3, which was $0.06 ahead of our expectations. This outperformance was primarily driven by better-than-expected revenue growth, which positions us well, as we enter the traditional slower leasing season. As shown on the bottom of Slide 4, we have raised $855 million of capital this year at a 4.3% initial cost, which includes the drawdown of our $500 million equity forward, which we priced at $250 per share and with the remainder coming from asset sales that we've sold at an average cap rate of 4.7%. We completed three development projects in Q3, two in suburban submarkets in the Northeast and one in Miami at a 7.2% stabilized yield. As Matt will emphasize later, our lease-up communities continue to outperform our original expectations by a wide margin. These projects are funded with yesterday's capital, at yesterday's capital cost and are slated to generate outsized value creation and earnings for investors. We also started two projects this quarter, one in Princeton, New Jersey and one in South Miami, with projected yields in the mid-6% range. I will come back to our positioning on new development and capital allocation at the end of our prepared remarks. In Q3, we made $50 million of commitments under our structured investment program or SIP and feel fortunate to be building this book of business in today's environment with these new commitments generating an attractive 13% return. Slide five provides the breakdown of our Q3 revenue outperformance relative to guidance from the end of July with a 30 basis point uplift from higher-than-expected occupancy, 20 basis points from higher rates and 10 basis points from improving bad debt. Turning to slide six. We've exceeded and raised guidance three times this year. We now expect core FFO to grow 8.6% in 2023, which is 330 basis points above our initial expectations for the year. Same-store revenue growth expectations are up 130 basis points. Expenses are down slightly, leading to NOI growth of 6.3%. And with that, I'll turn it to Sean to comment on the favorable demand and supply drivers in our markets and provide a fuller operating update.

Matt Birenbaum:

All right. Thanks Sean. Turning to slide 10. Our lease-ups continue to deliver outstanding results, laying the foundation for strong future growth in both earnings and NAV. We have five development communities that had active leasing in Q3 and those five deals are leasing up at rents that are $485 per month or 17% above our initial underwriting. This in turn is driving a 90 basis point increase in the yield on these investments to 7.4% far above any estimate of current cap rates and even further above the cost of capital we sourced to fund these deals back when they broke ground several years ago. After a relatively light year of deliveries in 2023, we do expect to see a significant increase in our apartment completions in 2024, which will provide incremental NOI and FFO as these communities reach stabilization. Slide 11 provides an update on our structured investment program where we initiated two new investments last quarter and $52 million at an all-in average interest rate of 13%. As we've discussed on prior calls these are three to five-year investments where we provide capital to merchant builders that sits above the construction loan but below common equity in the capital structure. We're still early in the build up of this new line of business and expect it to continue to grow to roughly $400 million over the next few years, providing a nice tailwind to earnings growth as these dollars get invested and start earning a return. We're also fortunate that we're able to underwrite most of this business in today's more restrictive environment providing a strong risk-adjusted return particularly for the latest additions to the program. And with that I'll turn it over to Kevin.

Ben Schall:

All right. Thanks, Kevin. We have consistently maintained a strong balance sheet throughout cycles. And as a result, we are well prepared for the current environment. As we have shown over the past couple of years, we proactively adjusted our capital sourcing and capital allocation activities based on changes in the environment as emphasized on slide 14. We locked in our equity forward in early 2022 to pre-fund future development activity. We shifted in the second half of 2022 and in 2023 to be a net seller of assets with a portion of the proceeds being utilized to fund acquisitions as we reshape the portfolio and the balance to fund accretive development. And we have continued to be responsive in adjusting our development start activity, reducing starts last year and this year as our cost of capital changed. As we've emphasized, we are 95% match funded on our development underway, which means all of that capital has already been raised at an attractive initial cost and allows us to deliver projects in 2024 and 2025 that will generate significant earnings and value. On a go-forward basis, we have raised our return requirements on new development. For a standard development deal, our target return was in the low to mid-6s in the middle of the year and is in the mid- to high 6s today. These target returns are up over 100 basis points since last year with the goal of underwriting 100 to 150 basis points of spread between development yields and market cap rates. We expect to be in the lower development -- we expect to be in a lower development start environment in the coming quarters and with spreads at the tighter end of this range after a number of years of outsized development profit margins. And while in the current environment we're focused on maintaining our balance sheet strength, we do believe that we are well positioned given our low leverage, ample liquidity and unique strategic capabilities to capitalize on opportunities that might result from market dislocations. In the near term, while volumes are modest, we're able to deploy capital at double-digit returns through our SIP program. Slide 15 concludes our prepared remarks with our key takeaways. We continue to deliver strong operating results with tailwinds specific to our suburban coastal markets incremental NOI to come from our developments and lease-up and all supported by a fantastic balance sheet. And with that, operator, please open the line for questions.

Eric Wolfe:

Hi. Thanks for taking my questions. I think you said that you raised your development yields, that's underwritten to be mid to high 6s. Just curious why you think that's the appropriate level? And what percentage of your future development pipeline with that criteria? So if you just take your rights pipeline and everything else what percentage would be started under that criteria?

Eric Wolfe:

Understood. That's helpful. And then you gave some good detail on the building blocks for same-store revenue growth for next year. Obviously the one piece that's missing is just your expectation around what market rents will do. Then I know it's too early to provide that but I was just hoping you could give us a sense for the process that you go through in terms of figuring that out whether you're building up or down? And then sort of if you were to do it today if you just have a sense for what market rate growth would look like?

Eric Wolfe:

Got it. That’s helpful. Thank you.

Austin Wurschmidt:

Thank you. So, more near-term I guess has the moderation in lease rate growth been partly strategic as you sought to backfill some of the occupancy you lost around midyear? And then you've just kind of continued to build occupancy into the softer part of the leasing season. Or is this more related to the pockets of softness across the portfolio like in Northern California, it looks like and then also in some of your expansion markets?

Austin Wurschmidt:

And then just on the external growth side or just investment side. I mean, how are you feeling about the size of the development pipeline? And based on what you do know today do you think that -- as those deliveries and completions kind of pick up next year are you going to be able to maintain the size of the pipeline in 2024? Or do you think your dollars in dry powder are better spent on new acquisitions just -- given the risk reward profile and some of your strategic goals of getting into those expansion markets?

Austin Wurschmidt:

Thank you.

John Kim:

Thank you. I wanted to ask on leasing trends in some of your markets, specifically Northern California which looks like the lease growth rates kind of nosedived in September and October. And that diverged from Seattle which is a similar market in terms of tech job growth where you saw an improvement. But can you just discuss the demand picture? And why there was such a difference in performance in those two markets?

John Kim:

That's very helpful. My second question is on bad debt, which you discussed has improved this year and is likely to be a tailwind in 2024 earnings. My question is how much of an improvement can you see from the 2.1% pre-resident relief funds that you got this quarter? And in particular Southeast Florida was surprisingly your worst-performing market in bad debt. And I was wondering if you could provide some commentary on that.

John Kim:

Great. Thank you.

Operator:

Our next question comes from Adam Kramer with Morgan Stanley. Please proceed with your question.

Ben Schall:

Yeah, Adam, we sent them out at 6% for November, December, which is relatively consistent with what we quoted for where we were for the 2 months of Q3 on the last call. We have seen in some markets a little more degradation in terms of the committed offer to realization, but it's still within sort of the 150 to 200 basis point range what we're seeing renewals come in at 4% to 4.5%, depending on the more recent time period you're looking at.

Ben Schall:

Yeah. As I mentioned in my prepared remarks, has been trending below 10% all year. It's about 9.5% in Q3. I think we're roughly 9% for Q2. So it has been trending down. As I mentioned, the long-term average is kind of in the mid-teens, and it's been as high as the sort of high teens kind of pre-GFC.

Ben Schall:

Yeah. Good question. In terms of pre-COVID levels, which are typically call it, 50, 60 basis points for us, the question is whether it's going to be a new normal or not. I think probably the industry expectation is given various regulatory changes that have occurred in most markets across the country that it might be ideal to get back to 50, 60 basis points, maybe 70, 80 is more realistic. I don't think we really know yet. And in terms of the time to get there, certainly, what I would say is I don't believe we'll get back to full stabilization by the end of 2024. I would expect it to carry into 2025. And what we really need to see is a little more movement as it relates to cases moving through the courts, particularly in markets like Maryland, D.C. and the Greater New York region. As I mentioned earlier, we've seen significant progress in Southern California. 6% bad debt down sub-3% now. We haven't seen anything like that in terms of percentage improvement in some of the other regions I just mentioned.

Operator:

Our next question comes from John Pawlowski with Green Street. Please proceed with your question.

Ben Schall:

Yeah. Good question, John. We can. We have seen some of that this year as reflected in what we've posted in terms of cost because there's yeah, just greater damage in the units. And obviously, you might do billing damage receipts back to the resident, but then you're pretty much immediately writing it off because you're not collecting it. So I would say that, that has been elevated this year, and I would expect that along with legal and eviction costs to also remain elevated in 2024. It may not be a significant growth rate from 2023 to 2024 but it should remain elevated in both categories.

Sean Breslin:

Yes, D.C. proper there's a number of issues there. As it relates to primarily, what you've got is sort of a seasonal issue. We have probably three assets there that have exposure to the student population near AU or other universities. And so you typically see that occur sequentially during that quarter and then it bounces back in Q4. That's the most meaningful component. There are other miscellaneous things as it relates to supply and number of submarket and other things that you could overlay on top of that but by far the sequential change for the student population is the most meaningful one.

Operator:

Our next question is from James Feldman with Wells Fargo. Please proceed with your question.

Matt Birenbaum:

Sure. It's Matt. I'll speak to that one. So again, just taking a step back here we sold $445 million worth of assets this year including one – our last dispo, which will close at the end – close next week. And those were at a kind of a blended average cap rate in the high 4s. And those were kind of sold and priced throughout the year better pricing earlier in the year, softer pricing later in the year. We bought three assets for about $275 million, all in the last 60 days. Those cap rates were more like mid-4s. And I would say in no cases where the seller distressed. One of those cases we did assume some debt, which probably gave a little boost to the price. So – and all of those assets, if we – if they were to price in today's market would certainly price at a higher cap rate than that I don't know how much higher. But same with the dispose. And again what happened is we pivoted to being a net seller of assets so we sell first. And in many cases we're holding some of those proceeds for a 10/31 exchange and that's informing kind of our appetite on the buy side. So we were net sellers of $200 million or really more like $230 million after you factor in the assumed debt in terms of the cash proceeds we realized from it. The other thing I'd say is when you think about what we bought versus what we sold, it is a good illustration of what we're doing with our portfolio allocation. We sold the four assets out of our established regions they were on average 25 years old. We sold them at an average price of $450000 a unit and the average rents on those assets was $3300 a month. The three assets we bought were in Dallas and in the Greater Charlotte area. In all three cases, there are assets where we are able to add value through our operating platform in many cases. It's part of getting to operating scale in those regions. So we think that – while the cap rate is the mid-4s the yield is more like a 5. Between some value add, we're doing a little bit of light value-add with washer dryers and some hard surface flooring, but a lot of it is just bringing it onto our operating platform, as we get economies of scale in those regions. And those three assets on average are seven years old. We paid on average $245,000 a door, which is below today's replacement cost as Ben mentioned and average rent of $1,700. So a much more affordable price point which we think has a much better growth profile.

Ben Schall:

Jamie, it's Ben. I'll step in. We're not seeing distress at this point. We do expect there to be some dislocation that comes through the system. And on the buying side, a couple of different areas in which we're hunting. One is what Matt talked about places where we can be adding to the density of our portfolio assets and nearby, other assets places where we can add incremental value by bringing the operating initiative activity over to our acquisitions, so that's very much top of mind. Another potential pool and we've been staying close to potential opportunities here are deals and lease-up that maybe are coming up against nearer term loan maturities. What we've been seeing there to date is situations where equity capital is putting more equity into those deals, effectively recapitalizing them and/or lenders who are agreeing to extend out those loans. And so, what you're finding is the borrowers and lenders are agreeing to say extend, it out you get the step-up in the interest rate not going to be a lot of cash flow generated off of the asset, but better to extend there, get the asset fully leased then monetize it, at least for the types of assets in the markets that we're looking to acquire in. Now, that won't be the case right for all types of equity. There's going to be equity that doesn't have the ability to put in more capital and it won't be the case for all types of lenders, right? There's only certain profiles of lenders that can extend out. So, it's an area that we are staying close to. Quickly on kind of two other areas of opportunity, one on the land side. So our developers as Matt talked about today are actively reworking our existing pipeline, recutting deals, restriking deals. We're also out looking for new land opportunities. And the current capital environment and our expectations for what that capital environment will be over the next year, we expect to see opportunities there. Apparently, there's going to be less competition from merchant builders in those markets. So, it'll be selective, but that could be a fruitful area. And then the third area of opportunity is providing capital to the third-party developers. And we have two programs there, DFP and SIP. We'll be selective. But for sure, in terms of the quality of sponsor, that's approaching us the quality of the real estate that they have under control and the return profile of those deals, all of that is enhanced in this environment. And so that's another place that we can deploy capital accretively.

Ben Schall:

So, in the SIP, it's -- we have a target of building that book of business up to $300 million to $500 million over a couple of year period. Given the financing markets, it is tough for deals to pencil, but there are some that do. We are very selective. These are deals we're underwriting not to own them, but to be comfortable owning them if we need to. And in places where we can get a 13% return; we think that's a pretty attractive source of capital. So it's an area of focus. I wouldn't necessarily say it's an area we're looking to accelerate activity. We want to build that book up in a measured way over the next couple of years.

Operator:

Our next question comes from Michael Goldsmith with UBS. Please proceed with your question.

Sean Breslin:

Yeah Michael, it's Sean. I'll take those. So in terms of customer behavior, I'd say the trends we've seen this year have remained relatively consistent. As I mentioned earlier in response to a question in my prepared remarks move-outs to purchase a home is well, well-below long-term averages sub-10% and has been below there for some time now. So not surprising given everything you're experiencing in the single-family for sale market in terms of run up in values and REITs and now the slowing market, et cetera people not terribly inclined to purchase a home and renting is not only more affordable but if you're a risk-off mode you may not want to consider it anyways. Nothing else notable I would say in terms of customer behavior at this point in time. As you noted, the year-over-year comp does get easier as we proceed further into Q4. So a little bit of that as I mentioned in October as it relates to the uptick in rent change in the Mid-Atlantic, Denver and Seattle regions. And we do expect rent change to somewhat stabilize as we look at November and December. And while it won't be anything that's super terrific in terms of a significant rebound as an example, it should be more stable than what we experienced last year based on what we know today.

Sean Breslin:

Yeah. Good question. As it relates to property taxes, which are about 35% of our expense structure we do expect another elevated year of tax pressure in 2024, most of it related to the expiration of those tax abatement programs that we experienced this year. And the level of impact next year will be relatively similar to 2023. As it relates to tax rate, or just tax growth in the Sunbelt or our expansion regions versus the saves regions independent of the exploration of the tax abatement programs. Certainly I would expect more pressure in the expansion regions and the Sunbelt in general given the significant run-up in values that they have experienced over the last three years relative to the established regions. I think that's pretty clear. There's always a lag effect. So the question is just, which market, which submarket tax jurisdiction et cetera, but certainly expect more pressure in those regions as compared to our established regions, which is still the majority of our portfolio.

Sean Breslin:

Thank you.

Joshua Dennerlein:

Yes. Hey, guys. I appreciate the disclosure on the two new product starts 6s. And then also how you're kind of doing that with the projects in lease-up right now to 90 basis point higher spread. Just trying to...

Joshua Dennerlein:

[Technical Difficulty] I am sorry.

Joshua Dennerlein:

That’s okay. I am sorry. [Technical Difficulty]

Operator:

The next question comes from Steve Sakwa with Evercore. Please proceed with your question.

Matt Birenbaum:

Yes Steve yes we may well start a deal in the fourth quarter that would be on similar economics to the Q3 starts. Again we're 95% match funded on development underway today. So if we have deals that we think make sense we think we do have some room there. So I wouldn't be surprised if we have a similar level of start activity in Q4 to Q3 maybe whether it's one or two deals I don't know. When we think about 2024 I think you're probably right. It probably is more back half weighted based on kind of how the capital markets evolve and kind of our access to and pricing of new capital that would fund that business. But we've been in a again for us if we track to roughly $800 million in starts this year or maybe a little bit under that that would be a pretty light year for us and certainly lighter than what we expected going into the year which was the same last year. So we're at a pretty modest level of starts volume relative to our kind of long-run capacity and averages and that's a response to what we're seeing in the markets but I don't think we would view that as a significant level.

Sean Breslin:

Yes, Steve, it's Sean. I can take that one. I mean we do expect 2024 to be another somewhat elevated year primarily due to a few factors I can touch on. One I mentioned earlier property taxes which is about 35% of our expense structure. We do expect it to grow at an elevated rate due to the expiration of those tax abatement programs that I mentioned previously. The pilot burden in 2024 the burn-off there is relatively similar to 2023 before we see it begin to step down in 2025. Utilities, which is about 12% of the expense structure the continued implementation of our AvalonConnect offering which is a profitable endeavor. We're expecting kind of $25 million of incremental NOI from that program, but it is a burden on OpEx growth as it's being implemented and we do expect that to be continuing through 2024 as well. And then two other sort of pressure points really are going to be insurance even though it's only 5% of OpEx. It's still a difficult market. We'll be trying to mitigate that pressure through the use of our captive and other strategies to help offset it relative to market growth rate, but it's still may be elevated relative to sort of normal trends. And then the last one is the repairs and maintenance and legal costs, which I mentioned earlier is a result of continuing to move out sort of the nonpaying residents and puts pressure on turn costs legal and eviction cost et cetera. Some of that will be offset by continued benefits from the initiatives particularly on the payroll side of things. But certainly, we won't be able to offset all those other macro trends that we'd see occurring in 2024 similar to 2023.

Sean Breslin:

Yes. I think the elevated relative to history is the operative statement there. I think that's appropriate. There may be a little bit of relief in some areas. Like in utilities we should have some better contracts in 2024 relative to 2023. But we still do have the AvalonConnect offering. Again, it's profitable but moving through the year. So I think your phrase is generally in the ballpark.

Operator:

Our next question comes from Connor Mitchell with Piper Sandler. Please proceed with your question.

Matt Birenbaum :

I guess, I can try and take that one. It's -- we underwrite everything more or less the same which is we develop our own view of what we think the NOI is going to be and where we think the asset value would be. And so in the SIP frequently almost always the sponsor will provide a projection of NOI that we think is overly optimistic. And again, we have a lot of data that we can leverage to do good underwriting in these programs and the fact that we own and operate assets and have real rent rolls and everything else in all of these markets is one reason why we think that this is an appropriate place for us to invest and a prudent way and leverage our capabilities and our proprietary data. So we get their underwriting. We kind of -- I won't say we throw in the trash but we do our own underwriting. And based on that we come up with our own view of where we think the NOI would be for that asset very similar to, if it was an asset we were developing. And then we build in a margin of safety on that when we think about how high we're willing to lend in the capital stack under the expectation that again we're going to be paid back out of an asset sale in the back end. And we are prepared to step in at our lender basis. And have the view that if we have to step in at our lender basis, because they can pay us back that would not be a bad outcome for us from an investment point of view the basis we would be in that asset. So there are some assets we just wouldn't lend on, because we wouldn't be prepared. We wouldn't want to own them really under almost at any price. So that's one of our screens in the SIP. As it relates to acquisitions or development, it's kind of the same. We'll just look at where we think the deal should underwrite. And based on that we'll formulate a view of what we think is worth and make an offer and see if we can tie it up.

Connor Mitchell:

Yeah. I appreciate that. That's great color. And then my second question and apologies, if you guys have already mentioned this, but how much of the improved earnings outlook is driven by developments versus operations?

Connor Mitchell:

Appreciate it. That's all for me. Thank you.

Brad Heffern:

Yeah. Thanks. So you guys reported a negative 80-basis-point newly spread in October. I'm curious how that compares to normal for this time of year and just generally how things are progressing versus the normal pre-COVID seasonality?

Brad Heffern:

Okay. Got it. And then I think in the prepared remarks you talked about hard costs and said that you're not really seeing cost savings in bids, but you expect to see them when they actually start going? Can you give us some color of where you think real hard costs in real life have actually gone?

Brad Heffern:

Okay. Thank you.

Rich Anderson:

Thanks. Good afternoon. Just a question on expansion market and the process to getting in there. The word was used staying flexible about an hour ago. And I'm wondering does the methodical way by what you're growing there offer you -- is that what's the word keeping you informed I guess and allowing you to pivot one direction or another. Or if you had a chance to do it perfectly in one fell swoop and everyone would stand up and applaud the transaction if you could get there all at once tomorrow would you do that? So, how committed are you? And a related part of that question is how is the Sunbelt performing not so much relative to the urban coastal areas where everyone knows that. But how is it performing relative to your expectations? And is it getting is it even more interesting to you even though it's underperforming relative to other areas of the country at the present time?

Rich Anderson:

A follow-up question is to Kevin perhaps. The 4.1 times leverage the target of 5% to 6% I mean, how do you ever get to that target anytime soon given the rate environment? And maybe one way is debt assumption, which was a part of a transaction you mentioned earlier. Is there any realistic lift to 4.1 in this environment, or could there be transactions here or there where you add debt at reasonable costs through your transaction activities? Thanks.

Rich Anderson:

Okay. Great color. Thanks very much.

Haendel St. Juste :

Hey, good afternoon. Thanks for taking my question. I appreciate the color earlier on the renewals for October, November color on October new lease rates. But I didn't catch if you did provide them your expectations for new lease rates into the year-end. So maybe some color there on then what would that imply for a full year 2024 earning? Thank you.

Haendel St. Juste:

Thanks for that. Can you give us an update on the loss of lease in the portfolio and perhaps where it has in Lewis?

Haendel St. Juste:

Okay. Thank you. And then last one and then apologies if you want to touch on this, but are there any markets that you commented that you're seeing an acceleration in concessions or perhaps more aggressive lease-up for merchant developers?

Haendel St. Juste:

Perfect. Thank you.

Anthony Powell:

Hi. Good afternoon. I guess a question on the expansion region loss lease of 70 basis points, which is maybe better than you would think given all the concern about supply growth in some of these markets. Is any one market driving that positive loss to lease? And do you think space markets could be a positive attributor to your same-store revenue growth next year?

Anthony Powell:

All right. Thank you.

Operator:

Our next question comes from Joshua Dennerlein with Bank of America. Please proceed with your question.

Ben Schall:

Yes

Matt Birenbaum:

Yes, Josh it's Matt. So the way we underwrite is we don't trend anything. So the reason why the current lease-ups are exceeding pro forma by so much, by 90 basis points is -- I mean basically, it's got to be one or two things. It's either rent growth between the time we started construction and the time, we leased it up which -- that is what it is in the current situation. Or in some cases, we were just too conservative in our initial underwriting. And even without market rent growth the offering that we put out there, got a bigger premium to the comps than what we had underwritten because we're pretty conservative in general. So when you think about the deals we're starting now and you ask where are they going to stabilize two to three years from now, when they lease up, the reason why they might outperform we might get a little bit of hard cost savings, that's certainly possible based on what I was saying although, we tend to buy it out pretty quickly. Or it could be rent less between now and then, or it could be just kind of a more favorable response from the market. So on average, over the long run, we tend to outperform by more like 20 to 30 basis points. So that's pretty consistent, but it will vary based on where we are in the cycle.

Sean Breslin:

I don't believe we did, but we're trending in the same general range in terms of economic occupancy kind of in that 95.7% range or so.

Sean Breslin:

Take care.

Ben Schall:

Thank you and thank you, everyone for joining us today. We look forward to connecting further with you in November. Talk soon.

Operator:

Good morning, ladies and gentlemen, and welcome to AvalonBay Communities Second Quarter 2023 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. [Operator Instructions] Your host for today’s conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.

Ben Schall:

Thank you, Jason, and thank you, everyone, for joining us today. I will start with an overview of our outperformance in Q2, speak to the limited new supply in our markets as compared to most other markets and then provide additional color on our guidance raise, our second raise of the year. Sean will speak to our underlying market fundamentals, including the progress we are making on bad debt and provide a further update on our operating model initiatives, which are exceeding expectations. And then Matt will highlight the continued outperformance of our new projects in lease-up and summarize our recent transaction activity, including the sale of three assets at a 4.7% cap rate. Our balance sheet is as strong as it has ever been with total liquidity of $3 billion, and Kevin is also here with us for Q&A. Turning to Slide 4 in the presentation that we posted yesterday. We achieved second quarter core FFO of $2.66 per share, which equates to a 9.5% growth as compared to last year and which is $0.07 per share higher than the Q2 guidance that we provided in April. I’ll speak more to the underlying drivers of that outperformance in a second. We completed two new developments this quarter and started one new project. And as a reminder, early in Q2, we completed the exercise of our $500 million equity forward, capital we raised at $245 per share and has subsequently been investing safely at rates in the low 5% range. In terms of our outperformance in Q2, it was primarily revenue-driven with same-store revenue growing 6.3% or 110 basis points higher than we had anticipated, as shown on Slide 5. Lease rates and other rental revenue were modestly favorable to our prior guidance, partially offset by slightly lower occupancy. The most significant driver of the favorable variance was underlying bad debt, where we have been successful as our landlord rights have been reinstituted of getting back and re-leasing apartments that were previously generating no revenue. As we look forward, we continue to expect our portfolio, which is two thirds located in suburban coastal markets, to benefit from significantly less competitive new supply coming online than in the Sunbelt and other parts of the country. Slide 6 shows the magnitude of this differential, where starts in our established regions have remained stable over time, while Sunbelt starts have increased 50% since 2020. The ramification of this activity is that in 2023, new apartment deliveries will be almost 4% of existing stock in the Sunbelt as compared to only 1.5% of stock in our established regions. And this meaningful differential was set to continue in 2024. Moving to Slide 7. We are raising our full year guidance for core FFO to $10.56 per share, which equals a 7.9% increase over 2022. As a reminder, we increased guidance by $0.10 in April to $10.41 per share, which was attributed primarily to Q1 outperformance and the earnings benefit of accelerating our equity forward. The second increase of an additional $0.15 per share incorporates our outperformance in Q2 and reflects our latest revenue and expense forecast for the year, including improved expectations for bad debt. As part of this updated guidance, we have increased our same-store revenue growth expectation of 6%, kept expense growth constant at 6.5%, and the resulting same-store NOI growth outlook of 6% is up 175 basis points at the midpoint. For bad debt, we are now assuming underlying bad debt of 2.3% for 2023, an improvement of approximately 50 basis points from our initial estimates. As it relates to operating expenses, while the midpoint of our guidance remains the same, we expect lower payroll costs driven by our innovation efforts and lower repair and maintenance and property tax expenses to be offset by higher legal, eviction and bad debt costs as we reclaim apartments from nonpaying residents. The further breakdown of the increase from $10.31 to $10.41 and now to $10.56 per share is shown on Slide 8, with $0.14 coming from same-store NOI. We also continue to adjust our capital allocation approach based on the changing external environment. While our developments in lease-up continue to perform exceptionally well, we have raised our acquired returns on new development starts given our increased cost of capital and focused on maintaining 100 to 150 basis points of spread between underlying market cap rates and our projected development. Based on these factors and as part of our guidance update, we have reduced our expected level of starts in 2023 to 775 million from 875 million. On the transaction side, as part of our portfolio repositioning, we continue to take the tack of selling assets first, locking in that cost of capital and then pursuing acquisitions in our expansion markets. Given this cadence and given that we are remaining selective on the acquisitions that we pursue, our guidance now assumes that we’ll be net sellers of assets this year with expected dispositions exceeding acquisitions by roughly $200 million. And with that, I’ll turn it to Sean.

Matt Birenbaum:

All right. Thanks, Sean. Turning to Slide 12, our lease-up communities continue to deliver outstanding results, laying the foundation for strong future growth in both earnings and NAV. We have five development communities that had active leasing in Q2, and those five deals are delivering with rents that are $520 per month or 18% above our initial underwriting. This, in turn, is driving a 70 basis points increase in the yield on these investments to 6.6%, well above current cap rates in the mid- to high 4% range and even further above the low 4% cost of capital we source to fund these deals when they started construction, consistent with our match funding strategy. Looking ahead, we expect to start leasing on an additional six communities before the end of the year, many of which are positioned to exceed our initial projections by a significant margin as well. As shown on Slide 13, with most of our development communities still early in lease-up or yet to open, we have clear visibility into a substantial future earnings growth stream from this book of business. Over the next six quarters, we expect to deliver an additional 3,600 homes, which are entirely match funded today, and which will drive incremental NOI growth and NAV creation on completion. To provide some additional insight into the transaction market, a summary of our recent disposition activity is shown on Slide 14. While we were able to close on three asset sales in the past few months, transaction activity is still relatively muted with total sales volumes off roughly 70% from 2022 levels. In general, cap rates on the assets that are selling tend to be below prevailing debt rates, although there are also listings that are not proceeding to closing due to a bid ask spread between seller and buyer. We were pleased with the results on these transactions and we’ll look to redeploy a portion of the proceeds into some limited acquisition activity in our expansion regions as we resume our portfolio trading and continue to make progress on our long-term strategic portfolio allocation goal of a 25% weighting to our expansion markets. And with that, I’ll turn it back to Ben.

Operator:

Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Eric Wolfe with Citi. Please proceed with your question.

Ben Schall:

Yes, thanks Nick. And for the wider group, what Nick’s referring to was the legal update that we provided in our earnings release yesterday. And as you pointed out, we are pleased we’ve been dismissed from that class action lawsuit. Nick, at this point, given its ongoing litigation in the wider industry, we can’t make any additional comments above what we included in our disclosure in the earnings release. The filings in the case are public. They’re out there, the extent that you or others want research the matter further.

Ben Schall:

We were dismissed from the consolidation of the class action lawsuits.

Matt Birenbaum:

Yes. Hey Eric, it’s Matt. I guess, I can speak to that one a little bit and then I don’t know if Kevin wants to talk to the longer term trend there, but I mean, probably the easiest way to think about it is that as that slide showed, we’re looking at 3,600 deliveries over the next six quarters. That’s about 200 deliveries a quarter and that’s – I’m sorry, 200 deliveries a month. And that is probably double the pace of what we’ve done over the last year or so. So, we’re going to be getting twice as many apartments that we’re going to be bringing online and ultimately generating NOI out of it.

Eric Wolfe:

That’s helpful, thank you.

Austin Wurschmidt:

Hey, good afternoon. As it pertains to lease rate growth trends, can you share a little bit more detail around how new lease rate growth trended in the second quarter to get to the 2.8% July? And then for renewals, how big is the spread been between asking rates and take rates? Because I think I recall in recent months you were sending out notices in the 7% range and it seems like maybe the take has come down a bit. Thanks.

Austin Wurschmidt:

And so just unpacking that as it relates to the guidance, you – I think you said your rent growth assumption in 2023 was revised hire to reflect the growth route by, but the back half lease rate growth, is that unchanged to versus the original guidance? I guess can you just share what that revised rent growth assumption is for the year?

Austin Wurschmidt:

That’s helpful. Thanks for the detail.

Operator:

Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.

Sean Breslin:

Yes. I mean we haven’t provided July bad debt data just yet because it hasn’t been fully closed out. We provided some preliminary estimates for July as it relates to rent change and things of that sort, which is what was included. So I think what probably is the easiest way to think about this is first half our underlying bad debt rate was 2.7%. In the second half, we expect it to be 2%, which reflects 2.2% in Q3 and dropping down to 1.9% in Q4. As it relates to occupancy, occupancy is correlated with the change in bad debt as we see skip and evict activity throughout the portfolio. So where we are for the second half of the year, as I mentioned in my prepared remarks is an expectation that economic occupancy will average roughly 95.5%, which is modestly below our original expectation, but is congruent with the fact that we are getting back more non-paying resident units that we anticipated that’s flowing through the turnover into occupancy but is also helping bad debt. So the two are correlated and so the expectation is again kind of mid-95s for economic occupancy in the second half based on our forecasted receipt of those non-paying units in the second half.

Sean Breslin:

Yes. I think the primary driver is what I was referencing as it relates to Austin’s questions, which is, we pushed hard on rate as it related to the first two quarters of the year. As you may recall, the eviction moratorium for LA expired at the end of March. So as we processed cases, we started to see more availability come into the portfolio in the latter part of the second quarter. And therefore, we started to ease on rates to then prompt more velocity in terms of leasing velocity of those incremental units. And so what you’re seeing on the new move-in side in particular is in places like LA as an example, where there is more inventory coming back to market. As we get into July, we wanted to push that inventory through the system, get it turned, get it released, get it occupied before we get into the slower and softer frankly fall winter seasons. So that pressure on new move-in specifically is to help spur leasing velocity to absorb more inventory than normal as a result of those non-paying units coming back to us.

Operator:

Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.

Ben Schall:

Yes. John, the 2% I mentioned is the underlying bad debt, ignoring the impact of rent relief, so to clarify that one. And then in terms of duration, I mean, it’s a good question. We essentially process about, call it, 1,400 skips and evicts the first half of the year. Our expectation is for roughly similar pace, maybe slightly more on the second half. And but based on the number of outstanding accounts that we have at this point in time and the pace of activity, particularly in a state like New York, which is moving more slowly. I do expect it to carry through into at least, I’d say, the first half of 2024. And then as you start to get to the back half of 2024 and 2025, I would expect to see normalization based on the pace we’ve experienced thus far.

Ben Schall:

Yes, Washington state is a big chunk of it, John.

Operator:

Our next question comes from the line of Alan Peterson with Green Street. Please proceed with your question.

Sean Breslin:

Yes. Good questions. So as it relates to the operating initiatives, when I talk about them first more holistically. At this point, based on what we have projected for 2023, we’ll be about halfway through our plan as it relates to achieving about $15 million in incremental NOI with the balance of that to come through 2024 and into 2025. Beyond that, there are other things that we’re investing in that we haven’t talked about in significant detail as it relates to the use of AI, which you started several years ago and have been in R&D mode and other areas of the business, some other automation efforts and various other things that will help drive additional value NOI to the portfolio, which we would – we will be happy to talk about as we get further along with those. But I would say, as of right now, if you think about what’s coming in the way of NOI assume there’s another roughly $25 million or so to come as it relates to 2024 and 2025. That’s kind of the high level summary where I’d leave it, that includes more than just the staffing side of it. That includes all of it, that’s underway at the moment.

Matt Birenbaum:

There’s not a lot of distress that we’re seeing out there yet in multi of any kind, honestly. I think if it shows – my guess is, it would be more likely to show up in some of our expansion regions where people were buying maybe with short-term value add business plans, where maybe they were borrowing short-term floating rate debt, thinking they were going to invest some money and improvements get a rent roll pop and then flip the deal out. So that business plan is not working for folks the way it had been. So there could be some pressure there or some kind of larger portfolios that people may have bought at a higher leverage point. There was just more of that transaction activity happening in the Sunbelt than in our coastal region. So maybe that means there’s more opportunity there if some of that goes sideways, but it’s pretty speculative.

Operator:

Our next question comes from the line of Sanket Agrawal with Evercore. Please proceed with your question.

Matt Birenbaum:

Yes. Hey, it’s Matt. I’ll speak to that one. Yes, it was really just one project that honestly, the returns got a little too tight relative to what’s happened with cost of capital and asset values. So I wouldn’t read too much into it as it relates to next year. We have a pretty robust pipeline, so we think we have the opportunity to increase our starts activity next year if things go the way we hope they will. So that was really just a deal specific situation there.

Sanket Agrawal:

That sounds right. And I had a follow-up to that. Like we were talking a couple of guys on the private side and they said that developers have pulled back on the development team. Do you guys see the same things on the ground? Are you guys pulling back on development side or something like that?

Sanket Agrawal:

Thank you.

Jamie Feldman:

Great. Thank you. Sticking with that last comment about the northeast markets, I mean, you’ve been particularly well positioned in both northeast markets and suburban the last couple years. How long do you think that outperformance of those markets can continue? And what are you watching that’ll continue to give you confidence in that situation?

Jamie Feldman:

But I guess – yes, I mean that’s helpful in terms of the data to watch. But like northeast has been incredibly strong versus other regions. What do you – what gives you confidence that it’s going to continue? Or do you think like it does start to revert to mean at some point?

Sean Breslin:

Jamie, one thing I would just add to that to give a specific example, if you think of Boston, which is a market that we’ve been in for a very long time, very active developer. Certainly, there have been very good demand drivers there as it relates to a number of different industries, highly educated workforce, good income levels. Our predominantly suburban portfolio is pretty supply protected. Most of those towns have fulfilled their 40B affordable requirements. So there’s not a lot of developments in the pipeline. That’s the kind of environment where we can be successful in development, but also our existing portfolio is pretty insulated as it relates to exposure to supply and tends to produce solid growth. So that’s a good example of one of those markets. If you think of New Jersey, parts of New Jersey, we’re the first development going in, in 30 years. So while it may not have the growth rate on a stabilized basis that is as attractive as some West Coast markets when they’re really moving along, the additional yield on that development and the total returns are quite attractive. So we’ll continue to allocate capital there. So those are a couple of good examples as to why we think those markets are attractive.

Matt Birenbaum:

Yes, sure. This is Matt. I can speak to that. And I would say the SIP business is not a distressed business. Basically, we are lending to developers who are building multifamily assets, very similar to the multifamily assets that we build and own and operate. And we’re just providing capital between the first mortgage construction loan and their equity. And where there’s been distress is in the lending world. And so the amount of proceeds they can get off that first construction loan are lower than they would have been a year or two ago. And therefore, they either have to put in more equity or borrow a little bit more money from somebody else. So in that sense, what we’re seeing that’s changed is, we’re going lower down the capital stack. So we’re lending from maybe 50% to 75% cost instead of 60% to 85% cost like we would have been doing a year or two ago. And we are happy with the fact that we’re just building that book of business today, and so we can underwrite it in today’s environment. The deal that we just closed on is a suburban garden community in Charlotte, actually fairly near the DFP deal that we started construction on in the first quarter, north of Charlotte. And that’s with a sponsor who is really first-class sponsor who actually have a DFP deal working with as well that we hope to start next year. So it’s a repeat business situation. And that’s pretty representative of the type of business that we’re looking for. That rate is kind of 12-ish, yield is around 13, a little bit more higher than 13. Just given the fees involved, that would have been 10 as opposed to 12 or 13 if it had been a year or two ago. So we are seeing a lot of inbound inquiries on that program. The challenge is finding deals that underwrite, just given kind of where asset values are relative to replacement cost. And that’s part of what we’re seeing in terms of developers finding it much more difficult to put their capital stack together, which ultimately is slowing start activity. But the good news is, we have our pick of the litter and really top quality sites and sponsors. The challenge is finding deals that underwrite because we’re not really bending in terms of the quality of the underlying collateral and how high it will go in the capital stack to lend against it.

Matt Birenbaum:

Our long-term goal is to have that plan be a $300 million to $500 million book of business and build that up over the course of several years. I think today, we’re at a little bit less than $100 million in commitments total. So, we’ve got room to run there.

Operator:

Our next question comes from the line of Josh Dennerlein with Bank of America. Please proceed with your question.

Ben Schall:

Josh, you cut in and out on the question. Can you repeat that, please?

Ben Schall:

Part of it’s just been our approach and we made this shift last year to selling first the market. There’s uncertainty there. There’s not a lot of capital that’s in play. So we wanted to take some assets to market, execute on those, lock into that cost to capital and then make the decisions around how we’re going to redeploy that capital. We are remaining pretty selective today in terms of our new buying activity. And part of that is, while to Matt’s point, we’re not expecting distress. Our view is that over the next six months to 12 months, there likely will be a greater set of motivated sellers and potentially in our growth areas, in our expansion markets that could be particularly true. If you take a softening operating environment and combine that with a capital environment where capital is less abundant that could provide some attractive opportunities for a platform and a balance sheet like ours.

Sean Breslin:

Yes, Josh. This is Sean. We didn’t provide specific guidance as it relates to new lease rate growth, excuse me. Well, we did say at the beginning of the year, which I would just reaffirm now, is that we did expect to see solid rate growth for the first half, which we have realized, and then begin to see some modest deceleration and blended effective rent change in the back half of the year. And I think that’s appropriate at this point in time in terms of where we are and what we’re seeing in terms of the inventory come back to us from some of the [indiscernible] I think that’s appropriate.

Sean Breslin:

Yes.

Alexander Goldfarb:

Hey, good afternoon. So two questions. First just going back to the RealPage, Ben is – are you guys totally out of any RealPage related litigation or is this just the consolidated? I’m just, sorry, just want to get clarification. Is this just a consolidated case or are there other litigations that you guys are still party of related to this RealPage?

Alexander Goldfarb:

Okay, thank you for that. Second question is on your outperformance of the developments, I’m assuming a lot of this is based on your land basis. So as you look at your, the options that you’ve struck on your development land pipeline, how many more years do you think that you’ll have above average development returns based on how much rents have moved? Just sort of curious, is this just a one or two year phenomena? Or do you think this could be several years where your developments are outpacing traditional because of where you bought the land versus where rents are now?

Alexander Goldfarb:

Okay. Thank you.

Operator:

Our next question comes from the line of Brad Heffern with RBC Capital Markets. Please proceed with your question.

Matt Birenbaum:

Sure. I guess to the second part, how we think about the future, again, we tend to look at everything on a spot basis, so today’s NOI, today’s hard costs. Now there are some deals that we have in our system, which we signed up in the last couple of years that are thin at today’s hard cost. And so in some cases, we are making the decision to continue to invest modestly in those deals to get them ready to go to see what happens to hard cost by that time because the reality of it is, it’s very difficult to know where hard costs are until you actually have a deal ready to bid and subcontractors see that it’s real. Ideally, there’s even some demo or something going on so that, everybody is constantly asking them if I had a job to build today, what would it cost, but that’s different than I do have a job ready to go today. I have the permits in hand; give me your best number. So what we’ve seen is in some markets, particularly again, some of those markets that maybe didn’t see quite the same excesses in terms of subcontractor capacity, again, particularly in the Northeast – suburban Northeast, where a lot of our dev starts are, we have seen costs come back maybe 5% to 10% and we’ve enjoyed some buyout savings on some of our more recent starts. And so once we bought that out, then that is reflected in the way we underwrite the next deal in that region. There are other regions where hard costs, it seems like they’re flattening out, but they haven’t fallen yet, particularly some of the regions that saw – were just really struggling to keep up with all of the demand and all of the elevated start activity over the last couple of years. I would put Austin in that category. I’d put Denver into that category. I’d actually put Seattle into that category, where we saw hard costs run up a lot and have not yet come back to us. And so we’ll see. We’re certainly hoping that they do. We’re seeing start activity start to slow down in those regions, but that may take a while before that plays through.

Sean Breslin:

Yes. No, good question, Brad. Nothing terribly unusual kind of it’s a mess here and there across different categories, but nothing that stands out as sort of oh, there’s a – there’s something going on as it relates to relocation or things of that sort. Home condo purchase is still less than 10%, which is a historic low for us. So there’s not much else in there other than sort of the normal stuff, family status, roommate changes, nothing else material I’d say.

Ben Schall:

Yes.

Michael Goldsmith:

Good afternoon. Thanks all for taking my questions. On Slide 10, you show the performance of the rent growth in different markets, and what’s clear is that the expansion regions are kind of at the lower end of where you initially projected compared to pretty much every other market is at the higher end. So when you think about the expansion markets, does this – the fact that it kind of ended up being kind of at the lower end of your initial projection, change your view on the rate of expansion? Or how quickly you want to move there? And just your thoughts about diversifying the portfolio overall? Thanks.

Michael Goldsmith:

That’s very helpful detail. And my follow-up question is just on the performance of the suburban versus urban, are you seeing any differences in terms of how the tenant is reacting or kind of how the consumer is positioned in these markets and how that has translated to the results in those two different types of regions? Thanks.

Michael Goldsmith:

Thank you. Good luck in the back half.

Operator:

Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

Sean Breslin:

I’d say New York is really a little bit the outlier at the moment in terms of the processing of cases, whether it’s Long Island or city or Westchester, it’s just moving – everything is moving more slowly. The backlog is significant, but it’s also significant in L.A., and L.A. seems to be moving along a little faster. So those are really the two markets and maybe to a lesser extent, a similar phenomenon is in the District of Columbia. We’re seeing things move more slowly. So I’d say New York is probably the outlier to the slow end followed by DC in terms of what’s going on. The rest of them is sort of just chipping along.

Sean Breslin:

Yes, it’s a good question. Different companies use different types of screening criteria, so I can’t really speak to the market specifically on that subject. That really is something that from an industry perspective, you acquire a lot of conversations in terms of how people screen their applicants to make that decision.

Sean Breslin:

Not any significant trends. That actually went the opposite direction through COVID. And we haven’t seen a significant trend indicate people are doubling up.

Sean Breslin:

Yes, you’re welcome.

Ben Schall:

All right. Well, thank you for joining us today, and we look forward to speaking with you soon.

Operator:

Good morning, ladies and gentlemen and welcome to the AvalonBay Communities First Quarter 2023 Earnings Conference Call. [Operator Instructions] Your host for today’s conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.

Ben Schall:

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 earnings stream that our developments currently underway 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 4, 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 like-term effective rent change of 4.1%. For the quarter, we exceeded core FFO guidance by $0.05, with the $0.01 of revenue primarily attributable to better-than-expected collection rates from residents, $0.03 due to lower operating expenses and $0.01 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 additional 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 $0.03 per share, after factoring in the incremental shares outstanding. We, in turn, increased our full year core FFO guidance by $0.10 to $10.41 per share at the midpoint. The breakdown is as follows

Matt Birenbaum:

Alright. Great. Thanks, Sean. Turning to Slide 9, our lease-ups continue to deliver outstanding results, laying the foundation for strong future growth in both earnings and NAV. We currently have 4 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 source 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 7 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 booked in Q1. This leaves over $130 million of incremental NOI to come as these assets complete construction stabilize. And as for the prior slide, that total NOI figure is also likely understated, given only 4 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 cut. And some of these drop-laying 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 3 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.

Ben Schall:

Alright. 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 also mindful that these are the types of environments, particularly in 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.

Nick Joseph:

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 if you could talk more broadly about, is this a one-off deal? Are you looking to scale this business? What sort of margin and economics could you derive from it? And then I know this is in the third-party management contract, but would that be of interest as well for other property owners?

Ben Schall:

Yes. I think as well, but 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, both of our operating model journey but as well as the role that the CCC and centralized services are planned 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 and at a centralized way. And this relationship allows us to make continued investments. Think about technology, process people that we think can then accrue to the larger platform here at AvalonBay. 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.

Kevin O’Shea:

Yes, Eric, let me kind of take a stab at it a little bit. I can’t really give you, I mean, an answer what number of units would have to be under this kind of an arrangement for it to be material. It probably 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 operating platform in the business. And so we’re in our 17th year with this experience. And I think that we’re pointing this out probably for two reasons. One, 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, that even draw, for our own sake, when we started, we weren’t at our current size of, whatever, 80,000 apartment homes when we started this in 2007, we were quite a bit smaller. And 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 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 Archstone 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 the fact that it is a relatively modest financial significance today, is the fact that a highly respected institutional multifamily owner, such as Gables, by entering the screen with us after its own due diligence on 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 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.

Operator:

Our next question comes from the line of Steve Sakwa with Evercore. Please proceed with your question.

MattBirenbaum:

Sure. Hey, Steve, it’s Matt. Yes, so our target yield or going in initial return on new development has been rising really over the last year as we saw cap rates rise and cost of capital rise, both debt and equity. So our target yields were probably in the mid-5s, mid- to high 5s last year. And now they’re kind of in the mid-6s, low to mid-6s, depending on the geography and the risk associated with the deal. So our start activity for the year is as the – it is probably a little more back half weighted just by the way the – as time goes by, we’re going to see more buyout savings on our hard costs. So in some – that probably plays 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 – but when I look at our development starts that are slated for this year, that’s about where the yields are. They are probably in the low 6s. 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.

Kevin O’Shea:

I feel 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. It 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 3 of the 7 rate starts we have planned for the year. And when I look at it, the other ones, I’m feeling pretty confident that we should track that, unless something very unexpected happens.

Steve Sakwa:

Okay, great. And then maybe just one question for Sean. On – you talked about, I guess, the renewals going out around 7%. And I know you don’t provide a split between new and renewals and you kind of just provide the blend. And April was a nice uptick. I guess given that we’re going in the spring leasing season, how – I guess, how much confidence do you have that 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?

Steve Sakwa:

Great. Thanks. That’s it for me.

Austin Wurschmidt:

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?

Austin Wurschmidt:

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?

Ben Schall:

Two areas I’d emphasize, One, just on the point of our relatively limited land holdings, when you look across our peer set, our landholding numbers is below a number of our peers, despite kind of our ability to execute at higher development levels throughout cycles. So we’ve got some room in there. The second part is in an environment right now, we recognize we need to be selective about that. But in places, 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 yes, there have been a couple of situations where land is getting repriced at 30% to 35%, where it was priced 9 months ago. If we can step in and control that land with relatively limited cost to look out a couple of years, and we think that will accrue some significant benefits.

Operator:

Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.

Sean Breslin:

Sure, Adam. This is Sean. Just a couple of 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 a sort of underlying bad debt, came in at around 3%, which is about 22 basis points better than what we anticipated. And that’s the $0.01 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. 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 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 it doesn’t necessarily make for a trend just yet, and we will 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.

Sean Breslin:

Adam, what I’d say is anything is possible. I don’t think that is probable based on the resident behavior we have seen thus far. So I would not anticipate that. To the extent that we, all of a sudden, cash started ringing in from people who haven’t paid, 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.

Operator:

Our next question comes from the line of Chandni Luthra with Goldman Sachs. Please proceed with your question.

Sean Breslin:

Sure, Chandni. This is Sean. Happy to answer that. First, in terms of Q1 activity, across all the leases we signed in the quarter, which was about 16,000 leases, the average concession is less than $200. So very, very modest. Obviously, 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, 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’re 30%, 40%, 45% of the leases, depending on submarket or getting some type of a concession. So those are the two places where we’re focused on at the most in terms of moving volume, but it’s not a significant issue elsewhere.

Matt Birenbaum :

Yes. This is Matt. I guess, I’ll speak to that one. So what we’ve said of cap rates and then our own trading activity, I think what we’re seeing is that there is a bifurcated market. There are a lot of assets that are not trading. Those that are, I would 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 submarkets that are on a lot of investors’ lists. For growth, those assets are still trading in the mid-4s cap rates. I think, in fact, I would have – if you’d asked me 90 days ago, I probably would have said high 4s, but – and we do have some assets actively in the market today that hopefully will close during Q2, and we have at least one that’s in that haves category, I would say, that’s probably more of a mid-4 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 report 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 a interest that have a less deep pool of bidders. And there, 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 5s. And so call that range anywhere from 4.5 to 5.25. 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, 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 seconds. 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 regions. So we would expect – I don’t know if anything is going to close on the acquisition side in Q2, but it is our plan to kind of resume that forward trading.

Operator:

Our next question comes from the line of John Pawlowski with Green Street. Please proceed with your question.

Ben Schall:

I think we are still early. There are more sellers than less who are actually willing to give current contracts to the time, right, extend out and see where it heads. But we are starting to see some situations where deals are breaking. And the two situations I was referring to had buyers who are relatively motivated. And when they are looking at on the landscape, this goes to Matt’s comments about our ability to execute our – that we don’t need to rely on construction financing, right, to execute projects today, those buyers are going to own the margin, look to somebody like AvalonBay to contract to – contract with. So that’s – yes, I’d say that’s the kind of the general environment. Our expectation is that there is more to come. Starts are – we’re expecting to be down substantially this year. And a big part of underlying all of 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 has also expanded out significantly, right? So on a relative basis, this is one of the parts that we’re starting to see. While our cost of capital has gone up or in 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, right? And that’s before putting on some preferred equity or mezz and that’s before getting to equity, right? So our relative advantage in a period like this, we think, is we’re relatively well positioned. And so selectively, we’re going to start stepping into some of these types of opportunities.

Matt Birenbaum:

Yes, John, it’s Matt. It’s – I ask Craig Thomas, my 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 have 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. But – and in some cases, people may be pulling permits and then getting bids and not liking the numbers they are seeing. But it is a little bit of a head scratcher, I would agree with you.

Operator:

Our next question comes from the line of Jamie Feldman with Wells Fargo. Please proceed with your question.

Matt Birenbaum:

Hi, Jamie, it’s Matt. I would expect, it’s probably more of the latter. 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 would be pretty unusual, our portfolio – usually sellers selling portfolios, it’s more opportunistic. And those things happen when there is an abundance of capital. And go back 3, 4 years, there was kind of a portfolio premium. Today, you talked about – I think, on the last call, there is a portfolio discount just given the capital markets. So we haven’t heard of anything like that. And I guess I’d be a little surprised.

Sean Breslin:

Yes. Jim, it’s Sean. What I would say is that, yes, generally, things were in line. The rent change that we experienced in Q1, that’s gave out 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, new supply is quite a bit less than what we are 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 would probably pivot more towards suburban assets outperforming.

Sean Breslin:

Yes.

Operator:

Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.

Ben Schall:

John, yes, we haven’t sized it yet at this point. We went through the pilot, as I described. We want to get to our first third-party client fully implemented. We get a little bit further out. We will start thinking about the profile of additional clients and even further down the road, thinking about where it could come, but we are not at that stage yet.

Ben Schall:

Yes. I will hit 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 talked about. Second is on acquisitions, and this gets into – we do think our relative trade, selling out of the established regions and into the expansion regions, is more attractive today. We have got a couple of assets now that hopefully, we will sell over the next couple of months. And so when we look to deploy that capital, the 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, nearby asset. But generally, in this type of environment we are not doing a ton of buying and selling. On the buy side, we are 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 would highlight goes broadly to the theme in a world of 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 out over that book of business, and we think we 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.

Operator:

Our next question comes from the line of Josh Dennerlein with Bank of America. Please proceed with your question.

Matt Birenbaum:

Yes. This is Matt. The guidance for the year, most of those deals are going to really impact earnings in ‘24 and ‘25 because they are 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 higher rents than kind of what’s shown on the development attachment, but the real lift there isn’t ‘23, it’s ‘24.

Matt Birenbaum:

I would say that, that was kind of the point of included in the slide, yes, that if the 17% uplift in rent is roughly comparable to what we have seen across our entire same-store book over that time, if that – if those seven lease-ups experience similar kind of rent growth to kind of what we have seen broadly over that time period. And yes, I mean we would be expecting to see the yields on those deals rise by like roughly similar amount.

Matt Birenbaum:

I think it’s just certainty. I mean when you ask somebody to give you a price on a deal you are not going to start for a year, it’s just – they are just giving you an estimate number. It’s not – you can’t take that number to the bank. Anyway, you don’t even – you don’t have final construction drawing. So, you are not contracting at that number. It’s more of an allowance. And so it’s natural for people to say, “Well, here is 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 will give you a – we will 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 have said, maybe they were working on five jobs, they only see two coming up, they have availability, and they are 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.

Operator:

Our next question comes from the line of Haendel St. Juste with Mizuho. Please proceed with your question.

Kevin O’Shea:

Yes, sure, 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. And latter time deposits with banking partners that are very highly rated, known to us, part of our credit facility syndicate. And so – 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 have structured that set of the cash investment activity so far. So – and we would retain liquidity to fund development from that source as well as liquidity on our line of credit, so we – of $2.25 billion, where there is 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 is – the cash we have invested or from our line of credit.

Ben Schall:

Yes. I appreciate that. I would start by emphasizing, I mean this is about this executive team, right. So, we are the ones setting the course for this business over the coming years, and we are 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 are working on. And so we have decided as a team, in certain areas, where we think we can accelerate that activity. And so you have seen that come. In terms of our strategic focus areas, we have 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, that’s what – those are what are driving us as we look ahead and I believe will create outperformance for us.

Operator:

Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.

Matt Birenbaum:

Yes. Hey Alex, it’s Matt. So, we don’t necessarily start with a particular kind of goal in mind. Really what we are looking for is the best risk-adjusted return. And we are taking it as an opportunity in these expansion regions to construct a portfolio from the ground up. And what we found over the last couple of years as we have started our investment there, that we felt like the supply/demand fundamentals and the pricing of the assets was just more attractive in the suburbs. So, if you look at our Denver portfolio, the assets we bought there, they have all been suburban assets. We did develop the one deal in RiNo to a very high development yield. But – so we are 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 we bought in Voka [ph]. We bought in Margao. We just recently bought a couple of different assets in Broward County. So, we have 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 submarket. But these Sunbelt markets, in the first place is not as much. They are not as urban in the first place. So, I don’t know that there is an urban submarket in all of Raleigh, Durham, in the Downtown Raleigh. And we are not looking at that. So – and in Charlotte, all of our development has been in the suburbs. We did buy the portfolio in the South kind – which is kind of the one urban submarket there that is very, very dynamic. So, I would say that’s the exception. But generally speaking, you are right, it may be a little bit of a different strategy than the way some others have pursued it. And it’s also kind of just more of the way the lifestyle is in a lot of the Sunbelt metros. They just – 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 stuff, so.

Kevin O’Shea:

Alex, this is Kevin. Maybe I will just respond strictly to the insurance aspects of this, and then may Ben or Matt may want to respond to the development implications. But you are 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 on to commercial tenants. So, having that capability to self-insure has been a helpful thing in recent years as the insurance market has become increasingly challenging. I am not going to get too specific about what’s going on with those property renewal now, because we renew on May 15th, so we are actually in the market for that. But we have, in the past, I would say, 7 years or 8 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 have the biggest piece, grew then by 4% to 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.

Operator:

[Operator Instructions] Our next question comes from the line of Ami Probandt with UBS. Please proceed with your question.

Sean Breslin:

Ami, this is Sean. 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, etcetera and the ability for people to access the kind of inventory they want, may be more limited, particularly on the single-family side, maybe condos, townhomes, et cetera, in 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 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.

Matt Birenbaum:

Hey, Ami, this is Matt. They are – 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 found so far, and the 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’ve done the development ourselves, but still probably at least 50, 60 basis points north of where an acquisition yield would be, if not more.

Operator:

Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.

Matt Birenbaum:

I would have – this is Matt. I think – and Ben and Sean may want to weigh in as well. It’s really interesting to see these states try to engage in that dialogue about. But 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, in New York and other states. So 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. 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’s kind of would be the point of it. What we’ve seen so far, at least in California, has been every time there is been something that, in theory, would have opened up more sites to development, there is 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 in your transit, but then they are saying it has to be prevailing wage, construction cost, 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 the 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 at existing communities and not have to go through its 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.

Anthony Powell:

Great. That’s it for me. Thank you.

Ben Schall:

Thank you. Thanks, everyone, for joining us today. We appreciate your support and look forward to speaking with you soon.

Operator:

Good morning, ladies and gentlemen, and welcome to AvalonBay Communities Fourth Quarter 2022 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. [Operator Instructions] Your host for today's conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Reilley, you may begin your conference.

Ben Schall:

Thank you, Jason, and hello everyone. I'm joined by Kevin, Sean and Matt, and after our prepared remarks, we will open the line for questions. I'll start by quickly summarizing our 2022 results and highlighting our progress on a number of strategic focus areas. As shown on slide 4, from operating results perspective, 2022 was a phenomenal year, and one of the strongest in the Company's history, with 10.9% same store NOI growth and 18.5% core FFO growth. We ended the year with core FFO of $9.79 per share, which just to reflect back, was $0.24 above our initial guidance at the beginning of 2022. On the capital allocation front, we proactively adjusted during 2022 as the environment and our cost of capital changed. In April, we raised approximately $500 million of forward equity at a spot price of $2.55 per share, which is still fully available. As the year progressed, we pivoted from our original expectation of being a $275 million net buyer to ending the year as a $400 million net seller, a shift of roughly $700 million in total. We also ratcheted down new development starts given the shifting environment -- to $730 million from our original guidance of $1.15 billion. Collectively, these moves put us in an extremely strong liquidity position and fully match-funded with capital secured for all of the development we have underway. We also made significant progress during 2022 on our strategic focus areas, three of which I want to highlight today. First, as detailed on slide 5, continue to make very strong inroads on the transformation of our operating model. We captured approximately $11 million of incremental NOI from our operating initiatives in 2022. In 2023, we're projecting an additional $11 million of incremental NOI from these initiatives, and looking further out expect meaningful contributions in 2024 and beyond. This uplift is being driven by a number of initiatives including our Avalon Connect offering, which is our package of seamless bulk internet, and a new developments Managed Wi-Fi, which we have now deployed to over 20,000 homes and expect to be at over 50,000 homes by the end of 2023. During 2022, we revamped our website and fully digitized our application and leasing process. What used to take 30 plus minutes of associate’s time can now be completed digitally in about 5 minutes. We also rolled out our mobile maintenance platform across the entire portfolio, allowing our residents and maintenance associates to interact much more efficiently and seamlessly. As a result of these initiatives, we believe we are enhancing the customer experience while also driving operating efficiencies, which over the past few years has resulted in a roughly 15% improvement in the number of units managed per onsite FTE. Turning to slide 6 as a second strategic area. We are focused on optimizing our portfolio as we grow. Our goal is to shift 25% of our portfolio to our six expansion markets over the next six to seven years. In addition to diversifying our portfolio, this shift reflects the reality that more and more of ABV’s core customer, knowledge based workers are increasingly in these markets. At the end of 2022, including our development currently underway, we increased our expansion market exposure to 7%, and subject to the capital allocation environment this year, we expect to be at 10% by the end of 2023. We're funding a large portion of this shift through dispositions in our established regions, which also allows us to prune the portfolio of slower growth assets and/or those with higher CapEx profiles, which should lead to stronger cash flow growth in the portfolio in the years ahead. Our third strategic focus area has been on leveraging our development expertise in new ways and in ways that drive additional earnings growth. More specifically, as detailed on slide 7, we are expanding our program of providing capital to third-party developers primarily as a way to accelerate our presence in our expansion markets. In 2022, this included a project start in Durham, North Carolina and a new commitment in Charlotte. During 2022, we also successfully launched our Structured Investment business, with over $90 million of preferred equity or mezzanine loan commitments made during the year. We believe that both of these programs will be increasingly attractive to third-party developers in 2023, and we're also fortunate to be building these books of business now at today's economics and bases versus in yesterday's environment. Before turning it to Kevin to provide the specifics of our 2023 guidance, I want to provide some additional context on our underlying economic assumptions for the year. From a forecasting perspective, we are overlaying the consensus forecast from the National Association of Business Economists, or NABE, on top of our proprietary submarket by submarket research data and model. The NABE consensus assumes a significant slowing in job growth during the year, down to about 50,000 jobs per month by the third quarter and a total of approximately 1 million of net job growth in 2023. The output of our modes is a forecast of market rent growth of 3% during the year. In a year in which we will need to be prepared for a wider set of potential outcomes than usual, there are a number of attributes of our portfolio, and particularly our concentration in suburban coastal markets, that we expect to serve as a ballast in a potentially softening economic environment. As shown on slide 8, the cost of a median-priced home relative to median income in our markets continues to serve as a barrier to home ownership and support demand for our apartment communities. This is in addition to the repercussions of today's higher mortgage rates, which make the economics of renting significantly more attractive. The other side of the equation is supply. In softening times, having an existing asset that is in direct competition with a recently built nearby project and lease-up can be particularly challenging. Our portfolio has some of the lowest levels of directly competitive new supply across the peer group at only 1.4% of stock, which we believe positions us well. And with that, I'll turn it to Kevin to detail our 2023 guidance.

Sean Breslin:

All right. Thank you, Kevin. Moving to slide 12 in terms of our operating environment. After a very strong first half of the year, we ended 2022 with several of our key operating metrics, including occupancy, availability and turnover trending to what we consider more normal levels. In addition, following two years of abnormal patterns, rent seasonality returned with peak values being achieved during Q2 and Q3 before easing in the back half of the year. More recently, the volume of prospective renters visiting our communities increased in January as compared to what we experienced in November and December, which translated into a modest lift in occupancy, and we do see amount of available inventory to lease as we entered February. Additionally, asking rents have increased about 100 basis points since the beginning of the year, which is beginning to flow into rent change. Based on signed leases that take effect in February, we're expecting like-term effective rent change to be in the low-4% range. Turning to slide 13. The midpoint of our outlook reflects same-store revenue growth of 5% for the full year 2023. Growth in lease rates is driving the majority of our revenue growth for the year, which includes 3.5% embedded growth from 2022 and an expectation of roughly 3% effective rent growth for 2023, which contributes about 150 basis points to our full year growth rate. We expect additional contributions from other rental revenue, which is projected to grow by roughly 16%, about two-thirds of which is driven by our operating initiatives, a modest improvement in uncollectible lease revenue and a slight tailwind from the reduced impact of amortized concessions. We're assuming that uncollectible lease revenue improves from 3.7% for the full year 2022 to 2.8% for the calendar year 2023. Of course, this improvement is more than offset by a projected $36 million reduction in the amount of rent relief we expect to recognize in 2023. The combination of the two reflects a projected 80 basis-point headwind from net bad debt for the full year 2023. Moving to slide 14. We expect our East Coast regions to produce revenue growth slightly above the portfolio average, while the West Coast markets are projected to fall below the portfolio average, and our expansion markets are projected to produce the strongest year-over-year revenue growth for the portfolio. One point to highlight is that the reduction in rent relief will have a more material impact on our reported 2023 revenue growth in certain regions and markets, for example, Southern California and Los Angeles. We have footnoted the projected impact for each region at the bottom of slide 14 and enhanced our disclosure in the earnings supplemental, so everyone has visibility into the impact of the change in rent relief as compared to underlying market fundamentals. Turning to slide 15. Same-store operating expense growth is projected to be elevated in 2023 due to a variety of factors. The first is just the underlying inflation in the macro environment, which is impacting several categories, including utilities, wage rates, et cetera. Second, we're expecting greater pressure on insurance rates, given the increase in the number and severity of various disasters over the past couple of years, combined with a relatively light year of claims activity in 2022. We're rolling all that cost pressure into the organic growth rate of 4.8%, you see on the table on slide 15. In addition to the organic pressure in the business, about 170 basis points of additional operating expense growth is coming from the phaseout of property tax abatement programs, primarily in New York City, and NOI accretive initiatives. The phaseout of the property tax abatement programs is projected to add about 70 basis points to our total operating expense growth for the year. While we'll generate some incremental revenue during the phaseout period, the ultimate benefit will be the extinguishment of the rent-stabilized program for those units in a particularly challenging regulatory environment. The impact from initiatives reflects a few key elements of our operating model transformation, including our bulk internet, Managed Wi-Fi and Smart Access offering, which as Ben referenced is bundled and marketed as Avalon Connect. While we expect to recognize an incremental $5 million profit from this specific initiative in 2023, it's adding about 150 basis points to OpEx growth for the full year. There's a modest impact from our on-demand furnished housing initiative, which is also generating a profit for 2023. And finally, we expect additional labor efficiencies to offset some of the growth in other areas of the business as we continue to digitalize and centralize various customer interactions. And then, if you move to slide 16, you can see the progress we've made to date for each one of these three initiatives and the projected incremental impact for 2023. As I mentioned, our Avalon Connect offering is projected to deliver about $5 million in 2023. Furnished housing is contributing another $1 million. And our digitalization efforts are projected to generate an incremental $5 million benefit in 2023. In aggregate, we're expecting an additional $11 million in NOI from these three strategic priorities in 2023 with a lot more to come in future years from these initiatives and others. Now, I'll turn it to Matt to address development.

Ben Schall:

Thanks, Matt. To conclude, slide 19 recaps our successes during 2022 and highlights our priorities for 2023. All of this is only possible based on the tireless efforts of our AvalonBay associate base, 3,000 strong. A personal thank you to each of you for your dedication to making AvalonBay even stronger as we continue to fulfill our mission of creating a better way to live. You're the heart and soul of our culture, and we thank you. With that, I'll turn it to the operator for questions.

Nick Joseph:

Thanks. And thanks for the call, presentation. It is always helpful as a lot of additional info. So, I always appreciate that. Maybe just starting on development in the transaction market. You mentioned the 100 to 150 basis-point spread. Can you quantify expected yields on the '23 starts and maybe what the current transaction cap rates are -- you're seeing in your markets?

Nick Joseph:

Thanks. That's helpful. And then just on the -- I guess, the continued reallocation of the capital into these expansion regions, do you expect any difference in cap rates between the buys and sells or as you reallocate that capital this year? And then, where should we expect any asset sales to occur, from which established markets?

Ben Schall:

And Nick, yes, in terms of the environment today, I just want to make sure you have the right expectations for activity now versus later in the year. We're testing the market with a couple of potential asset sales generally on the sideline on acquisitions until we see how those assets, one, if we decide to trade on them and how the pricing is and then we'll evaluate the potential trade into the expansion market through other acquisitions or potentially use those proceeds for other capital allocation decisions.

Matt Birenbaum:

They are, one in the Northeast and one in the Mid-Atlantic.

Steve Sakwa:

I guess, on page 13, you kind of break out all the drivers of growth. I was just hoping you could maybe tell me the areas where you have kind of the most confidence and the least confidence, where there could be upside, downside and if you also think about that by region. I guess, what areas are you thinking there could be upside in your forecast and potential downside?

Steve Sakwa:

Okay. Thanks. And then just on development, maybe for Matt, as you think about construction costs and what's happened with inflation, and I assume that that's starting to moderate. But how did that get factored into the $900 million of starts? And presumably, the yields are somewhere in that 6% to 6.5% range on what you're going to start. But I guess, what kind of cushion or upside could you possibly see if inflation continues to moderate?

Operator:

Our next question comes from the line of Austin Wurschmidt with KeyBanc.

Ben Schall:

Yes. Thanks for that, Austin. So, on the transaction side, as I mentioned, we're out in the market with a couple of assets for potential sale. Our transactions team is obviously staying close to the buying side of the market, but we're not currently actively underwriting any particular deals. We do have very detailed market-by-market analytics that are driving which submarkets. We have our close eye on type of product across various price points. So once we're ready to -- and if during this year, we decided to get back into our trading activity, we'll be ready to ramp that activity back up. In terms of your kind of broader question, the time period, we've set the broad target of getting to 25% over the next 6 to 7 years, like we've been making some good inroads over the last couple of years through trading, through our acquisition activity and then increasingly through our development funding program. We're hopeful that, in an environment like this, capital less abundant, maybe some dislocation, that there'll be opportunities for us to step in and potentially accelerate that activity. Our cost of capital, obviously, will need to be there to support that. But we could be in a window later this year where those types of opportunities start to present themselves.

Ben Schall:

Yes. Broad strokes, Austin, I'd guide you, this is not a hard and fast sort of area. But in the range of 10% upper enterprise value that we want to have under construction at a particular period of time, we're light of that today, and that's a reflection of that we have retrenched on development starts over the last couple of years given the operating environment. Yes. We've got the opportunity set that's there. Matt described that. So, we have the pipeline. We control that pipeline at a relatively limited cost. We’re spending a lot of time right now restructuring deals to our benefit because the land market has changed. So, that's there. We've got a phenomenal team, has been doing this a long time. So, an element will be how do we think about the spreads, right, how do we think about -- Matt was talking the kind of rental -- the trend lines on rents relative to the trend line on costs; how we think about maintaining a 100 to 150 basis points of spread to underlying cap rates and our cost of capital. That will -- those would be the signals where we start to lean in more fully.

Austin Wurschmidt:

Got it. But it's fair to assume, with where leverage is today, that capacity may be a little bit greater?

Operator:

Our next question comes from the line of Chandni Luthra with Goldman Sachs.

Matt Birenbaum:

Yes. I can take the first one. I'm not sure I heard the second one. Confidence in…?

Matt Birenbaum:

Okay. Yes, sure. So yes, it's Matt here. Are we seeing distress? No, but we're not really in that market, I would say, in the sense that the SIP is really targeted at providing mezz capital, either mezz or preferred equity, for new construction, merchant builders building new apartment communities in our markets. So, we're coming at the beginning of the story when they're putting together the capital stack to build the project. And what we're seeing there is given where interest rates have gone and given what's happened to proceeds, their construction loan proceeds is coming down. So developers are looking to fill that gap where maybe they were getting 60%, 65% construction loan before, now they're only getting 50% or 55%. So, we have seen kind of our investment move from maybe 65% to 85% of that stack down to, call it, 55% to 70% or 75%. And the rate has gone up, and we -- there are deals getting done in that 12% range. There are folks out there looking for short-term bridge money who started jobs two and three years ago and their first -- their construction loans are coming due, and they don't have enough refi proceeds to pay that off and their mezz. So there is a little bit -- I don't know if I call that distress, but there's a little bit of a recapitalization of newly built asset opportunity out there. That is not a market that we have gone to at this point. We're pretty much focused on the new construction side of this.

Chandni Luthra:

Great. And then, as we think about tech layoff headlines, obviously, January was a very big month. We saw a big bump in layoffs in January, and that was significantly higher than November, which, obviously, when you think about the impact of November, December, everybody -- you guys talked about sort of seeing a slowdown. But then you talked about towards the end of January rents accelerated a little bit. So, as we think about the fact that we are only sort of just coming off these headlines that keep hitting our screens every day, this morning we saw from Disney, are you seeing any early signs in your conversations with tenants, be it around move-outs or lease negotiations, of any notices? I mean what gives you confidence that things are in -- sort of on the right path, and we are not looking at things just falling off a cliff?

Operator:

Our next question comes from the line of Adam Kramer with Morgan Stanley.