Q3 2022 Equity Residential Earnings Call
Yes.
[music].
Good day and welcome to the equity residential third quarter 'twenty Two earnings Conference call. Today's conference is being recorded at this time I would like to turn the conference over to Marty Mckenna. Please go ahead.
Good morning, and thanks for joining us to discuss equity residential third quarter 2022 results.
Our featured speakers today are Mark Morel, our president and CEO and Michael Miller, Our Chief operating Officer, Bob <unk>, Our Chief Financial Officer is here with us as well for the Q&A our earnings release and accompanying management presentation are posted in the investors section of equity apartments Dot com.
Please be advised that certain matters discussed during this conference call may constitute forward looking statements within the meaning of the federal Securities laws. These forward looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events.
Now I'll turn the call over to Mark Marron.
Thank you Marty good morning, and thank you all for joining us today to discuss our third quarter results. As you can see from our press release equity residential had an outstanding quarter. Our revenue results in the quarter were driven by steady occupancy continuing strong renewal rate growth and decelerating, but still above.
Trend new lease rate growth.
We couple that with the continuation of modest expense growth, leading the same store NOI growth for the quarter of an exceptional 16, 2%.
With continuing positive financial leverage this led to a 19, 5% increase in quarter over quarter normalized funds from operations. We are proud to have improved margins and created substantial cash flow growth in a turbulent time in the economy I congratulate my colleagues across equity residential for their <unk>.
Hard work, taking care of our residents and their fellow employees and producing these impressive financial results.
We know at this late point in the year the focus naturally turns to 2023.
As usual, we are not giving guidance at this time, but in the management presentation. We posted last night, we tried to frame the material factors that will drive next year's revenue results.
In a moment Michael will take you through those factors in some detail we remind you that the success. We've had in 2022 will create a challenging comparable period. So we continue to expect a moderation in 2023 annual same store revenue growth, even if as we expect 2023 is a strong.
Above trend year.
Looking at it from the top of the house, we like our affluent renter customer and what we expect will be their financial and employment resiliency going into uncertain times, our target resident is high earnings and employed in knowledge industries with more durable incomes and employment prospects.
College graduate cohort, which we believe makes up the vast majority of our residents as an unemployment rate of one 8% compared to the three 5% overall unemployment rate.
Even if layoffs materialize, we believe that the tighter than average labor market for these knowledge workers will allow them to find replacement jobs quickly.
Finally, although high inflation has impacted everyone's real incomes are affluent renter is relatively more insulated due to their higher incomes and lower rent to income ratios. The average income for the residents who signed new leases with us in the past 12 months is $174000 or 12% higher than.
The group, who signed with US in the 12 months ending September 2021.
These new residents are paying a slightly less than 20% of their income in rent, which is generally consistent with prior rent to income levels.
On the apartment supply side, we see national apartment deliveries, reaching a cycle high point in 2023.
However, in the coastal markets, where most of our properties are still located we see supply as being lower and being delivered further away from our properties than in the past and thus likely less impactful the sunbelt markets, including the Denver, Dallas Fort Worth Austin, and Atlanta markets in which we are increasingly investing.
We will see higher relative supply numbers, then our coastal established markets and likely more impact, especially if thats coupled with the jobs slowdown.
For us this may turn into a nice opportunity to acquire assets in these expansion markets not necessarily at fire sale prices, but at better values than prevailed in the first half of 2022, when we felt that the market was overheated and chose to stay on the sidelines, we continue to see our strategy of having more balanced portfolio between.
Our established and expansion markets as appropriate as we follow our affluent renters. These new markets and mitigate regulatory and resiliency risks from over concentration in any market or in any state.
In addition, other housing alternatives remain expensive and in low supply.
So they have been declining of late current single family home prices continue to be at record levels, while rising mortgage rates are further stressed affordability, particularly for first time homebuyers.
Single family housing starts with declining existing homeowners are more reluctant to sell due to low locked in mortgage rates, along with minimal and expensive for sale replacement options and competition for homes from investors remains strong.
Going against these positive factors for our business is a significant impact of inflation on the economy, where job growth goes in response to the federal reserve's actions as well as volatility in the capital markets. The continuing impact of the war in Ukraine, and a myriad of other uncertainties. We are currently in an excellent spot but acknowledged that.
The risks and uncertainties are more elevated than usual and with that I'll turn the call over to Michael <unk>. Thanks.
Thanks, Mark and thanks to everybody for joining us today I am going to give some brief comments regarding current market conditions and then we can turn it over to the operator for question and answers.
We just completed one of the best leasing seasons in our history strong demand across our markets produced high occupancy as well as continued pricing power as we think about the trajectory of our pricing for the full year, we clearly benefited from a supercharged spring leasing season with more robust pricing power that started earlier in this.
Spring in many markets and we have traditionally seen.
This strength led us to adjust our same store revenue upward in July and to set our current expectations slightly above the midpoint or at 10, 6% for the full year 2002, which is the best same store revenue growth in our history.
In both the earnings release and in the accompanying management presentation. We have provided some key performance metrics, which demonstrate the strength of the leasing season and the fundamentals that position this portfolio well for 2023.
This includes updates on the percentage of our residents renewing with us which remains very healthy and is now consistent with historical levels. After some moderation in the summer which was expected as we were moving residents to current market rents.
This performance supports occupancy which continues to be solid at 96, 2%, even as we enter the slower part of the leasing season.
As you can see on page four of the accompanying management presentation and as we disclosed in our August 31 press release, our rents peaked the first week of August .
Which is typical for this time of year.
Yeah.
So where the tumor.
With more recent moderation than anticipated concessions are being used more than declines in rental revenue in these markets to drive traffic.
All other markets are basically in line with normal seasonality.
Overall, we continue to have good.
All of our markets with foot traffic generally in line with our historical averages for this time of the year.
While we see the same headlines as everyone else on tech hiring freezes and some layoffs or revenue performance is holding up although we readily admit that we are a lagging indicator.
Right now New York, and Southern California continue to lead in both same store revenue growth performance and our overall current pricing fundamentals.
<unk> San Francisco, while producing strong annual same store revenue growth are the markets that have struggled through the most of the year to gain meaningful momentum.
Longer term these two markets present growth opportunities as they continue to be under housed and have the potential to show improvement very quickly with the infusion of more certainty of jobs.
As Mark mentioned, we are not providing 2023 guidance this quarter, but we understand that 2023 is top of mind. As a result, we provided a framework of helpful building blocks for same store revenue and expense growth, which you can find on pages five through eight of the management presentation.
We would expect 2023 to produce quite good above historical average revenue growth based on activity already built into the rent roll from excellent rent growth that occurred in 2022, we call. This our forecast at embedded growth, which reflects the contribution to next year's revenue growth assuming no changes to the rent.
Will occur.
We expect this to be about four 5% by year end.
For historical context in a normal year or forecast that embedded growth would be just above 1% you can see this on page six of the presentation.
In addition to this favorable embedded growth we are positively positioned for leasing activity in 2023, moving forward our loss to lease which refers to the revenue improvement. We can expect for moving leases in place today to current market levels is significantly larger than historical years as evident.
On page seven.
Our current loss to lease of approximately 5%, we will seasonally moderate through year end, but certainly positions us for growth when leases mature and we capture this loss in 'twenty three.
For historical context, our loss to lease would be about 50 basis points at the end of a typical non recessionary year.
With that set up the mine, let's not forget about actual market rent growth during 2023 and its contribution to same store revenue growth.
Current visibility here is most opaque while our business has strong long term fundamentals the uncertainty around future economic conditions that Mark just mentioned is hi.
This 2023 intra period growth should remain healthy as favorable demographics continued low employment rates in our target demographic strong income growth and less direct supply pressure in many of our market point to the potential to see a strong spring leasing season.
That being said 2023 is unlikely to be as robust as the unprecedented rent growth numbers of 2022.
On the occupancy side general demand trends, including improving retention support strong occupancy above 96% for the balance of 2022 and should carry through into 2023, unless there is a substantial loss of jobs and our target renter demographic.
Outside of occupancy and the core revenue drivers that I just discussed bad debt net will likely continue to play a role in revenue growth as we expect the trend of reduced levels of resident delinquency that continue into 2023.
The lack of governmental rental assistance and 23 compared to the $31 million. We will receive in 2022 will require continued improvement in resident behavior payment behaviors in order to return us closer to historical norms and contribute positively to revenue growth.
An improved regulatory environment, coupled with the high quality of our affluent renter should lead us in this direction, but 2023 may be a bit of a transition year to get all the way there.
Switching to same store expense growth as you can see in the press release 2022 benefited from limited growth in property tax expense and brake controls of our payroll expenses.
And as a result, we expect to produce same store expense growth of three 3% for the full year of 2022.
As we described in the management presentation, if the inflationary environment continues as it is today, we would expect expense growth in 'twenty three to be elevated from these industry leading levels in 2022.
While we expect that less controllable areas like real estate tax may come under more pressure, we remain focused on initiatives that can assist and moderating growth in areas that are more controllable like payroll and repairs and maintenance.
We have had great success in creating efficiencies in our sales in office functions with over half of our portfolio running with shared resources and we expect that to continue to benefit us in 2023, as we centralize onsite activities, such as application processing and our move out and collection process.
On the service side of the business, we continue to leverage our mobile platform to create more opportunities to put our resources across multiple properties. We also we will strategically leverage third parties for outsourcing turns and assisting with after hours work to reduce over time pressure in the portfolio.
Overall, we are well positioned to continue the trend of expanding our fully loaded net operating margin, which currently sits around 69% into 2023.
To give a quick shout out to our amazing teams across our platform for their continued dedication to the residents and focus on delivering these terrific operating results with that I'll turn the call over to the operator to begin the Q&A session.
Okay.
Okay.
Thank you.
I would like to ask a question. Please signal by pressing star one on your telephone keypad.
Using a speaker phone. Please make sure your mute function is turned off to allow your signal to reach our equipment again. Please press star one to ask a question.
We'll pause for just a moment to allow everyone an opportunity to signal for questions.
We will take your first question from Nick Joseph with Citi.
Thanks, I appreciate all the building blocks on 2023.
We're looking at kind of same store revenue growth, obviously, the market rent will be a big determinant of it but.
Theres obviously these other building blocks in place already as you think about the interplay between the ability to push renewals versus that loss to lease.
We can.
How sticky can renewals be and how are you thinking about pricing those on a forward 30 or 60 days just given the more macroeconomic uncertainty.
Hey, Nick this is Michael So I think when Youre looking at the renewal performance again, our quotes for the balance of the year have already been issued so we have all of those quotes out there and right now we're seeing improving retention, we're negotiating a little bit more but thats clearly typical for the fourth quarter.
We have a pretty strong degree of confidence that we're going to continue to achieve about 8% to 9% in growth from the renewals. So we remain very optimistic about the renewal performance and clearly are seeing the trends of improving stickiness, but that is a common trend to see in the fourth quarter that that retention continues to grow.
I guess my question was more on 23, rightsize velocity lease trends down towards the end of this year.
With market rent growth as you start to stack ranked in 'twenty three.
If the last polices smaller at that point, how comfortable are you going to out earlier in the year with renewals just given normal seasonality on the market side, yes.
Yes, I mean, I think youre going to look at what your expectations are we'll watch what happens to us for the balance of the year and how we start January off is going to be the indicator as to how aggressive we are in March and April but we clearly are going to layer in intra period growth into these quotes into the first and second quarter of next year.
And then we have a great centralized negotiation team in place that we can always pivot if we need to but right now we're not seeing anything that tells us not to expect kind of growth in that renewal performance. After we kind of start the year off.
Thanks, that's helpful and then just on the.
Pricing sensitivity you talked around San Francisco, Seattle I think.
You've talked about the west coast, maybe being a driver for 2023.
The sensitivity that you are seeing today changed that overall view at all.
Well I mean, I think look if you backed us up a few months ago, where our expectations were for 2023, and I think I alluded to it in the comments I mean, we've got two markets right now that are exhibiting a little more price sensitivity than what you thought.
That we would be sitting in October and most of that sensitivity, it's not necessarily that the rates are coming down. It's the fact that the concessions came kind of a little bit sooner in the year than what we would've thought right. So youre seeing markets even for us in like San Francisco, where we're running 50% of our applications are now receiving about a month in Seattle.
At like a third of the applications at about three weeks, that's just a little bit more pronounced than what we would've thought so I think as we think about 2023 for those markets as I said in the prepared remarks, I still believe there's a lot of potential for those markets to deliver strong growth, we just need a little bit of clarity on that job for a little less ambiguity.
<unk> got good momentum with the quality of life coming back in both of those areas. So I still I still feel like we got the potential but sitting here today versus our view a few months ago.
The markets feel a little more price sensitive than what we would've thought.
Thank you.
Okay.
Yeah.
And we'll take our next question from Steve <unk> with Evercore ISI. Please go ahead.
Yes, thanks, good morning.
Mike I just wanted to follow up a little.
So up a little bit on.
The Seattle and San Francisco comments are those very specific to kind of downtown Seattle and downtown San Francisco are you seeing any of that weakness spreads kind of the east side of Seattle or down into the peninsula.
Yes, so we definitely felt a little bit in Redmond, a little bit more softening a little bit of the concessions are in that marketplace and I think in San Francisco, what you saw as the South Bay really kind of benefited through the year, even though it was delivering all of that supply and right. Now my guess is what we're feeling is a little.
A pressure from that hangover of supply in the South Bay, So it's not completely isolated to like the downtown or the CVD areas, but it is still mostly concentrated there.
Great and then I don't know for for maybe for Mark or for Bob just as you guys think about deploying new capital into new developments how has your return hurdle.
Just given the change in cost of capital given the change in the economy and the outlook how much more conservative are you being an underwriting and how high have your hurdle rates gone for new developments.
Yeah, Hey, Steve it's Mark Thanks for the question.
It certainly has gone up the two deals you saw US start this quarter were really things that were in play much earlier and we're kind of obligated on it's just the start that occurred. So we have let go of some deals we were pursuing we have talked a lot with the development team about the higher hurdle.
I'm not sure I have a precise number for you, but it was probably a number we were looking more like a 5% return on in place rents and now we're looking for something Steve probably a lot closer to a 6% return on in place rents, but <unk> got deals where there might be a story that is particularly compelling.
Like your basis players some other factor that makes it particularly interesting I'll also say the big competitor to development with US is acquisitions I mean, our sense is that pretty soon pretty soon might be a few more months, though the acquisition market will be more available to us again not at free prices not at fire sale prices, but boy, if we can buy it.
<unk> streams of income without having all of that development risk we will lean in on that so my sense is that acquisitions of existing assets will be more available to us at more favorable prices than a correction and a development market so to answer your.
Question I think the the hurdle is higher for us to.
To start new development, both because the cost of capital and because of the ability to deploy that capital instead and acquisitions.
Okay.
Great. Thanks, that's it for me.
And we will take our next question from Nick <unk> with Scotiabank. Please go ahead.
Thanks, I, just maybe following up on that.
Capital markets kind of outlook.
Mark.
How are you thinking about how cap rates, maybe have changed for apartment assets given that when we look today I mean, even to get GSE debt for multifamily there <unk> going to be.
Somewhere close to 6%.
Were hearing negative leverage is more of a problem for people underwriting assets I mean, what is your view on how that may affect cap rates.
And I'm going to take thanks for the question, Eric I'm going to take cap rates and sort of make it in the values in general I mean, the system definitely got a shock we talked about that on the last call. There is a pretty big bid ask spread out their sellers are saying to themselves six to nine months ago I could have gotten a much higher price I am still getting good cash flow growth is.
Michael <unk>, just described maybe I'll sit on my hands for a while and buyers are sitting there going while all risk assets of reprice Department should reprice to so our sense is that this lack of activity I mean transaction volume is just really low now it's really hard to peg value, but our sense is that cap rates and move from May.
A three five to something like a 5% cap rate for well located stuff and to your point that still requires negative leverage negative cash flow for a bit so that is.
A problem.
And Thats why you don't see a lot transacting on the flip side.
Like the apartment business I mean, there is a real dearth of these sorts of inflation protective investments in apartments. We've done a lot of research on this have typically perform pretty well in inflationary climates that as also by our count $375 billion or so of dry powder available.
Real estate private equity funds looking for a home in apartments or a favorite place to invest in so we think theres a lot of supportive stuff, but right now there's just not a lot of transaction activity and our sense is that again values are down probably 10% plus and some of that reason theyre not down more is because of this offset from increasing <unk>.
Cash flow.
Okay, great. Thanks, Thanks, Mark just another question on the on the balance sheet.
You guys did I guess paydown some of 2023 maturities with the sales this quarter.
Is it right that I mean, just from reading. This you have something like 500 million of.
Unhedged exposure to are on a <unk>.
Maturity next year based on the swaps you have in place.
Yes, it's slightly less than that we have about $825 million of debt.
That is maturing next year that needs to be refinanced $800 million of it needs to be refinances as secured of which we've got $350 million of.
At this point very attractively priced swaps against it.
Managing the treasury risk.
Alright, thanks, guys.
Okay.
We'll take our next question from John <unk> with Goldman Sachs. Please go ahead.
Hi, Good morning, Thank you for taking my question.
Michael I'd like to go back to that acquisitions point. So you guys talked about that.
Can be potential opportunity and therefore.
The grade might look better in terms of acquisitions versus development, what sort of opportunities do you think can come from this environment like is there a way to contextualize. It we understand it cannot be as good as 2021 likely but Ken it.
Look something like 2020, or maybe even 2019 from a volume standpoint, and then how would you think about funding good given you know.
We are still in that negative leverage that entity and you said that prices might come down but not at <unk>.
Level.
Yeah, Hey, Sean it's mark Thanks for that Great question.
Really hit on it because you really need to split this into two pieces, what do you feel about the asset price and we'll talk about that in the second and where are you getting the money from and so talking about asset price, we already like where it's headed where these assets are being talked about and again not a lot of transactions, but a lot of these sales that are.
Are being discussed are don't have that big premium to replacement cost at the end of 'twenty. One the beginning of this year, we saw transactions, where acquisitions were being done at 25%, 30% premiums to replacement cost you saw stand down we just don't see a history of making a lot of money when you pay those kind of premiums so we see there.
Price changes, having evaporated a good amount of that and we see deals.
Being talked about at least for sale much closer to replacement cost so we like that.
So when we think about asset pricing replacement cost figures in the cap cap rates certainly fingers in the price per pound all those things matter to us, but where we get the money because we're going to continue to trade out of some of these existing markets D. C. The state of California, New York, So where do those assets trade on a relative basis compared to the.
These expansion markets and if they trade in a way that makes sense to us I E. In a non dilutive way that'll be more interesting to us in terms of deploying new capital, which would have to be raised with that right. Now we think our unsecured debt rates, probably five and three quarters something like that that's a pretty mighty interest rate to overcome and cap rates being <unk>.
Round, five arent going to push that and again looking at where the stocks trading that doesn't make a lot of sense. So for us to be net acquirers is going to require I think some shift in our capital costs for us to be swappers of assets like we've been traders is going to require that trade to make sense and then for asset values to make sense and are starting to.
On a replacement cost basis, but I think your guide post of a 2018 2019 is a pretty good guidepost because I think what happened in the pandemic with ultra low rates that was the distortion, but I also don't think very high rates as the permanent future either.
That's very helpful color. Thank you.
Switching gears to the expense side of the equation, just a little bit.
One of the markets in your portfolio, where you think real estate taxes could pose a bigger problem and then on <unk>.
Is there any more low hanging fruit as you think about streamlining that.
That line item further just given where comparison going into next year.
Hey, Chad, it's Bob I'll start with the payroll tax side I think the most prevalent are probably the area that you see the most pressure already.
It's really in some of our expansion markets, particularly Texas, where youre seeing an aggressive amount of kind of reassessment activity and kind of push so I think that's going to be an area.
In the expansion markets, where we don't have a ton of exposure at the moment, but where you will see more real estate tax pressure.
The state of Washington has also won.
That is a area because it's been so negative rates of real estate tax growth has actually been negative. So you have a really challenging comp and the final area I think where youre going to see it is just we do have some for 'twenty one as step ups in New York State, which will contribute to growth as we go into 2023, so it's a little bit of a mixed bag, but those are the three areas.
I would call out specifically and I'll pass it over to Michael who will mentioned some of the initiatives and the payroll side, yes. So I think on the payroll front I don't think I would characterize any of this is like low hanging fruit left I think this is really just the strategic execution of these initiatives and.
As I sit here today I would tell you we're probably about two thirds of the way from many of these centralized.
Initiatives and that usually yields kind of that efficiency in the onsite payroll team as we start sharing and leveraging resources across assets. So I'm pretty optimistic that as we work our way through 2023, there is probably a third of.
The work left to be done with centralization, and it's going to continue to yield kind of the benefits that will help mitigate some of the pressures that we're feeling.
Thanks, guys.
Thank you.
Okay.
Our next question comes from China.
With Mizuho. Please go ahead.
Hey, good morning, guys.
So a couple of questions here I guess, the first is a follow up to an earlier question on.
So the capital allocation I'm curious what is the best use of your capital today.
You did take $500 million of business and proceeds to prepay some of the the bond maturity.
So perhaps some color on as you think about uses for capital today.
Thoughts on further debt reduction and stock buybacks and then maybe also what is the plan for the remaining $900 million of your unsecured bond maturities for next spring.
Alright, do you have like a four part question.
So I'm going to take parts of it.
All the way up to stock buybacks and I'll ask Bob to speak to the refinancing plan for next year. So when you talk about immediate capital allocation. Our hope is that we can accelerate our renovations are little more we've got a lot of great Super well located properties.
We'll touch ups in the kitchen, and Bath and stuff, especially if rent growth is going to moderate for a bit our experience has been that thats a good time to do these renovations and then when things start to accelerate again, you got some better product to sell and we're hopeful that that also means that some of these labor pressures that we've alluded to and others have to start to abate next year, you've got less acts.
And single family, maybe Theres, an opportunity because we are really having trouble getting contractors and sometimes getting things like appliances for renovation. So renovations as a good use of capital you should expect us to try and accelerate that again. These are all near term things innovation expenditures. So this relates both to we had a terrific presentation inside.
The company. This week about all we want to do relating to sustainability and whether it's solar panels and EV charging and all of that a lot of that stuff is pretty capital intensive a good part of it has some returns which is great. Some doesn't but I think we're going to you're going to see us lean in there both as part of our thought process on ESG in general and because of the return on.
The demands of our residents and finally, just the innovation part.
We kicked off a big data analytics portion side. The company that is expensive both in terms of talent and outside help in the long run we think it will help us drive revenue manage expenses better run the business better in general, but those are all areas, where we're spending money.
On the share buyback and you and I have had this conversation publicly and privately in the past, it's really hard though in this case to even think about it in a market where things are this uncertainty. We just talked about how hard it is to peg underlying asset values to really understand the relationship of your stock to underlying asset values.
And so to do that arbitrage, you're referring to is a very challenging thing right now it doesn't mean that we don't think the stock has room to go up certainly, but just at the moment, taking more risk, which would mean either issuing debt or selling assets into an uncertain asset sale environment. It just doesn't make a lot of sense. So I wouldn't say.
Share buybacks are top of mind at the moment.
And then following a big picture on the balance sheet, we feel very good about where the balance sheet as we expect to actually and the balance sheet.
At record low net debt to EBITDA by the end of the year will probably be in the mid fours. We're already at five as it is for the balance sheet is in great shape is very long duration as limited kind of interest rate exposure and we have almost no floating rate. So we feel really well positioned as we think about moving into 2023.
Component of that or the piece of debt that is due where the majority of it is actually a piece of secured debt.
That is $800 million that was done originally and in context with the Archstone transaction and had some structural requirements that will require us to refinance it. So what were anticipating is that we'll refinance that in the secured market.
We put on some hedges and attractively priced hedges to manage the interest rate risk and thereafter in 'twenty four we have no maturities at all so which is an anomaly right. So when you look at the $800 million or so we need to do over the next two years, it's very manageable.
On the cost of the new potentials.
That the arrangement that you just mentioned.
Where are you pegging that caused broadly or.
For new debt.
Yes. So this would be secured pricing, which is actually inside of unsecured right. Now. So if you looked at the gse's for and relatively low leverage because this is a very well supported kind of pool.
Probably without regard to the hedges we have in place are probably in the five five range. So about 25 basis points below what Mark had mentioned on the unsecured side.
But when you factor into the swaps that we already have in place that hedge a portion of it at kind of treasury rates that are effective around three we should be able to execute closer to five or maybe even sub 5% depending on what happens. This loan matures very late in 2023. So we have a long runway before we actually need to.
Refinance and the rate just to give you some more color handheld the existing rate isn't just that we listed right. There. There are hedges that went with that portfolio. So the actual rate running through the P&L as four in a quarter four in a quarter. So when you think about your modeling exercise as Bob said, we're really what will amount to the last month or two of 'twenty.
'twenty three and then going forward, it's really the difference between four and a quarter and wherever.
Rob ends up financing this and we've got the luxury of another year to see if we can pick our spot to do that in.
That's really helpful. Mark one more follow up on promises lends a lot shorter only maybe two parts.
Patrick you mentioned moving from about three and a half to around five for well located assets I'm curious, if you're seeing any distinction between coastal and sunbelt and how if so how that might play into your plans of rotating more of your your NOI to send out markets, maybe a bit sooner or any thoughts on that thank you.
Yeah, Thanks, Andy I don't have any.
Thoughts on that just because the transaction pool was so light there is so little going on in any market just sharing anecdotally at large.
National broker told us that a large southeastern apartment market. They didn't have a single listing at this time. So that's unprecedented so I just got to tell you. The markets are just not very liquid and so for me to be able to peg coastal or sunbelt I wish I could peg anything right now I think right now, it's just a little bit of every.
One feeling each other out what's the fed going to do how is that going to feel the operating results hold up all of those things hand out I think are a little bit in flux, but as I said in my prior remarks, we were really interested in the relationship between those two and if we can continue to non dilutive we trade we will.
Wonderful thanks for the color guys. Thank you. Thank you.
Our next question comes from Rich Anderson with SMB. Please go ahead.
Thanks, Good morning.
So back to that.
Kind of Sunbelt question.
People think of AQR is an urban platform at this point.
Understanding you're diversifying and looking into the sunbelt in your expansion markets, but the big fear there is supply and that now is becoming a reality and that doesn't just.
Suddenly start and then stopped it becomes a thing to deal with for some period of time. So is there a scenario. Despite what you just said that this trade idea into expansion markets, where opportunities present themselves because of some of those supply pressures.
It does not materialize and you start to look at these expansion markets and say, yes, maybe maybe this isn't exactly where we want to go because do we really want to get in bed with.
Extended standard period of supply growth.
Which is again, the big fear of getting into those markets. If there are any.
Yeah, Great question Rich, it's mark so it would require us to think about another risk differently too and thats political risk because one of the things that our coastal markets have I think more of though maybe not quite as much of as we may have thought as risk of rent control.
Risk of activity by politicians thats job destroying in growth destroying.
So from our perspective, we'd have to be balancing that differently as well there is no risk free apartment market. So if you're in Texas market, you probably have less political risk, but you may have more resiliency risk and you certainly have a lot more supply risk than a lot of our markets, but our experience with supply in the locations, we're trying to buy in and build in <unk>.
Frisco, Texas as you will have a year or two of that and then demand will meet that supply. So again, if youre, telling me that prices get out of whack.
Somehow the sunbelt trades tight even with all of that supply, that's probably not stuff, we're going to be acquiring or building much up but if the pricing relationship makes sense. Then we're trying to manage this political risk versus the supply risk.
Balancing that out makes sense to us. So that's that's kind of where we end up on that.
Okay.
And then second question for me one partner by the way.
Yeah.
The embedded growth math.
You define it as last month annualized and you get to four 5% for 2023, but is there another mathematical equation, where you think further back into 2022 lease that was signed in July at 20% higher rent.
Compare favorably.
In January and.
So my question is is the four 5% one number but is there another quote unquote embedded growth calculation.
Might be substantially higher than that giving voice to leases that were signed.
Late second quarter third quarter and so on.
Hey, rich, it's mark I'm going to start and I think Bob and Michael May end up correcting me, but I think that's the embedded growth and loss youre talking about more of a loss to lease a little bit in there and we split those two up so if you think about embedded is.
The rearview mirror those are already contracts that have been written leases that exist and in your example that loss to lease is us writing up to market. So if January rents are relatively low and then as we would expect seasonally they are higher in June and the lease you just referred to in June is written higher that additional increments, we're referring to.
That loss to lease and as the intra period growth. So we're talking about the same thing, we just kind of compartmentalize it a little differently because it was easier to think about in three pieces.
Okay. That's fair so maybe my definition of embedded loss lease plus your definition of embedded.
Maybe thats the way to think of it.
You had a one part question and we split it into three parts right. We're just we're just chopping it up a little different because it seems to us those are different variables and easier to explain but I think you're on it fair enough. Thanks very much guys.
Yeah.
Our next question comes from Robin Lu with Green Street. Please go ahead.
Hi, good morning.
My question I wanted to ask.
Across the portfolio.
Eviction prices begin to normalize in your market.
Any erosion in pricing power at market level.
Hey, Carl.
Yes. So robin this is Michael maybe let me just give you a little context overall around the eviction moratorium and kind of what we're seeing today relative to that activity. So for the most part the moratoriums have generally expire we still have a couple of these local areas in California.
Where there are various proof of our chips and restrictions.
And all most of these exceptions are set to expire in the beginning of early 2023.
I'd tell you right now that the teams today are all over this process of continuing to work with these residents who've experienced hardship and once we've exhausted all of those options. We're ensuring that we have everything filed properly. We are still in the very early stages of this eviction court process and we are <unk>.
<unk> to see some traction over the courts are actually moving through and following through with lockout. Overall this level of eviction activity in the portfolio is just it's not that material and we typically averaged less than like 1% of our move outs from for this reason so I would tell you even if everything was.
Accelerated through the court system today.
The volume would be more than manageable and would actually be a huge positive to us given the strength in the demand and the confidence we have in being able to fill those units were paying residents.
Short term I think going specific to your question sure we're going to feel a little bit of this occupancy pressure loss of occupancy pockets of southern California, but again the demand is so strong that we're going to quickly recover from that and I don't really see it playing into kind of the pricing and I think our view right now is that the.
Expectation Youre, just going to see us gradually fall back ended this pre pandemic level of eviction activity as we work our way through 2023 and Robyn It's Bob just to add real quick if.
If you think about those residents that are residing in not paying their fully reserved from a financial standpoint, so that occupancy that physical occupancy coming back into the market and us kind of capturing it like Michael just mentioned is a dollar for dollar 100% upside to financial results because whether it's.
50 lots of month or before its a full rental payment more than what's going through the financial statements. So it's a big net benefit.
Yes.
Got it.
Yes.
So I wanted to touch on.
Seattle.
Can you give a sense of the retention and foot traffic trends that you're seeing by market.
Todays really content.
19 level.
Yes. So this is Michael again, Robyn so the Seattle market today is renewing a little bit less than what we would say our historical averages would be San Francisco is again, it's more in line, but it's also a little bit lighter from a foot traffic and a application volume.
Standpoint, both markets demonstrate demand and I think as I said in my prepared remarks, it's just that a little bit lower more price sensitive level than what we would've expected, but when we're looking at this volume and comparing it to like 19 week. After week, we are seeing the foot traffic we are seeing the conversions to applications. It's just.
To add a little bit less of a price point.
And our hope right now as we get through this fourth quarter and turned the corner end of the year, we will see this retention start to improve.
And take a little bit of the pressure off of the front door and.
And we are seeing slight trends of that right now, but we need a little bit more momentum in time to kind of clarify on that.
Thanks for that.
Our next question comes from Joshua Dan in line with Bank of America. Please go ahead.
Yeah, Hey, guys I, just wanted to touch on supply.
Are you seeing for 2023 and beyond.
For Seattle, and San Francisco, how much of the supply dynamic playing into that price sensitivity that you guys were.
During two.
Yeah. So this is Michael let me start with the Seattle and San Francisco, So I think clearly in downtown Seattle, We're feeling some of the pressure from the new supply in that market and San Francisco like I said I think earlier in one of the responses to a question maybe a little bit in South Bay that they had a lot of supply. These.
These markets are set to deliver less supply next year, so taking a little bit of the pressure off and maybe with that I'll just transitioned to kind of an overarching view of supply for 'twenty, three which is.
For us we're very focused on this concentration the proximity of the new supply and from an operation standpoint winter. The first unit is going to actually start hitting the market to be leasing and when we look forward. These expected starts in 'twenty three relative to the proximity within like one or two miles of our location is.
Lower than previous years, which is a really good indicator that we should continue to feel less pressure from the new supply being right on top of us specific to 23 deliveries I would say that the overall direct pressure will be less but clearly like the DC market stands out as needing to see mark.
Improvement in absorption because it hasn't like another 15000 units coming online with slightly more of an impact from a competitive standpoint to our portfolio and then outside of D. C. Look we are going to have some pockets in L. A like Wilshire Koreatown Hollywood, where we expect to have some pressure next year.
And in addition to that I think the downtown Submarket of Denver, we're going to face some direct kind of had bad and besides those buckets every year, we have a small isolated pockets of supply, but as we look into 'twenty. Three we just see that we're going to have fewer of those concentrated pockets and we're just not.
I'm going to have as much kind of direct pressure on us and I think when we stand back and look at this this portfolio with these amazing locations are clearly in places where affluent renters want to live and still have these good demand drivers and that definitely insulates us from some of this direct pressure from the supply.
Thanks.
Okay.
Our next question comes from John Kim with BMO capital markets. Please go ahead.
Thank you.
I wanted to ask about your forecasted earn in a four 5%.
Based on leases, we signed this year I would've thought it.
It would have been maybe 50 to 100 basis points higher than that so.
I was wondering if you could talk about the factors that drove that.
Purely for key rents declining or are there other factors like occupancy and bad debt that are in this number and is there a chance that the earnings could come in higher than your current estimate.
Hey, John it's Bob So just level setting real quick on earn and flash embedded growth, which we do think of them as <unk>.
Pretty interchangeable they don't have any regard to bat like this has no regard to bad debt no regard to vacancy loss no any of that.
I guess is and I'm not maybe you can help me a little bit on how you're getting to your number is that you may be taking.
Taking blended rates and kind of averaging blended rates over the year in coming up with that number is my guess on how you are coming with your 50 basis points higher than what our embedded number is that how you are approaching it.
Yes, pretty much adjusting for timing of leases signed.
And I guess, what I would tell you is that the difference is really waiting so the way that we're calculating it really has actual waiting day by day as to when leases are in place. So if I took my blended lease rates over the year and just kind of extrapolate it and data mid quarter convention et cetera, I would probably come up with a number that's around a five.
But if you actually do the pinpoint matters, which we provided you that's the four and a half that number shouldnt move almost at all it's our forecasted number for the end of the year. So.
That number really shouldnt move much at all as we go into as we finish out the year based on our guidance does that help.
Yes, it does.
Bob I have you the loss to lease I know it's.
It's come down I'm talking on a half to.
A little bit over 5%.
And a lot of it was the leases we signed during the quarter to realize the market rents, but can you also talk about how much market rents have declined as part of that last week numbers since your last update.
Yes, I'll pass it over to Michael I think if you look a good visual as I pass it over to him is that pricing trend page, which is a couple of pages before maybe page five and the management presentation and you can kind of see that sequential trend, but that'll help you directionally and Michael you probably have that yeah. No. John I was just going to point you right to that page and if you look at kind of the month end.
Numbers down below in that chart, you can kind of get yourself, a proxy to understand depending on which month you pick of the peak.
It's 4%, 5% off of kind of that August number and.
Just work your way through that but I will tell you. When you think about that loss to lease and you think about the shifts that have occurred.
With the deceleration in that number it's really important to understand like that comparative period, if youre looking back to that summer period, and saying Boy you guys were 11 or 12% now you're sitting down closer to five indeed to remember that the majority of this decline is the seasonality that you can kind of see evident on page four.
Also every lease and every renewal that we have done since that point, we are capturing that loss to lease that we shared from a while ago and overall the loss to lease it may be a little bit lighter than where we thought it was going to be a few months ago, but I will tell you just.
It is directionally and definitely right in the ballpark of where we model. This thing for a few months ago. So we're just not seeing it and I think that page four really kind of highlight as to how you can think about that trend.
That's great. Thank you.
Okay.
And we'll take our next question from Ami <unk> with UBS. Please go ahead.
Hey, it's Michael Goldsmith.
Over the last couple of years, you saw residents desiring more space and decoupling have you seen any of that reverse as we move past Covid and then related to that have move outs due to high rents.
Doing rent stream to high increase presumably people aren't moving out to purchase a new home anymore. So.
What are where are they now moving to.
Hey, Michael This is Michael so on a decoupling or even a recoupling basis, we're just not seeing a material change.
Think during this pandemic recovery period, we've alluded to on the last call. We saw a slight decline in like the average adult per household.
We ran about 165, and we are down at like 157, and that was really more prevalent in our one bedroom unit types, where we used to have two adults and they moved into a two bedroom or did something different. So we looked at this even for the third quarter of these move ins, which there is some seasonality of that when do the three bedroom spill up and stuff.
Like that and we're right on par with where we were in the third quarter of last year. So we haven't really observed any of these material changes, but I will tell you we got great insight into it we're watching the transfer behaviors will watch and roommate activity. We're looking at unit type preferences on our website from prospects and we'll be on it.
If we see anything shifting we just havent seen anything shipped yet and then in terms of kind of the reasons for move out I mean, you alluded to the home buying Youre absolutely correct that number is materially down during the third quarter. We were at like 8% of our move outs sighted home buying is the reason for move outs that's competitive.
A 12% norm, but we did see a tick up in that rent is too expensive as a reason we're up at like 25% part of that was by design that we said this at the end of the second quarter that we're going to be fairly aggressive in July and August kind of pushing these renewals and holding the line and getting people up to market. So we knew.
We were going to take a little bit of that hit and we expected that number to go up as we work our way through the fourth quarter and first quarter. My guess is we're going to continue to kind of see that number moderate down, but I don't anticipate seeing reasons for move out to buy home materially changed at all my guess is it's going to stay very low.
Okay.
As a quick follow up to that.
Okay.
Those that indicated that rent was too high did you see any variations by region.
We believe certain areas of the country are used to kind of elevated rents and rates moving higher.
Over time, whereas maybe this phenomenon is relatively new so did you see any difference by market or region.
Not not a huge difference I will tell you in California, where you had $14 82, and you had some of the CPI plus five caps.
Maybe a little bit less we're citing that because they were going out at 9% or 10% increases against a market.
That was up 19% or 20% so those folks typically stuck around because they didn't have a lot of options.
I look at like overall I will tell you when you just look and Mark alluded to this in his prepared remarks.
<unk> of the new residents moving into this portfolio from an income standpoint, our income rent as a percent of income is right in line at 19%, which to me kind of points to this fact that these new residents moving in.
<unk> clearly going to be able to absorb kind of future increases that we pushed through into the portfolio.
Got it.
And then as a follow up question.
So suburban properties have been generally outperforming kind of.
The following.
The initial COVID-19 period, but.
We will see a shift faster urban like what is the current demand picture look like for our suburban versus urban.
And does that kind of does it look different in different markets, where there's where some markets are favoring urban more than suburban and the reverse.
Versus true.
Yes, so I mean overall, we're not seeing a significant shift of like urban and suburban we look at migration patterns, where people coming to us where are people, leaving.
And what is the renewal patterns look like and Theres nothing that really pops out.
I think clearly when you look at like Seattle, San Francisco and some of these urban markets. We continue to see this trend where we are drawing in new residents from a wider area from outside of the states from outside of the Msas, which we view as a positive meaning that these markets are continuing to draw.
People from all over kind of the country and even the foreign markets, but nothing that's really like a delineation that I can point to between urban and suburban that says they're acting materially different.
Thank you very much.
Our next question comes from Todd Mitchell with Piper Sandler. Please go ahead.
Hi, Thanks for taking my questions.
So it's two questions.
First I do just want to revisit the San Francisco and Seattle price sensitivity.
Once more.
My question is what do you guys see as being the largest reason for the price activity I know we talked about.
The supply pressure compared to other markets. It's also more concentrated in the urban areas. So does it seem that the supply pressures the primary cause or is there to push back to return to office of the large reason or perhaps another reason.
For the sensitivity of the concessions in these markets.
Yes. So this is Michael so I mean, clearly I think you cited a lot of those reasons.
In San Francisco and Seattle.
Early on there was an ambiguity around return to office there is still a little bit of.
Kind of sense of Okay. What does hybrid work really look and feel like across the tax clearly you've seen the press releases out or the articles being written on all of the recent announcements, which just creates a pause in people's minds around jobs and what are these folks doing with layoffs and grow.
When I look at it right now again I think this is like a material immaterial kind of change that we're seeing it's it's the markets that didn't really recover as much and I think what youre seeing is a market trying to hold on to rates, where they are in use concessions more than let that rate kind of moderate.
Down.
Okay. That's helpful. And then my second question is regarding the toll brothers JV.
And then in the current environment with the rapid rise in mortgage rates.
Has it impacted their willingness to do JV with you guys. It doesn't mean more or less demand for their products.
Whether they are more or less eager for a JV.
It's mark Thanks for that question.
We're just with them last week and they remain very committed to the joint venture is do we like us they realize the markets moved and the new deals have to hurdle over a higher number and have to make sense in this new environment. So.
They are adjusting but there is no that we sense no lack of commitment either on the personnel or capital side from toll and Theres, none from us as long as the deals make sense and I think that's the challenge right. Now is we're just not seeing deals that makes sense, because they're kind of priced in the old scheme and.
As I said earlier in my remarks.
Price system has changed in development yields need to be higher.
Okay.
Okay. That's helpful. That's all for me thanks.
Thank you our next question from Adam Kramer with Morgan Stanley . Please go ahead.
Hey, guys. Thanks, Thanks for the time I'll keep it quick here with just one.
I'm just looking at kind of the drivers of the same store revenue growth for 2023 look I think the embedded growth I. Appreciate the color earlier I think that's hopefully should be kind of well understood, but wondering knowing some of the occupancy and then the bad debt sides.
Occupancy.
It looks like it was a very moderate kind of stepped down in September versus October in October versus September .
I'm wondering kind of what the view is as we kind of get into next year and kind of the view on occupancy.
He called healthy physical occupancy would love to just.
Kind of elaborate on that and then I guess similarly on bi.
That rate currently of 225 basis points versus historical norms of 50.
I mean, it was just some of these kind of improved regulatory environment.
Where could that potentially take bad debt.
Next year.
Again, just thinking about potential impact on same store revenue growth in those building blocks.
Hey, Adam This is Michael maybe I'll start and just hit on the occupancy I will turn it over to Bob to hit talk about the bad debt. So for us what I'm, describing healthy occupancy to me that's running in a range of <unk> 96 to 96, five and I think right now it's too early for us to say, we'll expect in the fourth quarter occupancy does tail off a little bit.
We're seeing it in this portfolio its not unusual what we're seeing.
The help them when you turn the corner into January and how we're looking and feeling about that intra period job growth is really going to be how we kind of put into our model as to what the expectations are but right now I will tell you we still feel very comfortable saying that we expect next year to be in that range of what we would define as a healthy occupancy.
Yeah and from a bad debt standpoint, we do think over time that we should see a return back to kind of our normalized levels, which were pre pandemic. The 50 basis points you highlighted just given the nature of our resident base and and their rent to income ratios and all the positive things that we've talked about on this call the challenge from a financial standpoint.
Our financial statements standpoint, or something to keep in mind is that in 2022, we had about $31 million worth of rental assistance and thats not going to repeat itself in 2023 right. So in order for.
You to breakeven from a growth perspective on same store revenue.
Organic kind of bad debt has to improve by at least $31 million from there is when you would then see it start be a contributor to growth all that being said we have seen improvement in just the actual payment from our residents.
Every month kind of sequentially since June or so and would expect that trend to continue but it's a little bit of a race between that trend.
And this this bad debt or this rental assistance that we won't have in 2023, but we are optimistic that we will return over time to normalized.
Normalized levels.
That's all really helpful guys appreciate it.
Yeah.
Our next question comes from Linda Tsai with Jefferies.
Hi, Thanks for taking my question just one I know you are indicating that expenses go up for next year, but can you remind us why you've had greater success than competitors and keeping expense growth.
Whether these competitive advantages are intact on a relative basis for 'twenty three.
Yes, I'll start and Michael can add in if you like I think in the areas that are controllable are most controllable our innovation focus has really been on eliminating or reducing the amount of labor cost exposure, which has been something that has been very prevalent.
In the inflationary environment. So I think that we've done an excellent job of rethinking.
Where we can use technology, where we and mitigate labor exposure ours or contract labor it doesn't really matter what les.
Labor there is just by being more efficient by using technology by increasing visibility and a lot of the initiatives. We've had have really helped us deliver what has really been record kind of payroll growth and has kept the R&M line on the contract side, a little bit more in check even though there are other pressures there. So that's certainly been.
A big help and something that we're going to continue to focus on as we go through generation I'll call. It three point of of innovation the.
The other area that in all Candor has also helped us as real estate taxes right. We have benefited from in our jurisdictions, having lower real estate taxes.
Overall and that was I think very prevalent in 2022.
Not as likely to repeat itself as we go into 2023, because I think as assessors look back. They typically look back at historical performance and we've had record performance in our markets in 2022, and so thats going to put pressure on the real estate tax side.
That is a little less controllable.
And I guess the final part of the real estate tax side is the in California of course, you do benefit from <unk>. So you've got kind of 2% baked in there but on the other jurisdictions, we will have some pressure.
Thanks.
This concludes today's question and answer session I will turn the call back.
Thank you all for your time on the call and your interest in equity residential and we look forward to seeing everyone. During the conference season. Thank you bye.
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