Q3 2022 Avalonbay Communities Inc Earnings Call
Good morning, ladies and gentlemen, and welcome to the Avalonbay communities third quarter 2022 earnings Conference call.
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Your host your host for today's call Conference call is Mr. Jason Riley Vice President of Investor Relations. Mr. Riley you may begin your conference.
Thank you, Doug and welcome to Avalonbay communities third quarter 2022 earnings Conference call.
Before we begin please note that forward looking statements may be made during this discussion there are a variety of risks and uncertainties associated with forward looking statements and actual results may differ materially. There is a discussion of these risks and uncertainties in yesterday afternoon's press release as well as in the company's Form 10-K, and Form 10-Q filed with the FCC.
As usual. This press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today's discussion. The attachment is also available on our website at www Dot Avalon Bay Dot com.
And we encourage you to refer to this information during the review of our operating results and financial performance and with that I'll turn the call over to Ben Shaw CEO and president of Avalonbay communities for his remarks Tim.
Thank you Jason and thank you everyone for joining us today, I'm here with Kevin and Matt Don and after our opening comments, we will open the lineup for questions.
And in many ways Q3 continued our strong momentum from the first half of the year, we had significant year over year increases in our earnings operating metrics.
As referenced on slide four of our quarterly Investor presentation core <unk> for the quarter increased 21% as compared to a year ago.
Same store revenue increased almost 12% from last year, and two 2% sequentially compared to our strong Q2 figure.
Before progressing further in the presentation I wanted to emphasize a number of avalonbay specific drivers of future earnings growth.
First up and as Sean will describe more fully we expect to head into 2023 with an earn in above traditional levels and short just a simple roll through of our existing rent role creates positive earnings momentum, which can then be further enhanced by our underlying loss to lease.
And then three other drivers of earnings growth, which we estimate to generate in the range of $200 million of incremental NOI over the next several years.
The most significant of these drivers as the development projects, we have underway, which we refer to as projects with yesterday's cost and today's rents.
Our current lease ups continue to outperform currently yielding nearly 7% and we expect our current development activity to deliver $130 million of incremental NOI upon stabilization, which Matt will cover further.
The other two significant drivers are further margin improvement from our operating model initiatives, which we've targeted for $50 million of NOI uplift and expect to have delivered about 40% or $20 million of its NOI uplift to our bottom line by year end and the return on our structured investment program as we build that book of business up to.
$300 million to $500 million.
In a potentially recessionary environment, the $200 million of incremental earnings generated from these activities collectively serve as a ballast for our future earnings.
Turning to slide five while our Q3 performance was strong it was short of guidance.
Q3 core <unk> per share was <unk> <unk> below guidance and we've reduced our full year core <unk> per share figure by seven.
Updating our estimate our full year core <unk> growth to 18, 5%.
For the full year on the revenue side, while we contemplated the return of rent seasonality. The seasonal trend line has been slightly greater than historical norms.
On the expense side turnover has been slightly higher than we forecasted leading to higher repairs and maintenance costs to turn apartments and utility costs are projected to be higher.
Slide six highlights how we've been actively adjusting our balance sheet strategy during the year based on the changing capital markets environment.
Based on the steps taken by Kevin and Joanne Lockridge in our capital markets team our balance sheet is stronger than ever recently, we increased our line of credit by $500 million to $2, two 5 billion and extended the maturity date out to 2026.
Additionally, we have an interest rate swap in place for our next $150 million of debt borrowings.
And our $500 million equity forward proactively address the bulk of development funding through the end of 2023.
On the transaction front, we shifted our strategy earlier this year to a posture of selling assets first and locking in the cost of that capital before selectively deploying capital into acquisitions in our expansion markets.
Given cap rate movement has worked to our benefit.
As part of this shift we also pivoted during the year from expecting it to be a net buyer of approximately $275 million to being a net seller of 400 million or nearly $700 million total swing.
And in an environment, where profit margins on new development are likely to come down and the costs associated with that incremental capital has increased we've also reduced new development starts for.
For 2022, we've reduced our starts from 1.15 billion to a projected $850 million.
In 2023, while we haven't provided guidance regarding new starts are expected start figure is trending lower than we previously anticipated as we use the flexibility we have with our development rights pipeline to manage our land contracts and the timing of potential starts.
We will continue to make adjustments based on trends in rent and construction costs the spread between potential development yields and underlying market cap rates with a continuing target of 100 to 150 basis spread.
And our cost of incremental capital with a laser focus on making the appropriate long term value creation decisions and with that I'll turn it to Shawn to more fully discuss the operating environment and our approach.
Alright, Thank you Ben well before I start I'd like to give a big shout out to all of the Avalon Bay Associates are out there working hard to provide our customers with a high quality apartment home and service experience I'd like to thank you for your efforts with our customers and the performance you deliver for our shareholders.
Moving to slide seven our strong Q3 revenue growth of 11, 8% was primarily driven by higher lease rates, which increased nine 5% year over year, the reduced impact impact of concessions, which contributed 240 basis points and.
And other more modest contributions from other rental revenue and underlying bad debt trends.
As noted on the chart rent relief was 140 basis point headwind for the quarter.
As we recognized $5 7 million versus the $12 7 million from Q3 to 21 one.
Turning to slide eight same store trends during the quarter remained quite strong relative to historical norms.
Starting with chart, one turnover increased a little more than we anticipated as we pushed through healthy rent increases, but we're still well below pre pandemic levels.
As a result of the increased turnover physical occupancy ticked down to 96%, but remained roughly 20 basis points above our typical experience during the quarter.
Additionally, as noted in the two charts at the bottom of this slide while our availability increase relative to the last few quarters, we realized a double digit rent increase on the unit inventory re leased and occupied during the quarter at very favorable outcome that sets us up well for 2023.
Moving to slide nine I thought I would provide an overview of some of the key revenue drivers for our portfolio as we think ahead to 2023.
Beginning with chart one given the very strong rent change we've experienced this year will likely start 2020 with built in revenue growth of roughly 4%.
The second highest level in our history and more than a 100 basis points stronger than our starting point.
Roughly two 5% entering 2022.
<unk>.
In addition to the baked in revenue growth outlined in chart one.
[laughter] excuse me our loss to lease is currently running at roughly 6%.
And as depicted in chart two.
Providing plenty of opportunity to benefit from renewal rent increases as leases expire throughout 2023.
Shifting to the bottom of the slide three our collection rate from residents continues to improve.
At the beginning of the year that that was trending in the high 4% range.
But it has declined by roughly 200 basis points as the year's progressed.
As eviction moratorium has expired and the courts are continuing to make progress processing new cases.
We expect the overall downward trend to continue.
As we move into 2023, providing a tailwind for revenue growth.
Of course as indicated in chart four.
We will likely experience immaterial amounts of rent relief from 'twenty to 'twenty three.
As compared to the $35 million, we've recognized in 2022.
Resenting a headwind for 'twenty three revenue growth.
Now I'll turn it over to Matt to address development Matt.
Alright, great. Thanks, Sean.
Turning to slide 10.
If word development communities currently in lease up all.
All of which are in suburban locations that have seen very limited new supply and strong demand over the past few years.
These developments are benefiting from today's higher rents, while having a basis based on yesterday's lower construction costs, resulting in an exceptional yield on cost as Ben mentioned earlier of nearly 7%.
As these communities reached stabilization they will contribute strong growth to both NAV and core F. L.
As shown on slide 11, the vast majority of our development NOI is still to come.
The $2 $6 billion in development currently underway is mostly still in the earlier stages of construction and generated only $19 million in annualized NOI. This past quarter. As these assets proceed to lease up and stabilization. We expect another $130 million in NOI, which will drive further earnings growth over the next several.
Years.
It's also worth noting that this future growth is based on our conservative underwriting with untrained at rents that are set when construction starts as we typically do not mark rents on these projects to current market levels until we've achieved roughly 20% lease status.
And again with only four of these assets currently at that level of leasing the vast majority of our development underway should benefit from a further lift in NOI when they do open for business as evidenced by the $385 per month lift in rent as shown on the prior slide on those four deals that are currently in lease up.
In the transaction market. We've also been ramping up our disposition activity in the past quarter using the asset sales market to source attractively priced capital to fund this development.
We were able to close on the sale of five wholly owned assets in Q3, which were priced before the most recent increase in interest rates generating $540 million of proceeds at a weighted average cap rate of four 1% and pricing of $480000 per home.
We also completed the sale of the final assets in one of our private investment fund vehicles last quarter generating additional capital and with pricing of $470000 per home and a three six cap rate.
Since the start of the year as best we can tell cap rates have risen roughly 75 to a 100 basis points in our established coastal regions, where we've been trading out of assets well cap rates in our expansion regions have risen more on the order of 100 to 150 basis points.
Strong growth in NOI has offset some of this rise in cap rates, but on balance as value might be down roughly 10% to 15% and our established regions and maybe 15% to 25% in these expansion markets. We think this bodes well for our future portfolio trading activity as the relative value of what we're selling has been less diminished in what we were buying.
And with that I'll turn it over to Kevin to review, our funding position of the balance sheet, great. Thanks, Matt I'm turning to slide 13, as Ben mentioned in his opening remarks with a shift in the capital markets. This year, we've taken a number of steps to bolster our already strong financial position.
These steps include having increased our match funding of development underway with long term capital to approximately 95%.
End of the third quarter up from about 80% at the beginning of the year.
As a result, we have locked in the cost of capital on nearly all of the $2 $5 billion of development underway essentially with yesterday's lower cost of capital, which in turn will help to ensure that these projects will provide earnings and NAV growth when they are completed and stabilized.
In addition, as you can see on slide 14. Another step we've taken is the recent renewal and expansion of our line of credit to two and a quarter billion dollars, which is up by $500 million from our previous $1 $75 billion line of credit.
As a result, we possess tremendous financial strength and flexibility and particular at quarter end, we enjoyed $1.9 billion in excess liquidity relative to our unfunded investment commitments of $300 million.
Our leverage declined to $4 six times net debt to EBITDA at quarter end versus five one times in the fourth quarter of last year, and we remain comfortably below our target range of five to six times.
Our unencumbered NOI percentage remained at a record level of strength at 95%.
And our debt maturities are both relatively modest in size and well lathered with a weighted average years to maturity of just over eight years.
Thus as a consequence of our conservative approach to balance sheet management and the other actions we've taken recently, including the $500 million equity forward that we completed in April at a share price of $255, we possess tremendous financial flexibility and do not need to tap the capital markets to fund our business for an extended period of time.
Finally on slide 15, as Youre aware Avalon Bay has a has long maintained a commitment to being a leader in sustainability and corporate responsibility.
It's a goal that is consistent with our culture and our core values of integrity spirit of caring continuous improvement.
And it is of increasing importance to our residents to our associates and to our investors.
On Slide 15, we are excited to report that we received are higher score yet from the global real estate sustainability benchmark where krosby.
We earned the five star designation for the eighth year in a row.
We also earned the number one spot among the 11 listed multifamily residential companies and the number one spot among the 37 listed residential companies.
We are grateful for Gretzky for acknowledging our progress in this important area.
Especially grateful to our own people for their efforts in making these achievements possible and for their ongoing commitment to making a positive difference in the lives of our residents and the communities in which we operate.
And with that I'll turn it back to Ben.
Thanks, Kevin and quickly to summarize we're pleased with our continued strong earnings and operating momentum with a number of Avalon Bay specific earnings drivers in front of us.
In this environment, we have and will continue to adjust our approaches to strengthen our position until allow us to keep our focus on long term value creation.
And at that we are well positioned for a broad range of potential economic paths and to potentially step into opportunities based on dislocations in the marketplace and I'll end by reiterating our thanks to the wider Avalon Bay Associate base for their commitments to our ESG leadership and a broader dedication to our mission of creating a better way to live with.
With that I'll turn it to the operator to open the line for questions.
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Our first question comes from the line of Nick Joseph with Citi. Please proceed with your question.
Thank you.
I understand the seasonality returning this year, but a bit surprised it impacted <unk> as much as it did so I was hoping you could provide some more details on when it really started to diverge versus your expectations and then if there are any specific markets that drove it.
Yeah, Nick it's Sean happy to address that and you are correct that are you more of the impact is being felt.
Is there expectation in Q4 as compared to Q3.
If you look at the roadmap that we provided but for.
For the most part.
Did our jewelry or forecast.
We expected and communicated on the last call that seasonality would return, but our expectation based on what we have seen thus far is it would be about half the normal rate that we typically see.
And we started to see that begin to shift in August .
Kind of late August for Us and impacted sort of late August and moving into September and then continues to bleed into the fourth quarter. So that's really how it played out I mean, you can look at the rent change that we expect to July was pretty much spot on what we expected, but then as you move through the balance of the last couple of months here It has decelerate.
From what we anticipated mainly on the move inside renewals have held up relatively well.
But on the move inside has decelerated, which corresponds with the adjustment in asking rents as you move through the season. So that's how they played out and then in terms of markets.
For the most part there is really about three regions that are responsible for most of it is northern California, the Pacific northwest and to a somewhat lesser degree of the mid Atlantic those are really the primary three.
Thank you and then.
Yeah.
Recognize you guys are being a bit tactical adjusting your approach in that salary slowing a bit on the start side.
How are you thinking about now being the right time to grow.
Structured investment product.
Hello, Graham and what changes have you seen to the match marketing yields there.
Hey, Nick this is Matt.
You know the our entry into that space really was kind of a strategic decision that we made a year or two ago and so we're just building. The book. This is the first year. We've originated investments are actually think it's probably a good time to be entering that market because capital is getting more and more scarce so for sure.
Our phone is ringing more and more and Ah you know some of that is some of the relationships. We've established with some of the construction lenders.
And some of that is is just capital is getting harder to put together for new starts. So you know we have the ability to be very selective and measured about the business that we take on which we're certainly doing.
You know our rates are rising a bit in terms of the coupon that will be.
Charging on those investments and you know our underwriting will reflect what's going on in the current market. So we generally are looking at a kind of where we're.
Where are the lender basis will be on those assets. When they are completed and compare that to current spot values. Today are again, if everything kind of trended on N O I's and then when we look at what the what the margin is between those two and we.
I want to make sure that we've got an adequate margin there of safety and case asset values erode further so.
We think it's.
It's actually not a bad time to be in the business, but you know.
It is it's going to certainly be harder for developers to get deals to work and yeah. We may have to look at 15 deals for everyone that you know that we're willing to commit to.
Thank you.
Our next question comes from the line of Steve Sochua with Evercore. Please proceed with your question.
Yes, thanks, good morning.
I guess on slide nine if you were to combine the impact of you know slides three and four or a charge three and four kind of into a net bad debt number for all of 2022.
What is that number and you know what is your expectation for that trend in twenty-three broadly.
Yeah, Steve It's Sean happy to take that one so for the full year of 2022, we expect our reported net bad debt to be roughly one 7%, which includes the benefit of our estimation of 36% to $37 million of rent relief that we recognize where we'll recognize throughout the full calendar year.
If you strip out the impact of rent relief underlying bad debt associated with our resident base.
<unk> started the year in the high 4% range and is expected to end the year at roughly two 7%.
So if you look forward to 'twenty to 'twenty three the way to think about it is at this point, we expect really immaterial amounts of rent relief if any for 2023 as a result underlying bad debt trends for the full year 2023 would need to average essentially that one 7% that I mentioned to have a neutral.
Impact on revenue growth for the full year and so we certainly expect continued improvement in underlying bad debt trends as we move into 2023, but it's you know it's still early to provide a precise forecast I'd say at this point based on what we know.
In terms of what's happening with eviction.
The eviction moratorium in L. A as an example expiring in February and how things will play out in the courts and in markets like L. A it's probably more likely than not that net bad debt will be a modest headwind to 'twenty to 'twenty three revenue growth based on what we know today.
Oh, great. Thanks, and then just secondly, maybe for Matt I realize pegging construction costs is a little difficult, but if you were to kind of look at the projects that maybe our most near term on that to start next year.
Where do you think those are sort of penciling out on a on a return basis and you know is it that you need to see costs come down more to make those really work or is it that rents need to keep going up to to get them into the zone.
Yes, you know Steve its probably it depends it really does vary based on a D. All of the regions. So our.
Targeted yields have been moving up so.
Our current development underway.
As shown on the exhibit is in the high five deal than a lot of those deals when they actually start leasing will be above six you know because a lot of those deals as I mentioned aren't mark to market yet on the deals in the pipeline.
We haven't yet started that pipeline was underwriting somewhere on average to kind of the mid fives and thin you know based on where cap rates are trending towards today. So some of those deals will be comfortably above.
Prevailing cap rates and in our targets and therefore generate good value creation, even based on today's hard costs and rents and then some of those deals.
You know, we'll need some form of help in terms of a hard.
Hard costs potentially starting to level off or come down some.
And then some may require some a second look at the land.
You know most of it most of those deals that we have in the pipeline we have not yet bought the land on we've only bought the land on seven of 30, some development rights that we have so.
We do have the ability at that time to have another conversation with those land sellers, if if appropriate and if need be so.
You know, it's gonna be a combination of all those things we are definitely starting to see hard cost level off much better bid coverage not everywhere, but in a lot of regions.
And.
Think that.
Hopefully, there's a pretty good chance that hard costs. Some trades may start to come down obviously some of the commodities come down in lumber copper, but you know overall total hard costs are still well north of where they were on a year over year basis, if not on a sequential basis.
Steve I would add that was well put by Matt a couple of elements. This really gets into the underlying flexibility that we have in our development rights pipeline. So part of it is potential re trading wan to today's values.
The other part is maybe not the more significant part is with respect to timing right. So it allows us to manage the timing of our pipeline, which potentially allows some of the normalization that you were getting at in your question about the trend lines on rents and construction costs.
Great just one last one for Sean just are you seeing any sort of behavioral trends you know doubling up roommates folks moving out just in any markets that creates any sort of concern going into twenty-three from a demand perspective.
Yeah.
Yeah, Steve nothing at this point no.
The trend that we talked about as we move through Covid was the fewer number of adults per household.
We've looked at that carefully and that therefore that sort of remains attack. So we're not seeing the behavioral elements as you talked about that relate to people feeling pinched. If you want to describe it that way I mean, new lease income for our residents moved in in the third quarter was up 11% compared to last year move ins in the third quarter.
And values were up around 10, 11%. So it sort of matches things are kind of running equal.
And then the only thing I'd say is you know continue to see good movement.
Into our markets.
In terms of what we call. These big moves I mentioned in the past, which is people moving them from greater than a 150 miles away.
That was up roughly 20% in terms of volume in the third quarter as compared to kind of pre COVID-19 norms.
Solid trend in the urban environment solid trend in the suburban job center environments.
Same trend, but not as strong in some of the more outlines suburban areas. So that trend continues which I think is a function of a number of different things, but certainly people being called back to the office on a more consistent basis, probably has something to do with that.
Yeah.
Great. Thanks, that's it for me.
Yeah.
Our next question comes from the line of Austin, where she met with Keybanc. Please proceed with your question.
Hey, good morning, everyone. So I appreciate all the detail you guys gave on seasonality, but the the guidance reduction was a bit of a surprise given the loss to lease position you were in back in July and I'm. Just curious if at any point you considered providing an intra quarter update.
For you operationally about what was happening more real time through your portfolio.
Yeah, that's that's not our practice.
Overall, so we didn't feel like there was necessarily the need to do that and if you look at the breakout.
The roadmap for the third quarter, you know the revenue.
Where things came in relative to our expectations was a penny.
And that's it so we didn't feel like it was material enough to preempt the normal process that we go through.
Understand and then I'm just going to development a little bit you guys have historically targeted development in the 10% to 15% of enterprise value you've been running below that for various reasons in recent years, but over time I guess, what what's the right level of development that you think kind of gets the benefit of <unk>.
<unk> creation and also manages the earnings impact throughout a cycle without really getting dinged for the various risks associated with being in that business.
It's a good question.
One we've talked about from a strategic perspective.
It is a couple of comments on that.
One as we've thought about the opportunities in our expansion markets and one of the reasons. We're headed our expansion markets. In addition to more and more of our our type of customer knowledge based work are there. It allows us to take what we do well.
Development platform in and have a wider playing field. So that is part of the effort there.
In terms of the percentage of where we are today towards where we'd like to get to you right. Now it has been in the sort of 4% to 5% range and you know for a lot of last year. We were very actively looking to build up our development rights pipeline to take advantage of the opportunities now in reality right when our cost of capital changes right, we're going to change our rich.
And thresholds and we're going to change the level that we're pulling so longer term alright, we'd like to continue to grow our development book as a percentage of our business from where it is today, but recognizing the near term that we're going to be more restrained given the given the broader economic environment.
And then just last part so when you kind of look at the development.
Pipeline today I know there are moving variables specifically in the the owned versus optioned land portion, but what percentage of those deals would price based on the 100 to 150 basis point spread you outlined in your prepared remarks.
I don't know that I can put a percentage on it necessarily.
A lot of those deals.
Are deals that are going through entitlement process are still a couple of years out and so kind of knowing what comes out of that process.
You know kind of is we're very good at that but you know that that is speculative there's a wide variety of outcomes on some of those.
It's really hard to say you know kind of what I'll say is there's certainly.
Significant number that will work.
<unk> environment, and then there's a significant number that.
You know probably will require some kind of change whether it's some combination of hard costs are land value.
And we're.
Just continuing to work through this very dynamic environment.
No that's fair thanks, Matt.
Our next question comes from the line of just Spector with Bank of America. Please proceed with your question.
Great. Good morning. Thank you first question can you talk about any differences you're seeing between your urban portfolio.
Versus suburban assets.
Anything specific Jeff just in terms of performance trends overall or.
Just yeah exactly performance trends you you know if you could talk a little bit more about.
Move ins.
Verse turnover.
Rent trends are you seeing anything are there any differences between urban and suburban or are they acting similar.
Okay, Yeah. So.
That's helpful. So yeah, I mean, what I would say as of like on rent change may provide a rent change and they are in the earnings release.
You know I highlighted in my prepared remarks.
Which was you know essentially 11% for the quarter.
As you might expect given the recovery in the urban environment was a little stronger the urban side about 12, and a half comparative suburban which is around 10 two.
And then across the markets I mean, the other thing that I would point out that I mentioned earlier is a little more weakness.
In the urban environments in both northern California, and Seattle.
You know as opposed to say, New York City or urban Boston as an example.
Other than that you know things are you know.
About what you would expect in terms of you know rent incomes moving up excuse me lease incomes moving up with new move ins things of that sort and then as I mentioned, just a couple of moments ago that we are seeing.
More move ins from 150 miles away into our urban job center in suburban job center environment as compared to maybe some of the more outlying suburban areas. Those are probably the three that are top.
Top of mind for me.
Jeffrey other the other area.
Jeff the other area in terms of the suburban versus urban and Scott just to what we see is the general strength of our portfolio positioning Amazon on the topic of supply right now two thirds of our businesses in the suburban coastal markets.
<unk>, new suppliers abreast incentives stocks has been in the range of one 5% and as we look out next year that number is probably coming down even a little bit more so.
Potentially softening environment in a recessionary environment.
Our belief is you know markets with lower supply are going to prove out to be more durable and more resilient.
Thank you to clarify are you, saying, that's suburban versus urban or Youre, saying in all lower.
As a percentage so that's our that's our our one 5% of stock outs in our suburban markets and supply is higher in our urban markets. You know the other third of our portfolio is obviously also higher in the sunbelt markets right. So as we look out kind of over on overall portfolio positioning we think we're in a.
A relatively strong point from that perspective.
Thank you.
And then I had a follow up on the turnover.
You know I guess I think you do surveys on turnover like reasons to move out can you discuss that at that at all I mean, do you think you'd do those surveys.
Yes, if we do we track that and with respect.
And that goes all that kind of good stuff. So a couple of things entrepreneur first is.
The third quarter was the first quarter this year, where turnover wasn't materially lower as compared to last year. So if you look back at the data we provided in the earnings release attachments.
On previous quarter turnover on a year over year basis. It was down pretty significantly you know anywhere from 500 to 800 basis points versus the third quarter. It was basically flat year over year. So it was.
A little more turnover than we anticipated and in terms of reasons, a little bit of an increase in terms of people moving out due to rent increases not surprising given how much and we were pushing rents and then the other piece that really is out there.
I talked about the underlying bad debt trend improving.
Which is a function of a number of variables one of those is a more evictions as we move through the court process.
Or are people, who are just skipping out because they know they're getting to their court date, so a little bit of a pickup there those are really the only two that had any kind of pickup in terms of reasons for move out the others came down in terms of relocation.
It came down as it relates to the home and condo purchases you might expect things of that sort, it's all came down.
Just curious on the move outs because of rate do they comment on if you're you know.
Go back to live with parents or do they comment on where what they're doing are they going to have a lower price unit elsewhere.
Yeah that that's usually anecdotal we don't.
You always have that data to be tracking well, we check the ZIP code. So we have that kind of information, but in terms of what they're actually doing and the reasons behind it.
It kind of behavioral things and various things like that that tend to be anecdotal as opposed to real data that you can count on.
Great. Thank you.
Yep.
Our next question comes from the line of Adam Kramer with Morgan Stanley . Please proceed with your question.
Hey, guys. Thanks for the question just wanted to ask about rent to income ratios in the portfolio.
The latest metric that you have and maybe how that compares to a year ago, two years ago, or maybe kind of pre COVID-19.
Yeah No. Good question, Ed I think the right way to think about it is you know the comment that I made earlier and when you look at our new move ins in the third quarter four this year compared to last year. The household income associated with those movements was up around <unk>.
11%.
And if you look at the move in value associated with those move ins it was up about 10%.
So basically you know people are kind of.
Treading at a <unk>.
Consistent level from what you can think of it from in a rent to income perspective. So we have people moving in but that much higher income in our rents are up about that much it sort of makes sense overall.
Certainly you have some people that are moving out as I just mentioned due to rent increase.
Given the the numbers we've been pushing through that's not surprising, but we continue to source demand that is comfortable paying what we are expecting and their incomes appeared to support it.
Got it no that's really helpful.
Just in terms of the kind of loss to lease I think it was 15% last quarter I know you guys disclosed 6% last night.
I'm just thinking of in terms of how you view kind of been the last couple of months of the year here I mean, do you anticipate still having a loss to lease as you enter next year or what's kind of the rents that youre going to.
So youre going to find the next couple of months, probably eat up into that kind of that last 6%.
Yes. Good question, we certainly wont eat into everything, but I mean, maybe a simple way to think about it is if you think about the lease expiration volume that we have typically in the fourth quarter, it's around 20% of our leases expire those folks will get renewal rent increases.
And that will impact the loss to lease the third quarter is closer to 30% of our leases expire 30 32.
And that is when seasonal the kind of seasonality of rents kicked in so typically the most impactful quarter is as youre moving through the third quarter because of not only the heightened volume of lease expirations, but then you have rent seasonality kick in the fourth quarter is typically much more moderate in terms of impact on loss to lease.
As compared to the third quarter.
That makes a lot of interest.
Yes.
That's really helpful. I guess, just a final one year I think the kind of revenue disclosure around this kind of 40 to 43 building blocks not really helpful. Just wondering on the cost side and apologies. If you guys mentioned it I missed it but.
Look I think some some peers kind of across the <unk> space, we're talking about property tax expense increase and it's going to give you various dynamics there.
Certainly inflationary impacts right I was wondering maybe it again not asking you to guide here, but just maybe put a little bit of color around you know 2023 expense.
Spence growth kind of.
Building blocks or kind of potential potential.
Headwinds there.
Sure why don't I.
I'll give you a sense of maybe the top three or four categories, just set us about them a little bit.
And so for property taxes, which obviously is the greatest percentage of our expense structure. This year over kind of the numbers here that are just under 2%.
We don't expect the sort of 2% handle.
They were experiencing in 2020 to be in place as we move into 'twenty three 'twenty four.
There certainly will be upward pressure due to rates and assessment says you have heard from others.
Payroll.
<unk> to 2022 should remain very constrained due to our innovation efforts and you can see what that looks like.
The the expense attachment to the earnings release in terms of what 22 looks like.
And then maybe just a couple of others.
There is a maintenance certainly there'll be some wage inflation from our contractors.
Excuse me and a potential increase in turnover.
And then.
Sorry about the utilities.
There'll be some pressure on rates in the first half of 'twenty three.
Given the contract that we sign up for procurement of utilities in.
The middle of 'twenty two.
And there may be some pressure or will be some pressure from our bulk internet smart access offering.
But we also expect that profit to be substantial in terms of the growth next year.
Probably more than triple the level in 'twenty two as we move into 2023, so will there be some pressure on the opex side there'll be a nice boost to NOI given the revenue contribution from that activity. So those are kind of the top four in terms of maybe some color as to how to think about them.
Great. Thank you so much anytime we appreciate it.
Yep.
Our next question comes from the line of Alan Peterson with Green Street. Please proceed with your question.
Thanks, everyone for the time, Matt to your earlier point regarding renegotiating land pricing on the development rights pipeline from the conversations youre, having with brokers and other market participants are you getting the sense that land sellers are starting to capitulate on pricing.
So to what degree.
Yeah, Alan I would say it's early.
So the first thing is you know land only represents typically 10% to 15% of the total basis in the project.
Maybe you know maybe 20% in areas, where rents are higher and land represents a higher percentage. So it doesn't move the needle nearly as much as hard costs.
And land transactions are long lived deal. So yeah land deals that are closing now might be land deals that you cut.
Depending on the region 12345 years ago, depending if you're in California, or maybe if you're in you know taxes. It could have been six months ago, but.
So they are a lagging indicator and.
Dose brokers, sometimes are similar but it's.
It's going to take time there.
You'll see it first and we are seeing it first in the transaction market.
And then over time, it'll it'll work its way backwards through the system so to speak.
I appreciate that that's helpful and Sean in regards to the operating trends in October , but the high 3% effective rent change in northern California is that starting to imply negative new lease growth within that region.
No it's not it's still positive.
So positive are you getting the sense that you're going to need to turn on concessions or potentially reduce rents to maintain occupancy across northern California, or even the Pacific Northwest, which you mentioned was a little bit softer than the rest of the portfolio.
Yeah, I mean, I don't know exactly what's going to look like for the rest of the year, but certainly that's a possibility to the extent that we see some weak environments there for sure.
Okay. Thanks for the time guys.
Yeah.
Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thanks, Good morning, I had a.
<unk> on development starts.
That you produce.
Then you mentioned in your prepared remarks, the likelihood of compressed profit margins and.
And I'm, assuming that means the yield difference between yields and market cap rates. If that's the case what are you underwriting for a cap rates on developments that you're starting today.
Yes.
John the profits have come down.
Look back a year ago, we were running at development profits that were to a tune of 50% because the the spread between where we are developing two underlying cap rates was out to 250 basis points that type of arena.
That is compressed.
And what I would guide you to as I mentioned before.
As our focus on maintaining a 100 150 basis points of spread between where were developing and where underlying cap rates are there can be and likely be certain deals that are slightly below that but as a group.
That's the approach.
Yeah.
On the developments in lease up going to almost 7% yield.
Is that specific to those projects because of your overall pipeline at five eight.
So I was wondering if it was just.
These projects at least that they're currently at those levels.
Or is there a difference in the way that you're calculating.
The rent as part of that stabilized yield number.
Yeah, Hey, a J.
John and Matt So it.
I guess the answer to that is about to be clear that six to <unk>.
For deals four of the 17 development rights development communities are currently in lease up. So those are the only four that we mark to market and they are they're coming in at a fixed not today now they were originally underwriting underwritten sorry, if you look at that slide two I think a 665 so.
They were among the higher yielding deals.
On the.
In the development book when we started them based on you know some of that was timing some of that was location a lot of those are suburban northeast deals, but if we see the same uplift in rent on the rest of the book when we market to market when those deals come to lease that would push the rest of the book up another 40 basis points as well and obviously that's going to depend on what happens to market rents.
Between when we started the deals and today and then between today when they start leasing. So we may get less we may get more but on those deals we saw that 40 bps 40 bps uplift.
Thanks, Matt So just to clarify the five 8% yield on your overall development pipeline. That's on your original underwriting or is that based on the current market rents.
So it's based on the current market rents on those four deals which are at the <unk> nine and on the other.
<unk> 15.
13 are at.
What the initial underwriting was so.
If the like I say it the other deals have the same amount off with fat overall, five eight will probably rise to a six hour six one as a way to think about it that five eight represents four deals Hunter Martin.
13 deals that are not.
Understood. Thanks, a lot.
As a reminder, it is star one to ask a question.
Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.
Hey, good morning.
Thanks for taking the questions. So two items first on the turnover.
You guys pointed out in the presentation on page eight that turnover is still below pre pandemic levels. So just sort of curious as you guys.
As the numbers fell below what you thought you would achieve in the third quarter. It still seems like turnover is low historically. So were you guys just expecting turnover to be even lower and if that's not the case, how do we think about turnover returning two weeks.
Pre pandemic level, especially because I think you said that new rents for the ones that were being hit whereas the renewals were holding in there.
Yeah, Alex it's Sean.
Just to try to be clear, we expect it to be lower.
Independent of the historical norms and the reason we had our belief is if you go back and look at the turnover that we experienced in Q1 and Q2 relative to last year as an example.
Yes.
First quarter over first quarter of this year turnover was 35% last year Q1 was 44%.
Q2. This year was <unk> 46 last year was <unk> 58.
Q3 ended up being basically on top of last year. So we had two quarters earlier this year, where we're pushing rents pretty aggressively that there was a pretty widespread on a year over year basis.
So we expect Q3 to continue that trend of being below what we experienced last year, even though we were continuing to push rents and that was not the case. It was essentially on top of last year.
So hopefully that answers that question as it relates to turnover in our expectations.
And the second question is I think initially there were three markets that you guys highlighted as being weak.
Northern Cal Seattle, and the mid Atlantic you addressed northern Cal and Seattle to Jeff's factors question mine is if mid Atlantic if I heard correctly that mid Atlantic is one of the weak ones. That's a market that just friendly for the past decade has been sort of anemic. So was the was this the case where the market.
You thought would rebound and it just didn't or it's weaker than you know sort of the normal stuff that goes on obviously that market gets placed with supply.
Yes.
One thing, we should probably try to be clear about Alex is.
We've talked about weaker weaker it was just a little bit weaker than our expectations.
The revenue Miss was a penny on.
$600 million for the quarter. So it's not a when you run the math, it's not a significant dollar amount here.
And so we're still seeing you know.
Good growth in those markets.
Mid Atlantic as an example, if you take a look at it will.
While we experienced in Q3 rent change it was pushing 10%, California was nine <unk>.
Seattle was almost 12, but things began to decelerate a little more quickly than we anticipated.
I'd be careful about saying those are the weak markets like things are going south quickly type of approach as opposed to the rate of deceleration was just a little more than we anticipated in terms of rent change, but its still in absolute terms. You know these are pretty healthy numbers.
Well above historical norms, what do you think about the long term rent growth across our footprint. These numbers are pretty strong. So that's the way I would probably think about it but it's specific to the mid Atlantic.
There's three major regions suburban, Maryland, Northern Virginia, and the district.
Say the district, maybe one or two pockets northern Virginia, probably struggled the most particularly DC.
We're obviously utilization remains I think it's the second lowest in the country at this point behind San Francisco.
A lot of professional services jobs government jobs.
And so if people haven't necessarily had the need to be in the office.
We continue to see positive movement in that trend, but it's still not where it needs to be to really sort of pushed through and be in a position, where we could see stronger results.
The mid Atlantic overall, including DC so.
And if you look at just absolute job growth here of all of our regions has been the weakest this year.
So you have a combination of weaker job growth and then for the job that you do have not everybody has to be in the office and we just need to see better trends in that and that data to see the market pick up even more.
Yes.
As you know we were just down there and surprised that we can speak with some government folks that all the government people are still working from home. It's only the political people who are back in the office, which blew us away. So I your message is definitely resumes.
Thank you.
Yep.
Our next question comes from the line of Jamie Feldman with Wells Fargo. Please proceed with your question.
Thank you and that it might be a little bit more theoretical.
But your comment on underwriting developments at a 100 to 150 basis point spread to market cap rates I mean, how do you think about cap rates going higher and the risk, especially by the time developments are delivered just kind of what are your thoughts around that and how do you bake that into your underwriting.
Hey, Jamie it's Matt.
I'd say a couple of things the first and most important is match funding. So if we're match funding that deal with permanent capital when we start it because were either sourcing equity or debt or selling an asset. That's based on those prevailing cap rates. Then if cap rates are 100 basis points higher when that deal was finished we still locked in.
Spread.
If it works the other way and honestly it has like over the last few years, we finished deals and cap rates were a lot lower than they were.
In the environment in which we funded them so and I think the equity forward as a good example of that in terms of.
Locking in that capital based on kind of what the cap rate was or are the yield was on our stock at that time.
So that's the first thing beyond that.
Obviously as I mentioned, we don't trend rents and.
NOI that also most of the time rents and NOI are growing so most of the time there is some lift there and that provides a little bit more conservatism as well.
Okay do you think about underwriting today, what are you baking in for that cushion.
On the revenue side.
I was like I said, we don't we look at today's NOI today's rents today's expenses today's cost and so we come up with a spot yield and we'll come back compare that with a spot cap rate or spot asset values that asset was being sold today.
And then you know we don't.
Generally what we find if you look at we have a long history of the deals when they stabilized stabilizing at yields higher than what we underwrote because of that because we don't have the growth in there we have the growth in kind of a 10 year forward IRR model.
Long term return not in the not in the yields that we quote.
Okay, and so you're using spot expenses too is that what you said.
Yes.
And how do you think about the risk to that.
I mean, so again norm typically what we would see is when a deal stabilizes rents will moved opex won't move some as well the biggest the biggest piece of the opex as the property taxes, and that's really based on the asset values.
But that's going to be the biggest problem.
Probably mover and where opex settles out relative to where it was.
It's significantly higher it's usually because of the assets worth significantly more than we underwrote, which means we got more value creation, there, but generally if everything grows together.
We're in a very high margin high operating margin business, So we get operating leverage and.
If if rents and opex grow at the same percentage rate that means you're going to wind up with that much more NOI.
Okay, alright, great. Thanks, so much for taking my question.
Our next question comes from the line of <unk> <unk> with Credit Suisse. Please proceed with your question.
Hi, yes.
Good morning, Thanks for keeping the call.
My question is around the strategic initiatives you guys started with industrious co working space. Just wondering if you could talk a little bit about the economics of that business the size of the opportunity.
Actually what that could contribute to your bottom line.
Sure I would I would frame it just in the context of our overall initiatives of activating retail space at the at the bottom of our buildings have been a couple of different components of that one of which.
It was a we saw started our own small, but self start at our own co working on a.
Program or project out in California, which we call second space.
The industrious relationship, which you referenced as a pilot.
To further tap into their network of potential clients as we think about our second space product, but it is a it's an area where we're actively talking with multiple users and we think it's somewhere we can help create some incremental value, particularly to our residents above by creating a activated space at the ground floor.
And you'll just renting the space to industrial so there's no kind of shared revenue model or anything like that.
It's a I don't want to get too much into the details of a given the pilot nature, but it's a it's a share it's more of a shared model as opposed to the traditional retail model.
Great. Thank you.
There are no further questions in the queue I'd like to hand, the call back to management for closing remarks.
Thank you all for joining us today I appreciate the dialogue and look forward to seeing many of you at NAREIT soon.
Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation you may disconnect. Your lines at this time and have a wonderful day.