Q2 2023 AvalonBay Communities Inc Earnings Call
Yeah.
Good morning, ladies and gentlemen, and welcome to Avalonbay communities second quarter 2023 earnings conference call.
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Your host for today's conference call is Mr. Jason Reilley, Vice President of Investor Relations. Mr. Riley you may begin your conference.
Thank you, Doug and welcome to Avalonbay communities second quarter 2023 earnings Conference call before we begin. Please note that forward looking statements 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.
This press release as well as in the company's Form 10-K, and Form 10-Q filed with the SEC.
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 towards Flash earnings and we encourage you to refer to this information during the review of our.
Operating results and financial performance and with that I will turn the call over to Ben Shaw CEO and president of Avalonbay communities for his remarks.
Thank you Jason and thank you everyone for joining us today I will start with an overview of our outperformance in Q to speak to the limited new supply in our markets as compared to most other markets and then provide additional color on our guidance raise our second raise of the year.
John will speak to our underlying market fundamentals, including the progress we are making on bad debt and provide a further update on our operating model initiatives, which are exceeding expectations.
And then Matt will highlight the continued outperformance of our new projects and lease up and summarize our recent transaction activity, including the sale of three assets at a four 7% cap rate.
Our balance sheet is as strong as it has ever been with total liquidity of $3 billion and Kevin is also here with us for Q&A.
Turning to slide four in the presentation that we posted yesterday.
We achieved second quarter core <unk> of $2 66 per share, which equates to a nine 5% growth as compared to last year, and which is <unk> <unk> per share higher than the Q2 guidance that we provided in April .
I'll speak more to the underlying drivers of that outperformance in a second.
We completed two new developments this quarter and started one new project.
And as a reminder, early in Q2, we completed the exercise of our $500 million equity forward capital already raised at $245 per share and are suffering subsequently been investing safely at rates in the low 5% range.
In terms of our outperformance in Q2. It was primarily revenue driven with same store revenue growing six 3% or 110 basis points higher than we had anticipated as shown on slide five.
Lease rates and other rental revenue were modestly favorable to our prior guidance.
Partially offset by slightly lower occupancy.
Most significant driver of the favorable variance was underlying bad debt, where we had been successful as our landlord rights have been have been reinstituted of getting back and re leasing apartments that were previously generating no revenue.
As we look forward, we continue to expect our portfolio, which is two thirds located in suburban coastal markets to benefit from significantly less competitive new supply coming online than in the sunbelt and other parts of the country.
<unk> six shows the magnitude of this differential where starts in our established regions have remained stable over time, while sunbelt starts have increased 50% since 2020.
The ramification of this activity is that in 2023, new apartment deliveries will be almost 4% of existing stock in the sunbelt as compared to only one 5% of stock in our established regions.
This meaningful differential is set to continue in 2024.
Moving to slide seven we are raising our full year guidance for core <unk> to $10 56 per share, which equals a seven 9% increase over 2022.
As a reminder, we increased guidance by 10 cents in April to $10 41 per share, which was attributed primarily to Q1 outperformance and the earnings benefit of accelerating our equity forward.
The second increase of an additional <unk> 15 per share incorporates our outperformance in Q2 and reflects our latest revenue and expense forecast for the year, including improved expectations for bad debt.
As part of this updated guidance, we have increased our same store revenue growth expectation of 6% kept expense growth constant at six 5% and the resulting same store NOI growth.
Outlook of 6% is up 175 basis points at the midpoint.
For bad debt, we are now assuming underlying bad debt of two 3% for 2023, an improvement of approximately 50 basis points from our initial estimates.
As it relates to operating expenses, while the midpoint of our guidance remains the same we expect lower payroll cost driven by our innovation efforts and lower repair and maintenance and property tax expenses to be offset by higher legal eviction and bad debt costs as we reclaim apartments from nonpaying residents.
A further breakdown of the increase from $10 31 to $10 41, and now to $10 56 per share as shown on slide eight with 14 coming from same store NOI.
We also continue to adjust our capital allocation approach based on the changing external environment.
While our developments in lease up continued to perform exceptionally well we have raised our required returns on new development starts given our increased cost of capital and focus on maintaining a 100 to 150 basis points of spread between underlying market cap rates and our projected development.
Based on these factors and as part of our guidance update we have reduced our expected level of starts in 2000 $23 million to $775 million from $875 million.
On the transaction side as part of our portfolio repositioning we continue to take the tact of selling assets first locking in that cost of capital and then pursuing acquisitions in our expansion markets. Given this cadence and given that we were remaining selective on the acquisitions that we pursue our guidance now assumes that we will be net seller.
Of assets this year with expected dispositions exceeding acquisitions by roughly $200 million and with that I'll turn it to Shawn.
Alright, Thanks Ben.
Turning to slide nine to address recent portfolio trends.
We've experienced a steady improvement in underlying bad debt, primarily due to non paying residents, leaving our communities.
Q1 underlying bad debt was about 20 basis points better than we anticipated in Q2 that favorable spread grew to approximately 65 basis points.
Representatives at an underlying rate of two 3%.
It was up roughly 70 basis points better than Q1.
The elevated volume of non paying residents moving now which is certainly a favorable trend led to an increase in turnover and modest decline in physical occupancy.
Based on what we're currently experiencing we expect a continued steady flow move outs associated with non paying residents over the next few quarters, which will further reduce underlying bad debt.
As I've noted in the past our historical bad debt range is 50 to 70 basis points. So based on the Q2 rate of two 3%.
Still approximately 170 basis points away from reaching what we might consider normal levels, which bodes well for revenue growth in future quarters.
Moving to slide 10 to address our updated revenue guidance, we increased the midpoint of our same store residential revenue growth outlook of 100 basis points to 6%, which is supported by three primary drivers.
The first is better than expected underlying bad debt, which is projected at a full year rate of two 3% versus our original outlook of two 8%.
Consists of two 7% from the first half of the year and roughly 2% in the second half of the air.
The second is the higher than projected average rental rate, which is primarily based on what we've already achieved through July .
Combined with the rent growth, we expect to realize for the balance of the year.
And the third is an increased contribution from our innovation efforts, which is helping to drive a projected 16, 5% increase in other income for the full year.
We expect economic occupancy to be modestly below our original expectation trending in the mid 95% range in the back half of the year as we continue to recover homes from non paying residents.
All our established regions are projected to perform at or above the high end of our original revenue growth estimate except for Seattle, which is projected to be modestly above the midpoint.
Additionally, our east coast portfolio is projected to outperform our west coast portfolio by approximately 200 basis points for the full year 2023.
Transitioning to slide 11, we continue to make meaningful progress related to our re imagined the operating model as we indicated at the beginning of the year, we expected an incremental NOI benefit of approximately $11 million in 'twenty to 'twenty three.
Which is on top of the roughly $11 million, we realized in 2022.
Currently we expect to exceed our original 2023 objective by $4 8 million for a total incremental benefit of almost $16 million for the full year.
The material drivers of the positive variance include the faster deployment and resident adoption of our technology services offering and the accelerated realization of staffing efficiency, resulting from digitalized and customer related customer related processes.
I'd like to thank our operating and technology teams for their continued effort to drive our re imagined operating model and look forward to sharing more about the next iteration of it in future quarters.
With that I'll turn it over to Matt to address development.
Alright, Thanks, Sean turning to slide 12, our lease up our lease up communities continued to deliver outstanding results laying the foundation for strong future growth in both earnings and NAV.
We have five development communities that had active leasing in Q2 and those five deals are delivering with rents that are $520 per month or 18% above our initial underwriting. This in turn is driving a 70 basis points increase in the yield on these investments to six 6% well above current cap rates in the mid to high <unk>.
Per cent range and even further above the low 4% cost of capital we source to fund these deals when they started construction consistent with our match funding strategy.
Looking ahead, we expect to start leasing on an initial six communities before the end of the year many of which are positioned to exceed our initial projections by a significant margin as well.
As shown on slide 13, with most of our development community is still early in lease up or yet to open we have clear visibility into a substantial future earnings growth stream from this book of business over the next six quarters, we expect to deliver an additional 3600 homes, which are entirely match funded today, and which will drive incremental NOI.
High growth in NAV creation on completion.
To provide some additional insight into the transaction market a summary of our recent disposition activity is shown on slide 14.
While we were able to close on three asset sales in the past few months transaction activity is still relatively muted with total sales volumes off roughly 70% from 2022 levels.
In general the cap rates on the assets that are selling tend to be below prevailing debt rates. Although there are also listings that are not proceeding to closing due to a bid ask spread between seller and buyer. We were pleased with the results on these transactions and we will look to redeploy a portion of the proceeds into some limited acquisition activity in our expansion regions as we were.
Omar portfolio trading and continue to make progress on our long to start long term strategic portfolio allocation goal of a 25% weighting to our expansion markets and with that I'll turn it back to them.
Thanks, Matt so to wrap up I want to thank our 3000 Avalon Bay associates for their efforts and dedication in delivering very strong results in the first half of 2023.
As an organization we have also incorporated our ESG activities and so much of what we do and I'm proud that we are delivering on these initiatives with tangible and measurable progress across all of our key ESG metrics as shown on slide 15, and as more fully described in our 12 annual ESG report, which we issued last Monday.
Our final slide number 16 summarizes our key takeaways for a very successful quarter and with that I'll turn the call back to the operator to facilitate questions.
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Our first question comes from the line of Eric Wolfe with Citi. Please proceed with your question.
Thanks, Good afternoon, it's actually Nick Joseph here with Eric. So you saw the news that you were released from the real page litigation and it sounded like from other participants in this Ah that's kind of.
Typically it takes many years and I was wondering if you could kind of walk through the rationale that you provided that got you will be I guess dismissed without prejudice.
And are there other related cases that are still outstanding at a mall the Avalon.
Yeah, Thanks, Nick for the wider group, but nicks, referring to was the legal update that we provided in our earnings release yesterday.
And as you pointed out we are pleased we've been dismissed from that class action lawsuit Nick at this point given its ongoing litigation in the wider industry, we can't make any additional comments above what we included in our disclosure in the earnings release.
Filings in the case are public they are out there to the extent that you or others wanted to research the matter further.
And is that still the case or what they're out there I know there were a handful of kind of late.
Related cases with everything.
We were we were dismissed from the consolidation of the class action lawsuits.
Great Hey, it's Eric just a quick one on development I think you mentioned that.
This year, we're seeing a little bit less accretion from developments versus history.
Once developments delivering I'm just.
Various historically you know how much accretion have you generated per year from development and would you expect to get back to that in 2024.
Yeah, Hey, Eric It's Matt I guess I can speak to that one a little bit and then I don't know if Kevin wants to talk to the longer term trend there, but I mean, probably the easiest way to think about it is as that slide show and we're looking at 3600 deliveries over the next six quarters, that's about 200 deliveries a quarter.
And that's I'm, sorry, 200 deliveries a month.
And that is probably double the pace of what we've done over the last year.
A year or so so we're gonna be getting twice as many apartments that were going to be bringing online and ultimately generating NOI out of it.
Yeah, Eric the only thing I'll add this is Kevin I mean, obviously the level of accretion is a function of the volume of activity to be have underway and start and complete and the relative spread.
Relative to our cost of capital.
And so you kind of you can look historically what that has been if were you know historically, we've often started at our current size level, maybe a billion and a half maybe a touch less we certainly aren't doing that this year as you know, but at that run rate you know at a 150 basis point spread.
That generates you know probably about 150 basis points or so give or take of incremental core <unk> growth per year, obviously that moves around as things are delivered and as volumes change in spreads change, but that's just one way to think about that.
That's helpful. Thank you.
Our next question comes from the line of Austin <unk> with Keybanc. Please proceed with your question.
Hey, good afternoon, as it pertains to lease rate growth trends can you share a little bit more detail around how new lease rate growth trended in the second quarter to get to the 2.8% July and then for renewables, how big is the spread been between asking rates and take rates because I think I recall in recent months you were sending out notices in the 7% range and.
It seems like maybe the take has come down a bit.
Yeah.
Yeah. Austin This is Sean happy to talk through that a little bit.
On your second comment.
Comment as it relates to renewals the spreads do move around throughout the year and throughout various cycles.
And so when we originally talked about offer is kind of going out and the 7% range and where we ultimately settled.
Oh, you're talking about spreads that are within normal tolerances.
Typically 150 basis points or so sometimes a little bit less sometimes a little bit more I'd say July was slightly wider Q2 is slightly narrower. So I think we're in a relevant range as it relates to renewals.
Given the knowledge that it does move around depending on specific market conditions as.
As the year evolves as it relates to the first part of your question as it relates to a move.
Move in lease rates, we did provide a breakout for the quarter as it relates to new move ins versus renewals, which is at the footnote.
On the bottom of that attachment.
As it relates to how that's trending going forward, what I'd say is that we were pushing pretty hard on rate through the first two quarters of the year as we started to get back more inventory from those nonpaying resident homes.
We started to see it in the new move inside again to tick down which is really what started to reflect in July which was coming in at two 8% for new move ins is comparable we experienced during the second quarter. So that's where we started to see a little bit of softness but in terms of sort of basing the rent roll for the full year and how it carries forward into 2024 I think we are in.
Pretty good shape based on what we've realized through June and even July frankly, even though we did see some deceleration on the movement new move inside a particular in July .
So just unpacking that as it relates to the guidance I think you said your rent growth assumption and twenty-three was revised higher to reflect the growth through tight but the back half lease rate growth is that unchanged to you know versus the original versus the original guidance I guess can you just share what that revised rent growth.
This is for the year.
Yeah, Here's how I'd describe it is we expect the average lease rate for the portfolio for the full year to be about 70 basis points higher than originally anticipated.
Most of that is the result of what we have already achieved in terms of the expirations that we had through the month of July that are then cumulatively carrying forward through the balance of the year.
And our original outlook, we talked about the fact that we expected some modest deceleration.
And rent change as we move through the back half of the year, that's still the base case assumption for us, but what we've realized through the first seven months of the year has been strong and we will carry us forward for the balance of the here and that's how you get to that 70 basis point higher average lease rate for the full year.
That's helpful. Thanks for the detail.
Yes.
Our next question comes from the line of Adam Kramer with Morgan Stanley . Please proceed with your question.
Hey, guys I, just wanted to ask about bad debt.
There's a really good job of kind of giving the monthly trends.
It looks like dry what wasn't disclosed, but I think I mean, given the given the commentary on kind of the occupancy the physical the physical occupancy disclosure in the bottom left of that slide it looks like that kind of power July .
Just wondering if I should kind of read that as a sign of hey look bad debt. It kind of continued to trend lower in July or maybe I'm missing something there and kind of extrapolate maybe occupancy into into our bad debt rate.
Yeah, I mean, we haven't provided July bad debt data, just yet because it hasn't been totally closed out we provided some preliminary estimates for July as it relates to rent change and things of that sort, which is what was included.
So I think what probably is the easiest way to think about this is.
First half our underlying bad debt rate was two 7% in the second half we expect it to be 2%.
Which reflects two 2% in Q3 and dropping down to one 9% in Q4.
As it relates to occupancy occupancy is correlated with the change in bad debt as we see skipping a VIX activity throughout the portfolio. So where we are for the second half of the year as I mentioned in my prepared remarks, there's an expectation that economic occupancy will average roughly 95, 5%.
She was modestly below our original expectation, but it can grow with the fact that we are getting back more nonpaying resident units that we anticipated that's flowing through to turnover into occupancy, but is also helping bad debt. So the two are correlated and so the expectation is again kind of mid 90 fives for economic occupancy in this.
Second half based on our forecasted a receipt of those non paying units in the second half.
Yeah.
That's super helpful really appreciate that.
I'm kind of I guess, the one little follow ups off those question, but just on.
The new move in the like term effective rent change.
So it looks like a bit of a D. I think the <unk> number is really strong a little bit of a decile going into July is that a year over year kind of a comp issue is that a mix issue just with which leases came up came up and in the month.
Is there maybe something else that was kind of driving that T cell. Yeah. I think the primary driver is what I was referencing as it relates to Austin's question, which is we pushed hard on rate as it.
Related to the first two quarters of the year as you may recall, the eviction moratorium for L. A expired at the end of March so as we process cases, we start to see more availability come in to the portfolio in the latter part of the second quarter and therefore, we started to ease on race to then prompt more velocity.
In terms of leasing velocity of those incremental units and so what you're seeing on the new move ins side. In particular is in places like L. A as an example, where there is more inventory coming back to market as we get into July we wanted to push that inventory through the system get a turn get it released get it occupied before we get into a slower and softer frankly fall.
Winter seasons, so that pressure on new move ins, specifically is to help spur leasing velocity to absorb more inventory than normal as a result of those nonpaying units coming back to us.
Great. Thanks again for the time really appreciate it.
Yeah.
Our next question comes from the line of John Kim with BMO Capital markets. Please proceed with your question.
Thank you on your bad debt I just wanted to clarify is the 2% in the second half of the year on a gross basis or net of the resident relief funds you may expect to get and then how long do you think it takes to get to a more normalized level. I think you mentioned 50 to 70 550 to 70 basis points was kind of normalized.
Yeah, John the 2% I mentioned is the underlying bad debt ignoring the impact of rent relief.
So to clarify that one and then in terms of duration I mean, it's a good question.
We essentially process about call it 1400.
Skip to the VIX the the first half of the year, our expectation is for roughly similar pace, maybe slightly more on the second half.
And but based on the number of outstanding in accounts that we have at this point in time and the pace of activity, particularly in a state like New York, which is moving more slowly I do expect it to carry through into at least the first half of 2024.
And then as you start to get to the back half of 'twenty four 'twenty five I would expect to see normalization based on the pace we've experienced thus far.
Okay, great. Thank you.
Question is on operating expense I think you mentioned lower property taxes as part of your expectations for the second half of the year.
Is that related to Washington States or are there other markets that are driving the lower taxes.
Yeah, Washington State has a big chunk of a job.
Okay, great. Thank you.
Our next question comes from the line of Alan Peterson with Green Street. Please proceed with your question.
Hey, guys. Thanks for the time as.
Sean maybe a little bit more of a longer term question for you you guys are ahead on a lot of the operation initiatives, particularly on the labor efficiency side does that start limiting the opportunity set in 2024, and if possible could you quantify what the margin expansion opportunity is in the portfolio. If it were fully optimized.
Yeah no good question.
So as it relates to the operating.
Operating initiatives when I talk about our first more holistically at this point based on what we have projected for 2023, we'll be about halfway through.
Our plan as it relates to achieving about $15 million in incremental NOI.
With the balance of that to come through 'twenty, four and end of 'twenty five beyond that there are other things that we're investing in that we haven't talked about in significant detail as it relates to the use of AI wishes.
She started several years ago and have been in R&D mode in other areas of the business.
Some other automation efforts and various other things that will help drive additional value and then I'll watch the portfolio, which we would pay will be happy to talk about it as we get further along with those but I would say as of right. Now if you think about what's coming in in the way of NOI assume theres, another roughly $25 million or so to com.
As it relates to 2024 and 2025, that's kind of the high level of something right away and I'd leave it that that includes more than just staffing side of it that includes all of it that's underway at the moment.
Appreciate that and then just transitioning that to the transaction market, Matt across the conversations you're having with owners and brokers are you expecting more distressed opportunities to appear to appear within your established markets or in your expansion regions today.
I you know, there's not a lot of distress that were seeing out there yet.
In multi <unk> of any kind honestly I think if it shows up my guess is it would be more likely to show up in some of our expansion regions, where people were buying maybe with short term you know our value add business plans, whereas maybe they were borrowing short term floating rate debt thinking.
They were going to invest.
Invest some money in improvements.
You know get a rent roll pop and then flip the deal out so that business plan is not working for folks the way it had been so.
So there could be some some pressure there.
Or some kind of larger portfolios that people may have bought it at a higher leverage point. There was just more of that transaction activity happening in the Sunbelt are then in our coastal region. So maybe that means there's more opportunity there if some of that go sideways, but yeah, it's pretty speculative.
I appreciate that thanks for the time guys.
Our next question comes from the line of thank you.
With Evercore. Please proceed with your question.
Hey, good afternoon, guys. Thanks for taking my question so.
And you saw that you guys have drawn developments towards dawn <unk> billion. So we just wanted some color on that and.
Does it fall into the next year or like did you guys cancel an oncoming also on that.
Got it.
Yeah, Hey, it's Matt.
I'll speak to that one yeah. It was really just one project that.
Honestly you know the returns got a little too tight relative to what's happened with cost of capital and asset values. So I wouldn't read too much into it as it relates to next year.
We have a pretty robust pipeline so.
Where we think we have the opportunity to increase our starts activity next year, if things go the way we hope they will.
So that was really just a deal specific situation there.
Overall this was.
This is Ben just add a couple of comments on our framework here.
They're all like you've seen from US the last couple of years the discipline that we've had.
Both around adjusting our capital allocation approaches based on the changing external environment, including our cost of capital and then also a discipline around.
Around maintaining the spreads that we want between underlying.
Market cap rates in our stabilized development yield so when you hear Matt talk about a deal that we're moving from the system. That's us having those hard conversations to make sure that we feel like there is sufficient value being created for shareholders.
That sounds right and I have a follow up to that.
I'll give you a couple of guys on the Savage and Lisa.
We have pulled back on their desktop 19 net.
Do you guys see the same things on the ground.
Going back on the demand side or something like that.
I think if you if you're talking about kind of personnel and overhead we have seen a lot of that we have seen a lot of the private merchant builders start to cut back in some markets, particularly the markets where start activity had been really elevated some of the really hot markets.
We have.
I have not been in that position. Fortunately Ah you know again, we've had a relatively measured pace of start activity really for the last three or four years relative to our long term kind of averages.
And we're across a number of different markets and a lot of our markets honestly are less volatile.
And so if you look at actually where our starts are heavier right now at this moment it tends to be in some of those northeastern markets, where things didn't run up quite as hot and there are more steady.
We had a more stable environment as well so we're not seeing those same kind of overhead pressures.
Thank you.
Our next question comes from the line of Jamie Feldman with Wells Fargo. Please proceed with your question.
Great. Thank you.
Sticking with that last comment about the northeast markets, I mean, you've been particularly well positioned in both northeast markets and suburban.
The last couple of years, how long do you think that outperformance of those markets can continue.
What are you watching that I'll continue to give you confidence in that situation.
Hey, Jamie I'll make a couple of comments.
As we think about the prospects for the various markets and particularly our established regions versus the sunbelt markets.
Supply dynamics in our minds are going to continue to be a factor and a factor at this point into 2025, and that's just simply a function of start activity. The time. It takes to then complete those deals and then the lease up of that activity coming through the system. So.
This will be something in our minds and particularly if we are faced with an environment of flat are softening demand. The reality is those markets and submarkets with higher level of supplies and our minds are going to face a softening.
Operating environment.
But I guess.
Yeah, I mean thats helpful. In terms of the data watch, but like northeast has been incredibly strong versus other regions. What do you. What gives you confidence that's going to continue.
Or do you think like it does start to revert to the mean at some point.
I think we feel I think we feel fairly confident on the demand and supply dynamics in our suburban costal markets.
That includes the northeast.
On the demand side, there are elements of rent versus owning economics today, which stay very prevalent.
Some degree are if you look at the rent versus own spreads. The northeast has some of the highest levels there it could be $1000 more a month to own a home versus rent at home given where he same home prices go in and borrowing costs run and those are markets, where it's very difficult to build new single family supply right. Once that part of the process started.
Backup.
Yes, I think that's a factor gives us confidence and then as you think about kind of a reversion to the long term means yes.
The northeast and other suburban closer markets just haven't had the run up that we've seen in other markets. So there is an underlying stability there that also gives us confidence.
Jamie one thing I would just add to that to use as.
A specific example, if you think of Boston.
Which is a.
A market that we've been in for a very long time very active developer certainly there has been very good demand drivers there as it relates to.
A number of different industries.
Highly educated workforce. Good income levels are predominantly suburban portfolio is pretty supply protected most of those towns. So fulfilled their 40 being affordable requirements. So theres not a lot of development pipeline.
Kind of environment, where we can be successful development, but also our existing portfolio is pretty insulated as it relates to exposure to supply intends to produce solid growth. So that's a good example of one of those markets.
Jersey parts of New Jersey, where.
For the first development going in in 30 years.
So while it may not have.
The growth rate on a stabilized basis that is as attractive as some west coast markets when they're really moving along the initial yield on the yield on that development on total returns are quite attractive. So we will continue to allocate capital. There. So those are a couple of good examples as to.
Why we think those markets are attractive.
Okay. That's great very helpful color and then.
You talked about having I think you said the best balance sheet in your history $3 billion of liquidity.
S. I P activity was relatively light in the quarter. It sounds like from your comments on the Q&A that youre not seeing a lot of distressed activity out there just how do you think about putting capital to more capital to work in that S. I P book and can you talk about the actual transaction you did during the quarter or what's in the pipeline, maybe that'll give us a sense of where distress might be coming.
Yeah sure into that.
Yeah sure. This is Matt I can speak to that and I would say the business is not a distressed business.
Basically we are lending to developers.
You know who are building multifamily assets very similar to the multifamily assets that we build and own and operate.
And we're just providing capital between the first mortgage construction loan and <unk> and their equity and where theres been distressed in the lending world and so the amount of proceeds they can get off that first construction loan are lower than they would have been a year or two ago and therefore, they they have to put in more equity or borrow a little bit more money from somebody else.
So in that sense, what we're seeing that's changed as we're going lower down the capital stack. So we're lending for maybe 50% to 75% cost instead of 60% to 85% cost like we would have been doing a year or two ago and where we are.
We are happy with the fact that we're just building that book of business today, and so we can underwrite it in today's environment. The deal that we just closed on is a suburban garden community in Charlotte actually fairly near the DSP deal that we started construction on in the first quarter.
North of Charlotte and Thats, where the sponsor who is really first class sponsor who actually we have.
A DSP deal working with as well that we hope to start next year. So it's a repeat business situation.
And Thats pretty representative of the type of business that we're looking for.
That that rate is kind of 12 ish.
Yield is around 13, a little bit more of the higher than 13.
Just given the fees involved that would have been 10 as opposed to 12 or 13, if it had been a year or two ago. So.
We are seeing a lot of inbound inquiries on that program. The challenges finding deals that underwrite just given kind of where asset values are relative to replacement cost and that's part of what we're seeing in terms of developers.
Finding it much more difficult to put their capital stack together, which ultimately is slowing starts activity.
But.
The good news is we have our pick of the litter and really top quality sites and sponsors the challenges finding deals that underwrite because we're not really.
It really bending in terms of the quality of the underlying collateral and how high up will go in the capital stack to lend against it.
Yeah.
Okay. Thank you have you set a limit on how much you'd want to do with that assuming or did come your way whether.
Whether it's.
She'd or anything else.
Our long term goal is to have that plan, the 3% to $500 million book of business and build that up over the course of several years I think today, we're at a little bit less than a 100 and commitments total so we've got room to run there.
Okay, Alright, great. Thank you.
Yeah.
Our next question comes from the line of Josh General line with Bank of America. Please proceed with your question.
Yeah, Hey, guys. Thanks for the time.
Sure.
What's driving the thinking behind that decision.
Got you cut in and out on the question can you repeat that please.
Yeah, sorry.
You mentioned in your opening remarks, or now a net seller in guide, what's what's driving the thinking behind becoming a net seller this year.
Part of it's just been our approach and we made this shift last year to selling first.
Market, there's uncertainty there there's not a lot of capital that's in play. So we wanted to take some assets to market execute on those lock into that cost of capital.
And then make the decisions around how we're going to redeploy that capital. We are remaining pretty selective today in terms of our new buying activity and part of that is while to Matt's point, we're not expecting distress. Our view is that over the next six to 12 months, there likely will be a greater set of motivated.
Sellers.
And potentially in our growth areas in our expansion markets that could be particularly true. If you take a softening operating environment and combine that with the capital environment, where capital is less abundant that could provide some attractive opportunities for our platform and our balance sheet like ours.
Okay I appreciate that color and then for guidance.
Assuming for new lease rate growth in the back half of this year.
Is it.
Negative at any point on <unk>.
Yeah, Josh this is Sean.
We didn't provide specific guidance as it relates to new loose new lease rate growth excuse me well.
Well, we did say at the beginning of the year, which I would just reaffirm now is that we did expect to see solid rate growth through the first half, which we have realized and then begin to see some modest deceleration.
And blended effective rent change in the back half of the year and I think that's appropriate at this point in time in terms of.
But where we are and what we're seeing in terms of the inventory come back to us from some of the skipping of picking up so I think that's appropriate.
Thanks, Sean.
Yep.
Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.
Hey.
Good afternoon.
So two questions first.
Just going back to the real page Ben.
Are you guys totally out of any real page related litigation or is this just the consolidated I'm just sorry, just want to get clarification is this just the consolidated case or are there. Other litigations that you guys are still party of related to this real page.
There are no other litigations related to real page that we're aware of that we have not been this restaurant.
Thank you for that second question is on your outperformance of the developments I'm assuming a lot of this is based on your land basis. So as you look at your the options that you've struck on your development land pipeline.
How many more years do you think that you'll have.
Above average development returns based on how much rents have moved.
Sort of curious is this just a one or two year phenomena or do you think this could be several years, where your developments are out pacing traditional because of where you bought the land versus where rents are now.
Hey, Alex its Matt.
Really the outperformance.
Talking about is relative to our pro forma when we start the job. So the land price is already baked in there it's really about the rents and the fact that we had rents run up pretty significantly over the last two years, you know at a pace, particularly in some of these locations again some of these suburban coastal locations that were well above trend, we don't trend rents and the.
First place so whenever we quoted yield its the yield as if you know.
It's at today's NOI today's cost and then we don't re market until we at least at least roughly 20%. So.
So it is a little bit of a unique moment in time in the sense that we started those jobs.
The hard costs were good because we bought them out kind.
Kind of at the trough if you will.
Maybe in front of when some of the hard cost inflation that we've seen kicked in but we enjoyed it on the rent side. So the going in yield on those the underwritten yield I think it was maybe a five nine and.
The rent growth is driven to a six six so that's the 70 basis points of outperformance when.
When you look at the deals the next six deals to start lease up as I mentioned those deals also should have a pretty significant lift because again, there's there was a nice run up in rents between when we started the minimum we're going to start leasing them. So we still should be pro forma on those maybe not by as much but by a nice margin and.
When you start thinking about the deals that we're going to start you know in the next however, many quarters. There. It's more about just is it a good land basis and is it a good hard cost basis.
Are those underwriting to an initial 5859 no. We're now looking for mid sixes typically given what's happened to the cost of capital.
Okay. Thank you.
Sure.
Our next question comes from the line of Brad.
Heffern with RBC capital markets. Please proceed with your question.
Hey, good morning, everyone. Matt can you talk about how construction costs have trended of late and what you're underwriting for increases in the future when you're underwriting new deals.
Sure I guess the second part how we think about the future again, we tend to look at everything on a spot basis. So today's NOI today is hard cost now there are some deals that we have in our system, which science.
We signed up in the last couple of years.
Our thin at today's hard cost and so in some cases, we are making the decision to continue to invest modestly in those deals to get them ready to go to see what happens to hard caused by that time, because the reality of it is it's very difficult to know where hard costs R&D you actually have a deal ready to bid and sub contractors see that it's real.
Ideally, there's even some demo or something going answer that.
Everybody is constantly asking them if I had a job to build today, what would it cost, but that's different and I do have a job ready to go today I have the permits in hand give me your best number. So what we've seen is in some markets, particularly again some of those markets that maybe didn't see quite the same.
Excess is in terms of sub contractor capacity again, particularly in the northeast suburban northeast, where a lot of our depth starts are we have seen costs come back maybe.
5% to 10%.
We've enjoyed some buyout savings on some of our more recent starts.
And so once we bought that out then that is reflected in the way we underwrite. The next deal in that region. There are other regions where hard costs.
It seems like they're flattening out, but they haven't fallen yet, particularly some of the regions that saw.
We're just really struggling to keep up with all of the demand and all of the elevated start activity over the last couple of years I would put Austin in that category I would put denver into that category.
Actually puts seattle into that category.
Where we saw hard cost run up a lot and have not yet come back to us and so.
We'll see we're certainly hoping that they do we're seeing start activity start to slow down in those regions, but that may take a while.
Before that plays through.
Okay. Thanks for that and then maybe for Sean you say in the slides that two thirds of the increase in turnover in the second quarter was driven by recapturing the delinquent homes.
What's the other one third and is there anything unusual in there.
Yeah, No. Good question, Brad nothing terribly unusual kind of nits and nats here and there across different categories, but nothing that stands out as sort of Oh, there's a there's nothing going on as it relates to relocation or things of that sort of home condo purchase is still less than 10%.
Which is a historic low for us so.
There's not much else in there other than sort of the normal stuff yeah family status for May changes nothing else material.
Okay. Thanks.
Yes.
As a reminder, it is star one to ask a question.
Our next question comes from the line of Michael Goldsmith with UBS. Please proceed with your question.
Good afternoon. Thanks, a lot for taking my question on Slide 10, you show the performance of the rent growth in different markets.
What's clear is that the.
Expansion regions are kind of at the lower end of where you are initially projected comparing to pretty much every other market is at the higher end. So when you think about the expansion markets does this does the fact that it kind of ended up.
Being kind of at the lower end of your initial projection change your view on the rate of expansion or how quickly you want to move there.
Just your thoughts about diversifying the portfolio overall.
Yeah. Thanks, Michael.
I'll make a couple of comments one now reaffirm our goal of moving 25% of our portfolio to the expansion regions over a period of five or six years, we've talked before about some of the drivers behind that to just quickly to call out one our core customer the knowledge base.
Worker, we recognize that as is in a more dispersed set of markets today than they have been in the past and second and just think about an expanded playing field to take what we do well cross operations development to those new markets in order to create value for our shareholders.
In terms of kind of pace and execution goes to my comment earlier on the call could be an opportunity here, where there are some attractive more attractive opportunities for us to enter into those markets given some operating softening and given there's not a lot of other institutional capital that's active today.
And so we'll continue to be selective, but I think we'll have the choice of what we want to own.
On the acquisition side, we've been tending to focus recently on assets that we think are going to complement our development portfolio in those markets and so that's how that's looking at acquisitions that are generally a little bit older nature lower density lower in price point.
With a particular focus on micro locations that we expect to have more limited supply coming.
And then on the development side and gets gets in the land and the conversation we're having around construction costs. Our hope is construction costs will start to come down there are merchant builders, who were accumulating large portfolios of land.
And we are starting to see some of those deals come back and so selectively and I talked about this last quarter, we and Boston and our recent deal in Florida, we've been able to take land back at 30% to 40% from where it traded a year ago. So those are the types of opportunities that we're looking at but this is a longer term vision and we remain focused on moving in that direction.
<unk>.
That's very helpful detail and my follow up question is just on the performance of the Euro.
The performance of suburban versus are you seeing any differences in terms of how the tenant is.
Reacting or or kind of how the consumer how the consumer is positioned in these markets and how that is translated to the results in those two different types of regions. Thanks.
Yes, good question and nothing unusual in terms of underlying trends.
That indicate any significant movement I mean, we they may be different over the next two three quarters. We are hearing more about people being called back to the office, obviously, the Amazon announcement, which would have some impact on.
Not only urban portion of downtown Seattle, but also urban Bellevue, where they have a large campus. So I think it's.
Probably not a broader urban suburban trend other than as it relates to where people are going to work. If it's a suburban job center location versus the nerve is building that would be something that in the future may shift things, a little bit one direction or another but it's a little too early to tell.
Thank you good luck in the back half.
Yes.
Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.
Hi, Good afternoon, just a question on some of the markets, where youre getting back. The apartments, you mentioned, New York is one where it's moving a bit slower than any of the markets, where you're seeing either delayed or optical to getting back on units.
Yes, I'd say in New York is really a little bit the outlier at the moment in terms of the processing of cases, whether it's on long island.
Hey, you're Westchester, it's just moving everything is moving more slowly.
The backlog is significant but it's also significant in L. A L. A it seems to be moving along a little faster. So those are really the two markets and maybe too.
To a lesser extent the similar phenomenon as some of the district of Columbia, We're seeing thanks move more slowly so I would say New York is probably the outlier to the slow end followed by D. C. In terms of what's going on in the rest of them as sort of just.
Chip and a law.
Got it thanks, and maybe a more basic question when a tenant is.
There is a victim.
Eligible for new market rate apartment, I'm wondering where these people are going in.
It seems like lower demand overall for apartments, given the elevated activity in this area across the industry in the past few months.
Yeah, It's a good question.
Different companies you use different types of screening criteria, so I can't really speak to the market specifically on that subject.
And that really is something that from an industry perspective.
There are a lot of conversations in terms of how people screen there.
Africans to make that decision.
Are you seeing any more doubling up of anytime there's maybe some tenants who are living in apartments have to live with roommates or anything like that in your portfolio.
Not any significant transaction went the opposite direction through Covid and we haven't seen a significant trend indicate people are doubling up.
Alright, thank you.
Yes Youre welcome.
There are no further questions in the queue I'd like to hand, it back to Mr. Shaw for closing remarks.
Alright, well, thank you for joining us today, and we look forward to speaking with you 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.