Q3 2024 Elme Communities Earnings Call
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Speaker Change: Welcome to the LM Communities 3rd Quarter 2024 earnings conference call. As a reminder, today's call is being recorded. At this time, I would like to turn the call over to Amy Hopkins Vice President Investor Relations. Amy, please go ahead.
Amy Hopkins: Good morning and thank you for joining our third quarter earnings call. Today's event is being webcast with a slide presentation that is available on the investor's section of our website and will be available on our webcast replay.
Statements may during this call may constitute forward-looking statements that involve known and unknown risks and uncertainties which may cause actual results to different materialy, and we undertake no duty to update them as actual events and fault. We refer to certain of these risks in our SEC filing.
Amy Hopkins: Reconciliation is a gap in non-gap financial measures discussed on this call are available in our most recent earnings press release in financial supplement, which was distributed yesterday and was found on the investors page of our website.
Presenting on the call today will be Paul McDermott, our CEO, Tiffany Butcher, our COO and Steve Freishtat, our CFL. And with that, I will turn the call over to Paul.
Paul McDermott: Thanks, Amy. Good morning, everyone, and thank you for joining our call on Election Day. This is an exciting day for our region, and we look forward to watching the results unfold.
Paul McDermott: I hope you all have either voted or plan to do so. I will begin today's call by discussing the main factors driving our performance in our markets, including supply and demand dynamics and their implications for Elm.
Amy Hopkins: Tiffany will cover our operating trends and growth initiatives and Steve will discuss our financial results and outlook.
During the quarter, demand remained strong across the Washington Metro and Atlanta Metro regions.
Absorption in our markets was the highest it's been since the fourth quarter of 2021, driven by wage growth, stable employment, in-migration, and resident retention.
Wage growth has been outpacing rent growth for nearly two years in our markets, contributing to stable financial conditions for renters.
Employment data shows that job growth, on average, is stronger for middle income wage earners relative to higher income segments in our markets, which is a favorable trend for ELM.
Additionally, Elm's largest employment industries are either adding jobs or maintaining jobs, resulting in a stable base of employment for our residents.
In-migration, which is a more pronounced demand driver in the Atlanta region than the Washington region, is driving record levels of absorption.
Atlanta Metro in-migration is expected to have increased by over 20 percent
Amy Hopkins: by year-end 2024 compared to 2023.
Paul McDermott: And the region is expected to outpace the U.S. through 2029, with 5% population growth in the 20 to 34-year-old age bracket, according to Oxford Economics.
Paul McDermott: Resident retention also plays a significant role in demand dynamics, and our retention rate remains very strong.
Paul McDermott: Even if home purchasers return to a more normalized pattern, our value-oriented resident base tends to be stickier, with an average tenure of about 2.7 years.
Overall, we believe that demand outlook for our value-oriented price points is positive both in the near and long term.
Paul McDermott: Now, turning to supply.
Paul McDermott: The impact of supply on our portfolio differs across our markets, as our Washington Metro communities are facing very low competition from new supply, especially in our Northern Virginia submarkets, while our Atlanta communities are feeling more of an impact.
Paul McDermott: In the Washington Metro, annual net inventory growth was a healthy 1.8% during the third quarter, and annual net inventory growth for our Northern Virginia submarkets was just 1.1%.
Paul McDermott: Looking ahead over the next year, Northern Virginia's inventory growth is expected to remain at 1.4 percent, which is well below the U.S. average of 3.1 percent.
Paul McDermott: In addition to low supply overall, only a very small portion
Paul McDermott: or 4% competes with our communities on price.
Paul McDermott: For our Atlanta submarkets, net inventory ratios remained elevated at 4% during the third quarter.
Amy Hopkins: Additionally, we are seeing normal delays in deliveries with some delivery estimates that were previously anticipated to occur in the fourth quarter now expected in early 2025.
Amy Hopkins: While half of our Atlanta sub-markets had no deliveries over the past year, and only 10% of new supply in the third quarter was competitive with our communities,
Amy Hopkins: Supply is having a more widespread impact as rent compression and concessions have caused temporary disruptions to typical demand pools.
Amy Hopkins: On average, we do not expect supply to increase above the current level in our submarkets.
Amy Hopkins: However, we expect the curve to be relatively flat between third quarter of 2024 and the first quarter of 2025.
Amy Hopkins: In 2025, two-thirds of our Atlanta submarkets are projected to have net inventory ratios that are less than 1.7%, and we expect the overall level of demand relative to supply to improve throughout the year.
Amy Hopkins: Units under construction and new starts continue to decline significantly across our Atlanta Metro submarkets.
Amy Hopkins: owning to a very low supply in 2026 and 2027.
Amy Hopkins: Given the improving supply dynamics and favorable demand trends, our medium and long-term outlook for Atlanta is strong.
Amy Hopkins: Furthermore, over the near term, we expect to deliver marked improvement in NOI growth in Atlanta, which Tiffany will discuss in more detail. And with that, I'll now turn it over to Tiffany.
Tiffany Butcher: Thanks, Paul. Overall, our portfolio's fundamentals as we approach the winter months are in line with our expectations.
Tiffany Butcher: During the quarter, we generated stronger-than-expected performance from our Washington Metro communities. However, we experienced slower-than-expected improvement in Atlanta. As a result, we're trending towards the midpoint of the same-store NOI growth assumption included in our guidance.
Amy Hopkins: Washington metro occupancy has been a bright spot this year and we captured sequential occupancy growth for our same score portfolio driven by very strong performance from our northern Virginia communities. Retention rates remain above historical levels with strong renewal rates.
Amy Hopkins: We expect to end the year in a good place with stable trends across our portfolio and a strong revenue growth outlook into 2025.
Amy Hopkins: Touching on a few operating trends during the quarter, effective blended lease rate growth was 2.1 percent for our same store portfolio during the third quarter, comprised of renewal lease rate growth of 4.5 percent and new lease rate growth of negative 1.5 percent.
Amy Hopkins: New lease rate growth was negative 3.1% for our same store portfolio in October and Renewal lease rate growth was 4.4%
Amy Hopkins: We're signing renewals at an average rate of 4 to 5 percent for November and December lease expirations in line with our expectation for seasonal moderation at lease rates through year-end.
Amy Hopkins: Same-store retention has remained very strong at 66% during the quarter, up from 61% in the third quarter of last year, underscoring the longer-term nature of our resident base and our heightened focus on customer service excellence.
Amy Hopkins: Additionally, the percentage of move-outs driven by home purchases remained very low at just over 7% for our total move-outs for the quarter.
Amy Hopkins: Moving on to occupancy, same-store average occupancy increased 60 basis points sequentially to 95.2 percent, driven by strong demand in the Washington Metro, offset in part by the impact of new supply and the timing of evictions in our Atlanta portfolio.
Amy Hopkins: Same store occupancy trended down toward the end of the quarter, following the anticipated August peak and an increase in the pace of repossessions, which will have a positive impact on bad debt. In October, occupancy trended in line with our expectations, and we ended the month at a strong 95.1%.
Amy Hopkins: Turning to bad debt, while we're encouraged by the trend across our Washington Metro communities, which is nearing normalized levels, in Atlanta we expected to see more improvement in the second half of this year.
Amy Hopkins: Reducing bad debt is a top priority, and we have recently made additional process changes in Atlanta, in addition to the credit protections and income verification processes we implemented earlier this year.
Amy Hopkins: On a positive note, we've seen the pace of evictions improve over the last 45 days, as the resources needed to utilize House Bill 1203 with off-duty officers appear to finally be in place.
Amy Hopkins: Additionally, new delinquencies improved in October, resulting in lower month-over-month bad debt. We anticipate modest improvement in the fourth quarter, and we now expect bad debt for 2024 to remain relatively flat year-over-year.
Amy Hopkins: As a result, we anticipate a greater benefit from lower year-over-year bad debt in 2025.
Amy Hopkins: Turning to renovations, during the third quarter we completed renovations on 188 units, generating an average ROI of approximately 17%. We expect to meet our target of 475 full renovations and 100 home upgrades for the year.
Amy Hopkins: With nearly 3,000 homes in our renovation pipeline, we have more than enough runway to continue driving renovation-led value creation well into the foreseeable future.
Amy Hopkins: Moving on to operational initiatives, we remain on track to achieve our targeted NOI and FFO upside this year, driven by smart home technology, fee strategies, and payroll savings, following the launch of Elm Resident Services, which centralizes resident account management and renewals.
Amy Hopkins: Beyond our upside target through 2025, we are rolling out managed Wi-Fi across our portfolio in phases, starting with approximately 2,500 homes in Phase 1. We began the installation process in October and expect to substantially complete it by year-end.
Amy Hopkins: Given that resident adoption is a gradual process, we anticipate approximately 300,000 to 600,000 of recurring NOI in 2025, and 1 to 1.5 million once Phase I is fully adopted over the next two to three years. And with that, I'll turn it over to Steve to cover our 2024 Outlook and Balance Sheet.
Steve Freishtat: Thanks, Tiffany. Starting with guidance, we are tightening our 2024 core FFO per share guidance range to 92 to 94 cents per share, maintaining our midpoint of 93 cents per share.
Steve Freishtat: We are tightening our same-store multifamily NOI growth assumption to range from 1 to 1.5 percent.
Amy Hopkins: We now expect non-same-store multi-family NOI to range from $5.35 to $5.75 million, which reflects a lower midpoint due to rental pressure from new supply and a higher-than-expected tax assessment, which is under appeal.
Amy Hopkins: We are tightening the range and raising the midpoint of our other same-store NOI assumption, which consists of Watergate 600, to range $12.5 to $12.75 million.
Amy Hopkins: Interest expense is now expected to range from $37.5 to $38 million, which reflects a slightly lower midpoint due to the anticipated impact of interest rate cuts on our line of credit.
Amy Hopkins: Turning to our balance sheet, annualized net debt to adjusted EBITDA was 5.6 times at quarter end, in line with our targeted range, and we continue to expect our leverage ratio to finish the year in the mid five times range.
Amy Hopkins: Our liquidity position remains strong, with more than $330 million, or 65% of capacity, available on our revolving credit facility at Quarter End.
Amy Hopkins: With no secure debt and only one $125 million maturity prior to 2028, our balance sheet remains in excellent shape.
Amy Hopkins: Turning to ESG, I am pleased to share that we published our ESG report last week, showcasing our dedication to being an ESG leader within the Class B multifamily space.
Amy Hopkins: The report outlines our ongoing progress toward our efficiency goals and our increasing commitment to the health and wellness of our residents.
Amy Hopkins: In summary, our third quarter results were in line with our expectations and we continue to trend toward the midpoint of our core FFO guidance.
Amy Hopkins: While we would like to have seen more compression and bad debt at this point in the year, achieving our guidance is not dependent on significant improvement in our Atlanta performance in the fourth quarter thanks to continued strength from our Washington Metro portfolio.
Amy Hopkins: Looking forward, the stage is set for a Washington Metro portfolio to deliver another solid year of growth in 2025, and we expect to deliver meaningful improvement in our Atlanta performance next year with increasingly favorable supply-demand dynamics thereafter.
Amy Hopkins: And with that, I will open it up to Q&A.
Speaker Change: Certainly. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad.
Speaker Change: A confirmation tone will indicate your line is in the question queue.
Speaker Change: You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys.
Speaker Change: One moment, please, while we poll for questions.
Amy Hopkins: Michael Lewis, Paul McDermott, James Feldman, James Feldman
Amy Hopkins: Your first question for today is from Anthony Pallone with J.P. Morgan.
Anthony Pallone: Hey guys, you have Not Home On for Tony today.
Anthony Pallone: Maybe just quickly, on bad debts, you guys mentioned that delinquency improvements in Atlanta were going slower than anticipated.
Anthony Pallone: I guess, could you guys speak to, you know, where things currently stand in Atlanta and the rest of the portfolio, and I guess how much of a tailwind you guys are expecting going into 2025 from improvements there?
Anthony Pallone: Absolutely. This is Tiffany Butcher. Starting off at the portfolio level, bad debt was approximately 2% of revenue in the month of October, and that was really driven by a normalized bad debt in our Washington, D.C. portfolio of just below 1%. In Atlanta, we did experience higher than anticipated bad debt in the third quarter, driven in part by the longer eviction timelines that have been a challenge in the Atlanta market throughout the year, and due in part to the impacts of new delinquency.
Anthony Pallone: The good news is that we have seen a shift in both of those factors over the last 45 days.
Anthony Pallone: as we're seeing a faster processing of evictions.
Anthony Pallone: as the structure needed to implement Georgia House Bill 1203 is now in place.
Anthony Pallone: which is allowing off-duty officers to execute evictions, so that that pipeline is moving much faster. And we've also seen residents start to proactively move out in advance of their eviction timelines, which is also helping to speed up getting back those units from highly delinquent residents and being able to release them to rent-paying tenants.
Anthony Pallone: Additionally, we've also continued to adapt our internal processes and procedures, and we proactively work with residents to help them get current on-rent payment, which has contributed to the decrease in new delinquencies and overall reduction in bad debt that we experienced in the month of October.
Anthony Pallone: However, I will say that given the typical seasonality in Baghdad, we don't expect to see a meaningful improvement in Baghdad in the fourth quarter, and we expect to end 2024 in line with the prior year.
Anthony Pallone: We do expect the momentum that we saw in October of accelerating eviction timelines, coupled with our internal process and procedure changes, to really set us up for continued improvement in VAD debt as we head into 2025.
Anthony Pallone: Thank you for watching!
Speaker Change: Got it. Okay. And maybe also on Atlanta, is the low occupancy you guys experienced during the quarter, is that more of a function of those evictions and bad debts, or is it, you know, more so due to, you know, elevated supply deliveries? And I guess, are, you know, any concessions also being offered in your Atlanta portfolio?
Speaker Change: Sure. You know, I would say that in terms of the occupancy that we have seen in Atlanta, it is a combination of both supply-demand dynamics in our markets,
Speaker Change: And Greg can speak a little bit more in a second to some of the, you know, changes that we're seeing as we head through the peak supply in Atlanta. But it's also obviously contributed to the eviction timelines that we've had. And as we said, that does put a near-term pressure on occupancy, but it's good for the long term as we're able to release those.
Speaker Change: So I would say in terms of the occupancy being in the low 90s, it's a combination of both of those two factors.
Speaker Change: And then you asked about concessions. Overall, I would say at the portfolio level, concessions in the third quarter remained flat to the second quarter. We are offering concessions on about 14% of signed leases with an average amount of kind of less than a week, if you blend that across the entire portfolio.
Speaker Change: If you look, though, specifically kind of market by market, Washington, D.C. continues to be a very strong market with great supply-demand dynamics, so we have less need for concessions. It is much more sub-market by sub-market where there might be a small need in the Washington metro area. If you look at our third quarter new leases, we offer concessions on approximately 27 percent of new leases in the D.C. area, but an average of only 4.6 days.
Speaker Change: So D.C. remains a non-concessionary market.
Speaker Change: In Atlanta, we saw about 58% of new leases receiving some sort of concession in the third quarter, averaging approximately 12 days.
Speaker Change: So there is definitely a little bit more of a concessionary impact in the Atlanta market really driven by where we are in the supply-demand dynamics. I don't know, Grant, if you want to add just a little bit of color on the overall supply-demand dynamics in Atlanta.
Speaker Change: Sure, Tiffany. Tony, this is Grant. As Paul said in the prepared remarks, we do see gradual improvement in the net inventory ratios in the greater Atlanta area. It will be a slow improvement. We do think numerically, if you look at the data from the third-party folks, that the net inventory ratio is peaking in Atlanta this quarter, but it will be a very slow and gradual move through fourth quarter and first quarter and really starts to accelerate next year when you have sort of peak leasing.
Speaker Change: Season in the spring and summer and that's when it really starts to move and it continually Moves down and sort of accelerates throughout 2025
Anthony Pallone: And we think that really sets up for, you know, VISTA future.
Speaker Change: Got it. Thanks, guys.
Speaker Change: Your next question is from Jamie Feldman
Jamie Feldman: Great, thanks for taking the question. I guess just to start, just wondering if you think there might be any kind of slowdown in the DMV that puts the year at risk, or maybe a better way to ask it, can you talk about what's implied in your guidance for blends and occupancy in the fourth quarter?
Speaker Change: Sure. Jamie, this is Tiffany. I can speak to kind of what we're expecting in the fourth quarter and what's implied in our guidance.
Speaker Change: First of all, you know, occupancy has continued to remain incredibly strong in the Washington metro area. You know, we've been averaging over 96%. We are expecting occupancy to trend down slightly in line with typical seasonal trends. So we expect our occupancy to end in the kind of high 95% range as we head into year end. We also expect our retention to continue to remain strong as it has all year.
Speaker Change: In terms of blends in the DMV, we're expecting between 0 and negative 3% for new lease rate growth. We're expecting our renewals to be in the 4.5% to 5.5% range, which puts your overall effective blends at 2% to 3% in the DMV.
Speaker Change: I'm sorry. I'm sorry. I'm sorry. I'm sorry. I'm sorry.
Speaker Change: Okay, and then maybe the same question in Atlanta.
Speaker Change: So if you think about Atlanta, we have trended in the occupancy range in the low 90%. We do expect to remain in that range. As I mentioned before, we are seeing a faster pace of addiction.
Speaker Change: So depending on the timing of when some of those evictions hit, we could end up seeing a slight timing impact of when those evictions happen that could put some near-term pressure on occupancy, but obviously that will be a strong positive for the portfolio overall that will help to bring down bad debt.
Speaker Change: And then if you think about blends, starting again with our new least-rate blends, we're expecting to be in the high, negative to low, negative double digits.
Speaker Change: for new lease rates blends really reflective of the competitive dynamics in the market right now. But we still expect to have very strong renewals at two to three and a half percent. So overall blends in Atlanta for the fourth quarter, we're expecting to be negative three to negative five percent.
Speaker Change: Okay, just to confirm, so the new, you're saying what, like minus 10-ish?
Speaker Change: I would say probably, you know, negative 9 to negative 13 percent.
Speaker Change: Okay. For the fourth quarter.
Speaker Change: For the full year, it would probably be like negative 8 to negative 12 percent.
Speaker Change: Okay and then if you were to combine them both like what do you think the total portfolio looks like?
Speaker Change: For the fourth quarter, I would say the new lease rates are going to be a negative 2.5 to negative 3.5 percent, renewals 3.5 to 4.5 percent, so blends, say, half a percent to 1.5 percent.
Speaker Change: And then if you want to kind of translate that to what that means for the full year, new would be approximately, you know, negative two and a half to, say, positive 50 bps, renewals would be four and a quarter to five and a quarter, ZIP blends would be 1.75 to 2.75%.
Speaker Change: Okay, that's helpful. And then I think you had like a ten and a half percent sequential OpEx increase in Atlanta.
Speaker Change: If I read that right, is there something behind that or can you talk through what that's going to look like going forward?
Speaker Change: Yeah, Jamie, this is this is Steve and I can talk about so Q3 for OPEX and Atlanta really it was it was three things that I'll talk about
Speaker Change: The first is taxes, which we've talked about before. We had two reassessments in Georgia. They got, you know, closer to the purchase price. They're in a three-year cycle, so that was the biggest driver for the tax increase.
Speaker Change: But in addition to that, kind of if you look at the year-over-year increase
Speaker Change: We saw some favorable tax appeals last year in the third quarter. We're still waiting. We didn't receive any here in 2024 in Q3, but we're still waiting on a couple of appeals that we're expecting will hit in the fourth quarter. So there's some timing difference there that should net out by year end. The second one is insurance. We, of course, had a very large insurance renewal September of last year.
Speaker Change: That kind of finished playing out in the quarter. We did our insurance renewal September 1st for the next 12 months. It had a much lower increase going forward. We only had a 4% increase.
Speaker Change: So going forward, that should obviously be more muted on the insurance increase. And lastly, you know, we saw a number of evictions in the quarter and saw an increase in certain op-ecs, notably legal fees and trash costs related to those evictions.
Speaker Change: Okay that's helpful and I guess just big picture on expenses as you think about 25. Do you think your expense growth overall for the portfolio will be higher or lower than it was in 23, sorry 24?
Speaker Change: Yeah, and Jamie, we'll give our full guidance in February, but thinking about kind of the trajectory of expenses, and really it's a couple of the things that I just hit on in the Q3 for Atlanta. If we think about taxes, we had those two large increases from the reassessments.
Speaker Change: We don't see a three-year cycle, a community like that, hitting us in 25. So we think that the tax increases will come down a bit. On insurance, I just talked about the 4% increase.
Speaker Change: Much lower than the increase we had before. So we see non-controllable growth certainly coming down, and we see that coming down more so than controllable growth changes.
Speaker Change: Okay, and then last for me, just...
Speaker Change: With no acquisitions here today, just kind of want to get your latest thoughts on, you know, expansion into additional markets and some of your strategic initiatives, whether it's selling Watergate or entering new markets. You think you're on hold for a while? You waiting for market conditions to open up? Just kind of what are your latest thoughts on portfolio repositioning and investments?
Paul McDermott: Jamie, it's Paul. Let's start out with Watergate. You know, we had a good quarter there, and just as a backdrop, you know, Watergate has five and a half years of
Speaker Change: Walton, and it's currently sitting at the end of Q3 at 86% occupancy.
Speaker Change: We had four leases.
Speaker Change: executed during the third quarter for 13,000 square feet. Three of those were renewals, one of those was an expansion.
Speaker Change: and those average rents between $55 and $67.
Speaker Change: None of those had TI allowances associated with them. The expansion was a six-year deal, and that had 12 months of free rent associated with it, but we're very happy with the way that...
Speaker Change: the way that those executions took place, and we expect to close the year on the Watergate at 85% occupancy. As we've said in the past, Jamie, we'll obviously look at
Speaker Change: You know opportunistically monetizing the asset. It is not a long-term hold for us
Speaker Change: And we, quite frankly, you know, believe that the D.C. market is coming back. It has progressively gotten better. We have seen
Speaker Change: you know, more transactions taking place in 2024. So, again, we will provide more insights on that in February when we get 2025 guidance.
Speaker Change: But right now, you know, we're just pleased with the leasing execution that our team is doing. In terms of expansion markets right now, Jamie, you know, we continue to favor the Sunbelt markets. I think that...
Speaker Change: You know, when we evaluate opportunities, I think some of the hallmarks of markets that we like to get into are, you know, the markets have outsized job creation, they have wage growth, and in-migration in the future, and those are really what we, you know, we try to allocate capital towards. We're going to be probably more specific about...
Speaker Change: Expansion markets in our February guidance, but as I said we do favor the Sun Belt
Speaker Change: And we just, we candidly, you know, stepping back, we'd like to see more transaction activity.
Speaker Change: than we've seen so that we have more data points.
Speaker Change: We have seen a bit of a pickup in the fourth quarter.
Speaker Change: in terms of available transactions even in our current markets.
Speaker Change: with obviously D.C. because of the fundamentals and how well D.C. is doing, D.C. leading the country.
Speaker Change: right now, but our goal would be to continue with our geographic expansion and we'll be able to again talk more about that at the end of the year and also as we have more data points.
Speaker Change: to collect on those markets by year-end.
Jamie Feldman: Okay. Very helpful. Thank you.
Speaker Change: Your next question for today is from Anne Chan with Elm.
Speaker Change: Thank you for watching. I hope you enjoyed the video. If you did, please give it a thumbs up and subscribe. I'll see you in the next video.
Speaker Change: Hey, this is Anne with Green Street. Do you expect total capital expenditures to increase, hold steady, or decline in the next few years?
Speaker Change: Thank you.
Speaker Change: And so from a CapEx perspective, I think our CapEx is
Speaker Change: This year and probably next year, driven really by a lot of the initiatives that we're doing. And I would mention a couple of things. One is the renovations.
Speaker Change: that we've done. I think we're going to do about 475 this year. Next year we might do slightly more than that, but that spend I would expect to either maintain it or go slightly up.
Speaker Change: Another thing that, you know, might be an increase is the managed Wi-Fi, which, you know, we're rolling out to a number of communities, you know, in the fourth quarter, you know, we're looking at additional
Speaker Change: communities in 2025. And those returns are in the 30 to 40% range which Tiffany talked about, some of the additional NOI that we're gonna get next year. So as we look to do some of our ROI initiatives, I think that is gonna drive the CapEx over the coming years.
Speaker Change: Thank you.
Speaker Change: Thank you.
Speaker Change: Great, thanks. And just one more for me. Going back to the bad deaths in Atlanta, where do you think levels are going to ultimately stabilize at?
Speaker Change: Thank you. Bye. Bye.
Speaker Change: Great question and you know, I would say if you we're gonna give really detailed guidance on bad debt in February and kind of where we see the trends through, you know, 2025
Speaker Change: You know, I think if you are looking for kind of where normalized levels of bad debt could be, you look to kind of pre COVID, it was probably more in the two to two and a half percent range. But I think that it'll take time in the market to get back to those kind of normalized
Speaker Change: Bad debt levels going forward, but we do think that there is going to be significant improvement in our bad debt from where we are today Through next year and we'll give detailed guidance on that in February
Speaker Change: Great, thank you so much.
Speaker Change: Your next question is from Cole Bardawill with Wolf Research.
Cole Bardawill: Hey guys, thank you very much for the time. One question I just wanted to ask on, with everything happening in the election today, I was just curious if you've seen any changes, like historically, in demand trends, you know, in the months after an election, just specifically with the D.C. Metro market, or is it kind of business as usual?
Speaker Change: Cole, this is Paul. A lot of that obviously depends on the outcome of the election. The one word we have always used around here is alignment.
Speaker Change: When you have alignment, that tends to drive more legislation, more jobs, and more localized demand for office space.
Speaker Change: So if we do see, and that is House, Senate, and the White House
Speaker Change: If we do see that, we would expect to see a pickup in demand for not only office space, but probably a lot of the product types because they all draft off of one another.
Speaker Change: But again, I think that's the alignment.
Speaker Change: is critical.
Speaker Change: for any type of movement. If there isn't alignment, we traditionally, you may see a pop initially.
Speaker Change: you know, just on staffing changes and some type of overflow where you have duplicative efforts, but we don't really see that being a long-term value proposition for D.C. office.
Speaker Change: Okay.
Speaker Change: Got it. Thank you. And then just kind of one specifically I had on Atlanta I saw that your occupancy was up sequentially quarter over quarter 130 BIPs So it seems like it's trending in the right direction Do you expect that kind of to continue going forward and also are you prioritizing just occupancy over rate currently? And like how are you guys thinking about that specifically?
Speaker Change: Great question Cole. I would say starting with the last part of your question We are definitely prioritizing occupancy over rate growth at this point. We feel like that is the best way to drive NOI
Speaker Change: in the current market environment. So we are definitely prioritizing renewals and retention and driving occupancy growth through the year.
Speaker Change: You know, as I mentioned earlier, we are in the low 90s. I would expect that we will stay in the low 90s through year end.
Speaker Change: As I mentioned, there could be some near-term impacts associated with just the timing of evictions. But that would obviously overall be a good story because we would be getting those units back and able to release them to rent-paying tenants.
Speaker Change: So, as we think about kind of where we expect to end the year, it would most likely be in the low 90s. We do see occupancy trending up as we head into 2025, particularly as we get into our spring and summer leasing season. And so, we are absolutely prioritizing occupancy at this point in time and really focused on driving our occupancy growth and bad debt improvement throughout the portfolio.
Speaker Change: Okay, awesome. Thank you very much, Rich.
Speaker Change: Thank you. Bye.
Speaker Change: Your next question is from Michael Gorman with BTIG.
Michael Gorman: Yeah, thanks, good morning. Tiffany or Grant, I'm curious as we think about 2025, obviously you talked about heading into the fourth quarter, but then the improvement in the supply picture and the net inventory ratios. Should we expect new lease growth to inflect in 2025 and turn positive? And kind of what are your thoughts there in terms of the trajectory? How quick is the recovery in a market like Atlanta?
Speaker Change: I think Grant can maybe give you a little bit more detail on the inventory ratios and then I'll come back and give you the impact that I see that happening on new lease rate growth. So, Grant, do you want to just kind of walk through the supply peak? Sure. Sure, Michael. Happy to give you some more context.
Grant: The equation really works out as, you know, supply and demand, and on the demand side, we are still seeing extremely strong demand. So over the last year, you know, we had nearly 21,000 units absorbed in Atlanta, so that's the good news that we are working through that. We obviously do still have elevated supply as we move through the sort of slower part of the year in terms of lease-ups, that elevated net inventory ratio like I talked about earlier will remain relatively flat, although peaking, but really gradually coming down so that if you look at where it is currently, it's about 4.4% region-wide. If you look to the third parties and so what they're projecting, it's back down by the
Speaker Change: end of 2025 to around 3%, which is still elevated, but it's significantly, you know, better than it is today. And really, the time that that really starts to accelerate and you start to see more change is during that
Speaker Change: spring and summer leasing season when you will see, you know, typically that sort of seasonal pattern of additional absorption.
Speaker Change: And then just kind of with that backdrop, I would just say that with the continued market rent constraints in the Atlanta region propelled by the supply that Grant was talking about, you know, it's going to take time for market rent to recover, for new lease rate growth to turn positive.
Speaker Change: As I had mentioned earlier, we do expect that new lease rates in Atlanta will remain negative through 2024. And as we think about 2025, we think that there's going to be significant improvement in our NOI, but that's going to be more driven by occupancy and bad debt improvement versus new lease rate growth.
Speaker Change: Okay, great. That's helpful. Thank you. And then, Paul, just ...
Speaker Change: Quick question, maybe on the capital allocation side, you talked about
Speaker Change: where the pricing is and how that fits into how you're thinking about entering into new markets. Thanks.
Paul McDermott: Sure, Mike. So let's start off and maybe we can just go down the list.
Speaker Change: I mean, I'll start with the sellers, because we really haven't seen...
Speaker Change: You know, the amount of transactions that we're used to seeing, obviously, although, as I said earlier, there has been a slight pickup in the fourth quarter, I'd say two-thirds of the sellers that we...
Speaker Change: have observed have liquidity needs.
Speaker Change: i.e. the Blackstones, the Starwoods, and about a third of the Avalanche.
Speaker Change: have really been just sellers taking profits, i.e. developers with syndicated equity or merchant developers with institutional capital, returning that.
Speaker Change: I would say in terms of the pricing, you know, even starting back into late 23 when we did our last deal, the discount to replacement cost was a big component for us.
Speaker Change: And we've seen that gap, that discount to replacement costs closing. We've definitely seen pricing become more aggressive.
Speaker Change: I would say the buyers that we are observing are institutional capital, PE shops, family offices. The only groups that have really been on the sidelines have been the odysseys.
Speaker Change: quite frankly we haven't really seen in some time. They are underwriting flat to negative increases in the first couple years.
Speaker Change: And the recoveries are really in years like three to five. And that's pretty consistent with what we've heard from not only our own research, but our competitors just in terms of a runway in 26, 27, and 28, particularly in the value-add space.
Speaker Change: Just going down, Michael, the cap rates right now. The core space, we're seeing 4.5% to 5% cap.
Speaker Change: Core Plus is in that $4.75 to $5.25, and the value-add has really been, you know, a five and a half cap and up, and obviously that would vary from sub-market to sub-market.
Speaker Change: Great, thank you for all the detail.
Speaker Change: And if there are no further questions, I'd like to hand the floor back over to management for closing comments.