Avalonbay Communities Inc (AVB) — Q2 2019 Earnings Call Transcript

Thank you, Cody, and welcome to AvalonBay Communities' Second Quarter 2019 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's 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 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.avalonbay.com/earnings, 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 Tim Naughton, Chairman and CEO of AvalonBay Communities, for his remarks. Tim?

Yes. Thanks, Jason, and with me today are Kevin O'Shea; Sean Breslin; and Matt Birenbaum. Sean, Kevin and I will provide a brief commentary on the slides that we posted last night, and then all of us will be available for Q&A afterwards. Our comments will focus on providing a summary of the Q2 and year-to-date results, an update to our 2019 outlook, a review of portfolio performance and then lastly, a discussion of risk management. Starting now on Slide 4, highlights include core FFO growth of just under 2% for the quarter and 3.6% year-to-date. Same-store revenue growth in Q2 came in at 3.1% or 3.3% including redevelopment, with most regions except Seattle clustering in the 3% range. Year-to-date same-store revenue growth stands at 3.3%. We completed a $90 million development deal in New Jersey this quarter at an initial yield of 6.5% and $240 million so far this year at an average yield of 6.4%. Meanwhile, we started another $430 million in 3 communities located in the mid-Atlantic, Southern California, and Boston markets. And lastly, we raised almost $600 million this past quarter in external capital at an average rate of 3.9% and have raised roughly two-thirds of our projected capital needs for 2019 in the first half of the year. Turning now to Slide 5 and our revised outlook for the full year. We expect a core FFO growth of 3.9% or $0.05 a share and 60 bps above our original outlook. Same-store revenue growth remains unchanged at 3%, and NOI growth is up 25 bps to 3.25% driven by lower-than-expected OpEx, which is down 60 basis points from our initial outlook. Development starts are expected to be down modestly in the $900 million range. And then lastly, in terms of acquisitions, we're projecting $300 million for the year, which really reflects what we've closed so far through Q2 plus what is expected to close in Q3. Acquisitions are roughly offset and funded by an increase in dispositions and opportunistic CEP activity that took place in the first half of the year. Turning now to Slide 6. The upward revision to core FFO growth is being driven primarily by the unbudgeted acquisitions and a favorable interest rate environment on newly issued and existing floating rate debt. Projected outperformance in our same-store portfolio has been offset by shortfalls in the redevelopment and lease-up portfolios. Turning to Slide 7, which provides many of the key assumptions underpinning our revised outlook. And I'm not going to go through this entire chart, but economic growth is moderating as expected, with the recent print of Q2 GDP growth of 2.1%, which is down 100 basis points from Q1 and the rate that was experienced for much of last year. The consumer remains in good shape but is also showing signs of moderation, with retail spending decelerating from its healthy pace of last year and auto and home sales flattening in recent quarters. Consumer confidence remains at a healthy level for now, supported by a very healthy labor market. Business investment has been relatively healthy so far this year as well, although business confidence has recently declined to a cyclical low as the prospect of trade wars weighs heavily on the psyche of many executives and capital allocators. This and other leading indicators have caused the Fed to reverse course with its rate cut earlier this week. Let's now turn to Slide 8 and see how this economic backdrop is impacting fundamentals in our markets. Job growth is expected to be in line with our initial outlook of 1.3%, with most regions in the low 1% range, with the exception of Northern California and Seattle, which are projected to produce job growth in the low to mid-2% range. And while wage growth is projected to remain healthy at around 3%, this is 50 basis points below our initial assumption. And then lastly, while completions remain healthy at 1.9% of stock, this projection is down 40 bps due to the continuation of project delays experienced over the last few years, mostly from shortages in skilled labor. And so fundamentals are a little mixed from what we expected at the beginning of the year. Job growth is in line, deliveries are projected to be lower than expected, and wage growth is expected to be slightly less than our initial outlook. And with that, Sean will now discuss our markets and portfolio performance in more detail.

All right. Thanks, Tim. Turning to Slide 9. We've seen a steady convergence in the performance of our markets over the past few quarters. The East Coast has accelerated as a result of improved rent growth in both the New York and mid-Atlantic regions, while the West Coast has decelerated due to slowing growth across the majority of the markets in Northern and Southern California. Rent change for our same-store portfolio is following a similar pattern of convergence, with every region producing like-term effective rent change in the 3% to 4% range during Q2. Turning to Slide 10 to address our same-store revenue outlook. We tightened our range and maintained the midpoint of 3% revenue growth for the full year. In terms of the regions, we expect the mid-Atlantic and Pacific Northwest to trend to the upper end of our original range, while Northern and Southern California are projected to come in closer to the lower end. Within the regions, better performance in the mid-Atlantic is being supported by continued improvement in both suburban Maryland and Northern Virginia. Each market posted greater than 3% year-over-year revenue growth in Q2. The District of Columbia remains weak due to the volume of new supply, and revenue growth is running in the low 1% range. The Pacific Northwest has certainly exceeded our expectations for performance, with annualized job growth of 3%-plus in the last 6 months, supporting stronger demand as roughly 9,000 units are being delivered into the market this year. In Northern California, San Jose has been leading the way, supported by roughly 3.5% annualized job growth over the past 6 months. Job growth in San Francisco has also been healthy, but performance has been a bit more mixed given pockets of new supply in certain submarkets. The East Bay has been the weakest-performing market in Northern California due to more modest job growth and the impact of new supply. We're projecting roughly 4,700 new units will be delivered in the East Bay submarket this year, which is more than what's expected in San Jose and San Francisco. In Southern California, we have experienced weaker performance in Los Angeles, San Fernando Valley and to a lesser degree, San Diego. Some of the weakness in the Los Angeles and San Fernando Valley markets relates to slower job growth earlier in the year. In addition, the Governor extended through mid-November the anti-gouging protections that were adopted following the wildfires last year. These protections kept rent increases at 10% above the lease that was in place immediately prior to the fires, so we can't profitably serve the segments of the market looking for shorter-term leases during the summer months. The absence of the rent premium and incremental occupancy associated with short-term leases has negatively impacted our expectations for performance in the greater Los Angeles market through Q3. In Boston, job growth in the low 1% range and a reduction in the volume of new supply has resulted in relatively steady performance across our portfolio. The slightly weaker for-sale market and more modest demand for temporary workers has tempered the demand for short-term leases, which has modestly impacted our outlook in Boston for Q3. And in New York/New Jersey, we have seen a steady improvement in market fundamentals as job growth has accelerated to an annualized rate of roughly 2% in the past 6 months and the pace of new deliveries, particularly in New York City, has slowed. While performance has improved, we are expecting our revenue growth in the region to moderate in the back half of the year, in part due to the recently adopted rent regulations, which will impact both rental rate growth and the generation of fee revenue. I thought I would also provide a little more insight into the key drivers of our overall same-store revenue growth, particularly as it relates to the first half of the year versus our expectations for the second half. During our first quarter call, I mentioned that roughly half of our same-store revenue outperformance was supported by the reclassification of bad debt and the other half from better occupancy. Through midyear, our same-store revenue growth of 3.3% was roughly 30 basis points ahead of our expectations, 20 basis points of which related to the reclassification of bad debt and an incremental 10 basis points from better occupancy. Looking forward to the second half of the year, we don't expect a material change in fundamentals. In fact, we expect overall rate growth in the second half of the year to mirror what we generated in the first half. The deceleration of revenue growth is the result of tailwinds we benefited from in the first half of this year that won't support incremental growth during the second half of the year. Most notably, as I mentioned, bad debt was a roughly 20 basis point lift in the first half of the year but is projected to be net neutral in the second half. The benefit resulting from our investment in data analytics to better screen prospective residents and enhance our collections effort was primarily realized in the second half of 2018 and the first half of 2019. Second, as we noted during the earnings call this past January, new entrants into our same-store pool from development and redevelopment represent a larger-than-normal percentage of our same-store asset base this year. The amortization of concessions from this pool of assets in the first half of last year provided a roughly 20 basis point lift to our revenue growth rate in the first 2 quarters of this year, but that benefit dissipates during the back half of 2019. And finally, the combination of the New York rent regulations and the extension of the anti-gouging protections in the greater Los Angeles region is projected to result in about a $2 million shortfall in revenue in the back half of this year, which represents about 22 basis points of growth for that period. Now turning to Slide 11. Our development communities in lease-up continued to perform well. During the second quarter, we averaged 32 leases and 38 occupancies per month. Average rental rates were about 2% ahead of pro forma, and yields were up 10 basis points to a very healthy 6.6%. Our performance in certain communities has been quite strong. At AVA Esterra Park in Redmond, Washington, occupancies now reached 53 homes per month, for a total of 160 for the quarter. And rents are currently trending about 5% ahead of pro forma. The projected yield is 6.3%, easily a couple hundred basis points above market cap rates. At Avalon Teaneck in Teaneck, New Jersey, new residents occupied 49 of the 80 homes we delivered during the quarter. Average rental rates at Teaneck were also about 5% ahead of pro forma, and the projected yield is 6.6%, leading to healthy value creation. And with that, I'll turn it over to Kevin to talk further about our development portfolio and the balance sheet.

Great. Thanks, Sean. Turning to Slide 12, we highlight the significant future earnings growth expected to be generated from development underway. Specifically, we have $2.7 billion in new apartment communities that are under construction or recently completed with the projected 6% yield on stabilization. These communities are expected to generate $165 million in annual NOI on stabilization, of which only about $3.5 million in NOI is reflected in our second quarter earnings. This external investment activity, which is already 80% match-funded with long-term capital, will provide us with a durable source of high-quality earnings growth from brand-new, well-located communities that will enhance our portfolio for many years to come. Turning to Slide 13. We show our $3.8 billion pipeline in future development opportunities, which are controlled at a very modest cost and offer a lot of flexibility as it relates to timing the start of construction. Only about half of our development rights are conventional conditional agreements or options to purchase land with private third-party land sellers. The other half are roughly evenly split between asset densification opportunities, where we are pursuing additional density at existing stabilized assets and public-private partnerships, which are generally long-term development efforts that span a number of years. These types of projects allow more flexibility to align the start of construction with favorable market conditions. In addition, it's worth noting that in creating this pipeline, we've been careful to limit our financial exposure so that we enjoy an attractive set of development opportunities at a modest upfront cost. At the end of the second quarter, land held for development was a mere $19 million, and pursuit costs represented an additional $60 million, allowing us to control nearly $4 billion of future development across our markets for an upfront investment of only 2% of projected total capital cost. Collectively, this investment in our pipeline is as low as it has ever been as a percentage of our total enterprise value. And while we've been active on development, we've also been disciplined in maintaining a strong balance sheet.

All right. Great. Thanks, Kevin. And so in summary, our business plan remains more or less intact for the year. Our expectation for core FFO has increased modestly. The portfolio is performing slightly better than expected, with full year NOI growth of 3.25% projected, 25 basis points higher than initial outlook. Rent growth continues to converge to the 3% plus or minus range across our footprint. Lease-ups are performing well, as Sean mentioned, and are projected to contribute meaningfully to FFO and NAV growth over the coming quarters. And lastly, 10 years into the current expansion, we are intensely focused on risk management on both sides of the balance sheet. On the investment side, we are positioned to deliver growth from new development but in a risk-measured way, with modest pursuit costs and land inventory exposure and match-funding development as we start construction. In terms of our capital position, our credit metrics and liquidity are at cyclically strong levels and better-than-industry averages. And with that, Cody, we are ready to open the call for Q&A.

I want to better understand the deceleration of same-store revenue growth in June. At NAREIT, you reported same-store revenue growth of 3.4% for April and May, which was 40 bps ahead of your expectation at the time, but then with 2Q growth only at 3.1%. That implies June growth in the mid-2% range, and then guidance was maintained. So what exactly happened in June relative to the first 2 months of the quarter?

Hey, Nick, it's Sean. Happy to elaborate on that. So as you pointed out, April and May basically came in at 3.4%, which back-end means June was essentially 2.6% or an 80 basis point reduction in the year-over-year growth rate. Really, 3 components driving that. First is economic occupancy in June was down about 30 basis points to 95.9% versus the 96.2% in April and May. Occupancy normally does decline in June just given the volume of activity and lease expirations, but it's probably down about 10 basis points more than we anticipated. So that's 30 basis points total though. Bad debt was a tailwind of 20 basis points in April and May due to the write-off of some straight-line rent in our retail portfolio last year at that same time that provided a lift. As compared to June, it was a headwind of 20 basis points as it more normalized, so the total swing in bad debt from plus 20 tailwind in April and May versus a drag of 20 in June is a reversal of 40 basis points. And then the balance of 10 basis points really relates to decelerating tailwind from other residential revenue as the New York rent regulations kicked in mid-month, slightly less of a lift related to concessions and a couple other just miscellaneous things. So the big bulk of it was the 30 basis point change in economic occupancy and then the 40 basis point swing related to the issues on bad debt that are kind of lumpy.

That's very helpful. And then you mentioned that lease-up continues to perform well, but you're expecting margin and lower new development and lease-up NOI this year versus initial expectations. So what's causing the variance versus your initial guidance with that bucket?

Yes, it's Matt here. I can address that. The lease-up net operating income for this year was largely back-loaded. Currently, we have only a few assets in lease-up, specifically eight. In the first quarter, we had around five. We do expect this to grow over time, as we're opening new communities soon. However, there have been delays in obtaining the first certificates of occupancy for a couple of significant communities on the West Coast, specifically in East Bay and Hollywood, which are quite large. This means we're opening these doors about a month or two later than we initially anticipated.

Sean, I wanted to revisit the issue of bad debt compensation. I need clarification on how it was a negative 20 basis point impact in June, but you mentioned it would be neutral for the second half. Can you explain how that would work? What happened last year that would lead to a net neutral situation for the second half of 2019?

Yes. So as we had talked about, I think, earlier in the year, we had made some pretty nice investments in data analytics that impacted both how we were screening prospective residents as well as our collection efforts. And we've realized the benefits of that kind of in the second half of '18 and first half of '19. So any tailwind from that is not present in the second half of 2019. It's basically sort of a net neutral. And then in addition to that, I had mentioned the noise within the second quarter as it relates to retail defaults that basically sort of propped up April and May growth rate because the write-off occurred last April and May. As compared to June, we didn't benefit from that. So it was really kind of a plus 20, minus 20 for the quarter. It was essentially a net neutral, and you'll see that continue as we move into the second half of the year as well. So we got a nice lift out of the investments we made, but the benefit is now burned off as we moved into basically June through the balance of the year.

Okay. That's helpful. I know you mentioned earlier that there was an impact on rents due to some changes in the short-term rental restrictions.

L.A. Yes.

Yes, in L.A. Can you quantify the impact there for the second half as well? Is that something that matters? There just wasn't a number attached to it.

Yes. Yes. Good question. Our expectation is really there's 2 issues out there that will impact the second half that were not anticipated. One is the rent regulations in New York, which for the consolidated portfolio and same-store is a little over $1 million, it's $1.05 million. And then we're also expecting about $1 million shortfall on revenue across Southern California, mainly focused in Los Angeles, as a result of the lost rent premiums and incremental occupancy that's typically associated with short-term leases that we can't profitably offer to those customers because we're limited to a 10% rent premium based on the rent caps that are in place. So it's not a profitable bet to make for a 2 or 3-month lease, do that for a 10% premium. When you consider the incremental downtime, vacancy, turn costs, different rents when they're done.

Okay, I understand that one or two of your competitors have increased their focus on the short-term rental program. Would you say that their recent success in this area is due to markets outside of Los Angeles? It seems likely that it is.

If you're complying with the anti-gouging laws related to 10% rent caps, I suspect that people are not offering short-term leases in that market. At least, in our view, it wouldn't be a profitable offering.

This is Lauren Weston on for Richard Hill. Could you just provide a little bit more color on what drove expenses higher? Specifically, in California, we see same-store expenses up nearly 7%. So can you just provide some more color around what drove that?

Sure. Happy to do that. This is Sean, Lauren. As it relates to Southern California and Northern California, both up north of 7%, a number of sort of unusual things going on there. In terms of Southern California, there was a supplemental property tax assessment that came in. That's responsible for about 30% of the increase. We had our insurance renewal. It's about 15% of the increase. The other thing is we had a pretty soft growth rate last year. It was a little bit of a tough comp as it relates to the timing of maintenance projects and stuff. So it's kind of one-off items, if you look at it. And then in Northern California, some of the specifics there. In terms of property taxes, it's about 20% of the increase. Utilities were about 15% because of a rebate last year, sort of a year-over-year comp issue. And then in both regions, we were hit harder with benefits based on some claims activity in the second quarter, that impacted those numbers. So that's what's happening specifically in the California markets. In terms of just overall expense growth, maybe sort of high-level comments on things that are sort of outside the normal range. Payroll was up. About 2/3 of that relates to the increase in benefits cost that came in late in the quarter based on claims activity, and the balance of it was related to merit increases. If you look at payroll on a year-to-date basis, about 90% of the growth in payroll is due to benefits, but it's been offset by headcount reductions on site as part of our operating model work. And headcount on site is down about 4% year-over-year. So that's what's happening in that category. And then things like marketing on the positive side certainly reduced costs for ILS and PPC marketing, along with material reductions in our call center costs as a result of our adoption of AI for lead management earlier this year. Those are some of the outliers.

So I have a question based on the macro assumption changes that you made. So your delivery assumption is now down 40 bps to 1.9%. So I was just curious if you can give a little bit more color on which markets those were in, and have you seen any material benefits in '19?

Yes. Shirley, Sean. Happy to address that. In terms of delays, the delays were most pronounced in New York City and Northern New Jersey, about 1,500 units in New York City, 1,900 in Northern New Jersey, about 2,800 units in San Jose. And I mentioned in my prepared remarks that San Jose is kind of leading the way in Northern California. It's been a healthy market, certainly supported by reduced deliveries. And then about 3,900 units in terms of fewer deliveries in Los Angeles. Those are the ones that are most pronounced. And yes, our expectation is, that's sort of the heart of your question, is that we would expect these deliveries to bleed into 2020.

Okay. That's good color. And on job growth and wage growth. So your assumption came down 50 bps versus job growth that was only up 10 bps. So I was curious as to how you guys think about that dynamic between those 2 drivers in relationship to demand.

Shirley, this is Tim. First of all, those are not our numbers; we rely on third-party figures. The wage growth number reflects the entire population. It’s a valid question regarding our resident base. Our residents likely experience somewhat stronger wage growth, particularly due to the higher concentration of individuals with 4-year college degrees in our units. I'm not entirely sure why the growth falls short from 3.5% to 3% given the labor shortage and tight job market. However, the key point from our perspective is that the major demand drivers are largely aligning with our expectations, with slightly better job growth and marginally weaker wage growth—though the difference is so small it could be considered a rounding error.

This is Trent Trujillo on with Nick. Sean, going back to the revenue growth from June, what drove the occupancy drop beyond expectations? Is that from pushing a little bit too aggressively on rent or not enough demand, move-outs to buy or some other factor?

Yes. I mean I'd say, generally, this relates to us having our foot on the gas earlier in the year. As we mentioned during Q1 and the early part of Q2, occupancy was running ahead of plan. So that would ignite a price response in terms of us being somewhat more aggressive. And so when you're talking about plus or minus 10 basis points, that's a little hard to call it that close in any 1 given month. I think I mentioned in my prepared remarks that, normally, you see declines in occupancy as you move into June. And so it was incremental 10 basis points or so as a result of what was primarily that effort. And then in addition to that, the only other thing I'd point to is you start seeing some of that short-term demand in L.A. show up in June, and we didn't have that this year.

Okay. And are you able to disclose the spread between asking rents and what was accepted, what was signed?

In terms of renewal offers? Yes. So in terms of renewal offers, those numbers typically run anywhere from 60 to 80 basis points. If you're in a really soft market, as much as 100 basis points, if that's what you're looking at in terms of overall acceptance.

Okay. And then, I guess, shifting a little bit, I'm sorry if I missed this. But if you haven't spoken about it yet, can you give an update on the condo sales process at Columbus Circle and how you're positioning that asset given the generally slowing high-end condo sales market in New York?

Sure. This is Matt. I can provide you with an update on both the residential and retail leasing. Regarding the residential, we've been open for sales for about three months and currently have 23 executed contracts, which aligns with our expectations. The average sale price is around $3 million, and 80% of the units are priced below $5 million. We've noticed some softness in the market for homes priced above $5 million. We're actively gathering market feedback and will continue to monitor the situation. On the retail side, we've executed another lease for 2,600 square feet on the ground floor since our last call, bringing our total leased area to 69% based on square footage and roughly 55% based on revenue. To remind everyone, we have approximately 66,400 square feet of rentable retail space. So far, we've leased about 45,500 square feet, leaving around 21,000 square feet still available. About 12,000 square feet is located on the second floor, and we are currently in negotiations with a prospective tenant for that space. Additionally, there are roughly 9,000 square feet remaining on the ground floor in two separate areas. Progress is being made as expected, and we will continue to advance on this front.

This is Alex on for Drew. Given the softness in Southern California, curious if you could give us some commentary on why you're choosing to both buy and start developments on assets in the region. Are pricing and yields adjusted to reflect the conditions today? Are you guys expecting some incremental improvement in your underwriting?

Sure, Alex. This is Matt. I can address that. Southern California is performing well, and as Sean noted earlier, the performance across all regions is aligning. Historically, Southern California has been one of our most reliable and strong-performing regions. It boasts a highly diversified economy and a solid long-term track record. While we typically won’t see rental growth around 5%, 6%, or 7% like we do in peak years in Northern California or Seattle, it doesn’t experience significant rental declines either. Currently, its performance aligns with its historical trends, which we find favorable. We acquired a relatively small asset there last quarter and are starting a significant project in Orange County this quarter, with plans for another project in Southern California later this year. The development pipeline is contingent on when those projects are ready to commence. Both of these projects were agreements made 2 to 3 years ago. We haven’t entered into new development in either Southern or Northern California recently due to more challenging development economics. However, we have a pipeline of deals established earlier in the cycle where the economics are still viable, and we’re also concentrating on asset densification opportunities. We added one of these projects in Southern California late last year that may commence next year, along with several in Northern California and one in Seattle.

Great. That color's really helpful. And then looking at the Belltown Towers, the WhyHotel deal. Curious if the initial leasing activity is what motivated that, or was it already in the hopper, and then kind of why you're talking about it. I know we're only dealing with 50 units right out of the gate, but just curious if you could give us some color on how that agreement works and kind of where you guys could see that going if it turns out to be a success.

Sure, this is Matt. I can address that. Yes, we have been discussing this for about 1.5 years. It's particularly beneficial for large assets like high-rises because of the way the building and fire code units work, which leads to many units being turned over in a short timeframe. This results in a significant amount of standing inventory regardless of market strength. It's suitable for situations like this, where we need to turnover all those apartments quickly. This creates extra capacity and allows us to temporarily generate revenue from that capacity. The deal includes a base rent and a participation component based on their performance. The initial term is 6 months, with some options for extension. We aim to have the leasing fully completed in about a year, so if all goes well, they would likely be there for around 9 or 10 months. I believe they are scheduled to open later this month in August.

Tim or Matt, just curious to get your thoughts on your long-term outlook on your Connecticut portfolio and then suburban Jersey, Central, Northern New Jersey. 3 to 5 years, will you be net growers or shrinkers in those markets?

Sure, John, Tim. I think we've talked generally about capital allocation particularly as it relates to our expansion markets of Denver and Southeast Florida, and that we'd fund those, in part, out of selling out of some of our northeast markets. We have been selling some of our Connecticut communities. In the case of New Jersey, we've always had a deep and robust pipeline to create a lot of value. So it just kind of makes sense to sell some of those assets over time and recycle capital within that region. But I think probably New Jersey will continue to be more active from an investment standpoint than Connecticut. It's a healthier economy than Connecticut. And if you look at kind of what we have, left in Connecticut, it tends to be the stuff kind of closer, Southern Fairfield, closer to Westchester, where it feeds more off of the dynamics in the city and Westchester County.

Okay. And I know you've pruned in Connecticut the last 5 years, give or take. Is Connecticut a full exit in the coming years?

We have not made that decision. Most of what we have left is likely more aligned with the properties we own in Westchester. We do own in areas like Darien and New Canaan that are relatively insulated from supply issues. However, if the state's finances continue to deteriorate, we will keep evaluating our ownership position there.

Okay. And then last one for me. Just the land bank going forward and sites we don't yet see on Attachment 9. I guess in 2 or 3 years, when these roll in, is the mix more suburban or less suburban than the sites currently under construction?

Hey, John, it's Matt. I'd say it's probably pretty similar, likely more suburban. We don't have much urban development under construction right now, and we have one high-rise in the pipeline among those 28 development rights. So we're continuing to find much better value in the suburbs and better risk-adjusted returns. Our sweet spot is really high-density wood-frame product, and I expect that to continue until the cycle shifts.

I think Sean, you mentioned in your prepared remarks that New York rent regulations will contribute to a $2 million shortfall in the second half of this year in revenue. Can you just remind us or clarify what exposure you have to rent-stabilized units that are not 421-a units in New York?

Yes. So John, this is Sean. I'll clarify a couple of things. The $2 million actually represented 2 different components that I quoted. One is a little over $1 million in terms of the impact in the second half of the year of the New York rent regulations. The other $1 million is the loss of short-term lease revenue, both premium and occupancy, in L.A. That's the shortfall in the second half of the year, the $2 million. As it relates to the New York regs specifically, in New York City, we have 4 assets representing about 2,100 market rate rent-stabilized units that basically have another 10 years to run sort of on a weighted average basis to maturity. That would be impacted in terms of the cap on taking preferential rents to legal rents when people move out, things like that, if that's what you're looking for in terms of information.

And what will be that impact going forward?

Yes. We haven't modeled it beyond this year. As you get out 6 months, 12 months, 18 months, there's a lot of different assumptions that go into turnover rates and things of that sort. So we've not done a complete modeling on that over a longer period of time. So at this point, we're providing what we believe is the second half of 2019 impact. And once we see the market response to what's been adopted in the way of turnover, the potential impact on OpEx, the potential impact on the spreads between preferential rents and our ability to go to legal, what they would have been versus where they come in based on the RGB guidelines, just to make assumptions to model until we start to see some market response to the regulations that were adopted.

Sure. Then if I could ask a couple of questions on your blended lease growth rate, just the easier one first, a, do you provide a guidance for what this will be this year? And then secondly, when I look at Page 10 of your supplemental, it shows 3.3% this quarter and then 3.2% in the second quarter of last year. But if I look at last year's supplement, and I apologize, you may not have this in front of you, but last year's supplementals had about 2.8%. So is that difference of 40 basis points just change in mix?

Yes, there was a change in the basket. As we mentioned earlier on this call and in January, the number of new entrants into the same-store pool from development and redevelopment was unusually high this year. These assets typically perform better regarding lease renewal changes and new move-ins due to factors like the burn-off of concessions. You are only leasing half the units during turnover instead of the entire building in the first year, among various other drivers. This can significantly impact our rate growth in the following year.

And what's your expectation for this year?

Our expectation for this year was blended rent change of 2.8% for the full year, which is up about 20 basis points from what we achieved last year at 2.6%. And that's still our expectation for this year.

John Guinee here. I have a curiosity question. I noticed one of your slides shows $19 million of land on the balance sheet, along with another $60 million in pursuit costs. Can you clarify where the pursuit costs appear on the balance sheet? Are those being expensed?

John, this is Kevin. They would show up in our other assets category, which we provide detail on in connection with our 10-Q.

Great. Okay, other assets. All right. And then second, looking at a lot of your recent starts, as you mentioned, your sweet spot is high-density wood-frame. Looking at Marlborough, Owings Mills, Brea, can you talk a little bit more about the product? Is this surface park? Is it wrap? Is it podium? And by the way, when was the last time you actually started a high-rise?

Sure. This is Matt. Those deals, Brea and Owings Mills, are both wrap deals. And Marlborough is a small second phase that's actually garden and direct-entry product. It's kind of a piece of land joining a community we completed there a couple of years ago. The last high-rise we started was the East Harbor deal in downtown Baltimore, which we started last year. And Southeast Florida is different because everything's concrete there because of the hurricane codes, but we did start the deal in Doral last year, which is 7 stories, 8 stories. That would be right on the verge between what you call mid-rise or high-rise, although technically, it's the mid-rise code for Southeast Florida.

I've got 2 for you. On the first one, just broadly speaking, taking a step back from the quarter, we asked some of your peers about suburban versus urban kind of exposure. I think EQR kind of mentioned you don't like the suburban areas because when supply hits, there's not enough demand to absorb it. UDR kind of focused on just the first string. What's your perspective on it? Obviously, we've heard from you before, but just how do you see that playing out when the cycle turns?

Yes, this is Tim. First of all, I believe much of our suburban portfolio could be considered first string as well. I view it as infill or urban-adjacent. Our properties are mostly situated in employment centers, where economic activity and jobs are concentrated. As we’ve mentioned before, we maintain a somewhat indifferent stance between suburban infill and urban areas. We allocate capital in the markets seeking the best risk-adjusted returns, which can change over time. Sometimes, urban areas get overbuilt, while at other times, suburban areas do. Throughout different points in the cycle, there are better investment opportunities in one over the other; it's not always just one type. This approach is central to our strategy. If you analyze it over the long term, rent growth patterns in both areas tend to align closely, though they can occasionally diverge within the cycle. Currently, urban areas are experiencing rent growth at or slightly above suburban areas, marking the first instance of this in about four years. Although there is still more supply in urban markets, it indicates that demand in those areas is growing stronger. We acknowledge this situation; however, supply has been excessive in urban markets over the past four to five years. We're beginning to observe that many urban submarkets are catching up and, in some instances, surpassing suburban markets. As Matt pointed out, if we look at total returns on invested capital, our focus has generally been on infill suburban properties due to their favorable development economics and a generally healthy supply and demand balance in those areas.

Got it. And just as a quick follow-up to that, are you seeing other developers kind of incrementally shift their focus to the suburban infill markets that you guys have kind of been involved in since, I guess, '17 and maybe even earlier?

Yes. I think to some extent. I mean the average developer is a merchant builder. It's not an investment builder. And so just really, you're looking at deals where they think they can get the highest risk-adjusted initial going-in return, maybe not quite as focused on what the long-term return will be because they tend to exit pretty quickly. So I would say that it's probably been just because construction costs in some of these urban markets have kind of gotten out of control, that there's probably been unbalance, a bit of a shift from urban to suburban because it's been more economic, at least from an initial yield standpoint.

Just 2 questions. First, on New York, and maybe I missed it upfront, but 2 parts to this. One, did you guys quantify the revenue hit from the new regulations as far as fees and all that stuff? And then, two, on that front, given presumably we'll see less supply given the tougher regulations, your 421-a assets, do those in your view become more valuable because eventually they'll be market rate? Or the impact of the real estate tax abatement burn-off, coupled with maybe the length of time that the 421-a units are in existence, make it probably something that you'll look to continue to pare just as you sold some 421-as in the past?

Yes, Alex. This is Sean. Why don't I start with that one and then others can jump in as well. In terms of the dollar impact, yes, we did mention that in the second half of this year, we expect the impact on same-store sales and to our portfolio to be just over $1 million across the state. About 90% of it relates to the loss of fee revenue across the assets, which is not just in New York City, as you know, but across the state and then modeling some assumptions as it relates to turnover and things like that. But we don't really have the market feedback on that just yet. And then in terms of the 421-a assets, Matt can jump in on that, but one of the things that we'll be trying to do is as we get market feedback about what happens to turnover rates, what happens with the RGB guidelines in terms of increases that's going to help kind of give us a better sense of the profile of loss to lease over a longer period of time and what impact that may have in terms of value at the end of the expiration of the tax abatements. But it's hard to predict what that looks like today.

Yes, I agree. There has been some discussion regarding the impact on future new supply in New York. The affordable New York program, which replaced 421-a, remains unaffected by these changes. Therefore, in the short term, it does not alter the outlook for new supply. Over the past couple of years, the rental economics for new rentals, particularly in Manhattan and the boroughs, have not been favorable due to high construction costs compared to rental prices. However, this situation has not fundamentally changed. There are speculations about additional restrictions on landlords, such as fees, the ability to charge late fees, and eviction restrictions, and whether these will affect the desirability of owning multifamily real estate in the long term, subsequently influencing supply. It is still too early to determine that.

Okay. Regarding your condo tower at 15 West 61st, do you believe it would now be more valuable as a rental since it is free from rent regulation? Or do you still think it is more valuable to sell as a condo on an IRR basis?

We have consistently emphasized that the site provides significant flexibility, particularly in not being bound by any specific regulatory framework regarding rents when it comes to rental assets. This was the case previously and remains unchanged. Therefore, we are currently marketing condos and seeking market feedback to confirm our assessment of the value difference between the property as a condo versus as a rental. We aim to gather as much data as possible on this matter before making a final decision.

Just a couple of quick ones here. I was curious if there's been anything that you've seen on the demand front in terms of pullback or peaking early this year. Could you just provide any detail or thoughts there?

Yes, Austin, this is Sean. Nothing material at this point. I mean pretty normal seasonal patterns throughout the markets this year. I think we'll learn more in the second half of the year in terms of some of the mix, macroeconomic sentiment that's out there and how it might influence demand. But at this point, not a material shift.

Okay. I appreciate that. And then secondly, you footnoted 2 acquisitions are expected to close in the third quarter to get you to the $300 million you've now assumed in guidance. I think you included 1 of the 2 in your release, but can you provide some detail on the second deal, location, economics, et cetera?

Sure, Austin. It's Matt. The second deal is in suburban Miami-Dade County. So it would be our third stabilized asset in Southeast Florida. So we're pretty excited about that. We expect it to close later this month, and it's close to $100 million, and it's kind of a mid-4% cap.

I appreciate that. And then just any other update on the acquisition opportunities in your expansion markets, be it South Florida or Denver, beyond the $100 million that you just announced?

We're actively looking at acquisition opportunities, and the market remains quite active. Denver has slowed slightly, with several properties in lease-up facing challenges in reaching full occupancy, possibly delaying their market entry until they are fully leased. In Southeast Florida, the pipeline and volume appear stable, and we're still exploring options there. Overall, cap rates have likely decreased a bit over the last few quarters due to interest rates, with almost everything we are selling falling below 5% regardless of the location or age of the properties. We're also observing similar trends on the buying side, with expected purchases generally falling in the mid-4% to high-4% range.

Yes, Austin. This is Tim. It's interesting that if we look at operating performance or cap rates, it appears that everything is aligning around 3% for rent growth and in the mid- to high-4% range for cap rates, almost regardless of the market at this time.

Yes. Thanks, Cody. Nothing else on this. And thanks for being on the call today, and enjoy the rest of your summer.