Avalonbay Communities Inc (AVB) — Q3 2019 Earnings Call Transcript

Thank you, Vicki, and welcome to AvalonBay Communities' Third 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.

Thanks, Jason, and welcome to our Q3 call. With me today are Kevin O'Shea, Sean Breslin, and Matt Birenbaum. Sean, Matt, and I will provide brief commentary on the slides that we posted last night, and all of us will be available for Q&A afterwards. Our comments this morning will focus on providing a summary of Q3 and year-to-date results; an update on operations, including some areas of innovation and the operating platform; and then lastly, a review of the development portfolio. Starting now on Slide 4. Highlights for the quarter include core FFO growth of just over 2.5% for the quarter and 3.3% year-to-date. Same-store revenue growth in Q3 came in at 2.7% or 2.9%, including redevelopment, with most regions clustered in the 2.5% to 3% range. Year-to-date same-store revenue growth stands at 3.1%, or 3.2% including redevelopment. We completed a $90 million community in Seattle this quarter at an initial yield of just over 6%, $335 million so far this year at an average yield of 6.3%. We purchased 2 communities totaling $135 million in the quarter, including our third community so far in Southeast Florida, where we also have one development underway. We sold 4 communities in Q3 totaling $260 million, including the last few assets in Texas that were acquired as part of the Archstone transaction. Lastly, in late September, we entered into a forward contract of $200 million of equity, which will be settled over the next year and will help fund the remaining cost to complete the development currently under construction. And with that now, I'll turn it over to Sean to discuss operations.

Okay. Thanks, Tim. Turning to Slide 5. This chart represents the trailing 4-quarter average rent change for our same-store portfolio and shows the East and West converging to average roughly 3%. During Q3, however, rent change for our East Coast portfolio was 3.6%, 80 basis points greater than the 2.8% produced by our West Coast assets. The last time our East Coast portfolio outperformed the West from a rent change perspective was Q4 of 2010. During Q3, the East Coast portfolio was led by a 4.6% rent change in New England, up 50 basis points year-over-year; and 3.8% in the mid-Atlantic, up a very healthy 140 basis points year-over-year. On the West Coast, our Pacific Northwest portfolio produced like-term rent change of 4.1%, which was essentially unchanged year-over-year. Northern and Southern California delivered rent change in the 2.5% to 3% range, each down more than 100 basis points year-over-year. Turning to Slide 6. I'd like to highlight a few of the components of revenue growth in the first half and the second half of this year. As indicated on the chart, we expect relatively stable rental rate growth, which is the primary driver of same-store revenue growth throughout the year. However, as I mentioned during our Q2 call, revenue growth in the first half of this year benefited from the burn-off of lease-up concessions from new entrants into the same-store pool, a reduction in bad debt and healthy revenue growth from our retail portfolio. In total, these components contributed an incremental 70 basis points to rental revenue growth during the first half of the year. We don't have much of a tailwind from those same components in the second half of the year, and the benefit we are realizing is being offset by the impact of rent caps in L.A. and the recently adopted rent regulations in New York. As a result, revenue growth in the second half of the year is more in line with actual rental rate growth. Turning to Slide 7. I'd like to share a little bit about what we're doing on the innovation front, which will enhance our operating margins and allow us to reach new customers. As indicated on the left side of Slide 7, we're leveraging various technologies, our scale and new organizational capabilities to create value through a number of initiatives, including those identified on the right side of the slide. Some of our margin-enhancement initiatives relate to leasing and maintenance service, which I'll address in more detail shortly, along with customized renewal offerings and centralized renewal administration. In addition, we're studying opportunities to use AI, digitalization, and various other technologies to improve the productivity of our property management organization, including our call center operation. We're also using our scale and technology to reach new customers. In the residential space, a segmentation study indicated that roughly 10% of the renter market would prefer a furnished apartment home. We started offering furnished apartment homes in select locations about 18 months ago. Based on early results, we expect to scale it to 5% or more of our portfolio over the next couple of years. In addition, we are pursuing a strategy to profitably serve the limited service segment of the rental market through the development of a new community featuring high-quality apartment homes and amenity-light design and limited community services. As compared to our typical development community, we expect to reduce capital cost per home via thoughtful design, choice of materials, and the elimination of almost all the amenity space. On the operating side, we expect to reduce operating expenses by eliminating most of the on-site staff as most of the customer interactions would be facilitated by technology and the cost of maintaining what tends to be expensive amenity spaces. The net benefit to the customer is a rental rate approximately 10% to 20% below other new communities in the area. Our first pilot community is currently under construction, and we expect initial results in the next 12 to 18 months. Turning now to Slide 8 to provide more detail on a couple of initiatives. About 18 months ago, we mapped out all the customer journeys tied to leasing an apartment and created a new technology-enabled self-service model for most leasing activities. We started implementing the first phase of our redesigned customer journey earlier this year, which includes the use of an AI-powered automated leasing agent and the adoption of a more dynamic demand-driven staffing model. Our automated agent is now fully deployed across the entire portfolio. The screenshot on the right side of Slide 8 represents a clip of a recent text conversation our agent had with a prospective resident. The automated agent operates 24 hours a day, 365 days a year, and we're seeing improved performance metrics as a result of our adoption of this technology, including about a 700 basis point improvement and leads to our conversion ratios. We implemented our new staffing model in 2 regions this year and expect to adopt it across the entire portfolio by the end of next year. We've seen a substantial improvement in productivity across the 2 pilot regions and expect similar results in our other regions. Other components of the new leasing model included more self-guided tours and self-service move-ins. Overall, we expect to realize about a 50 basis point improvement in our same-store operating margin as a result of our new approach to leasing, which is primarily driven by an increase in the productivity of our leasing teams. Turning now to Slide 9. We've also created a road map for our new maintenance service model. There are several phases to the plan, but it includes digitalized workflow and procurement, automated scheduling via a new optimization platform, the application of data science to predict demand and enhanced associate performance metrics. We're in the process of integrating the new maintenance platform with our other enterprise systems, which would allow us to implement the first phase in Q1 2020 and realize stabilization of roughly mid-year 2021. We expect another roughly 50 basis point improvement in our same-store operating margin from our new maintenance service model, which is primarily driven by an increase in the productivity of our maintenance teams. And lastly, turning to Slide 10, I'd also like to provide an update on some of our environmental initiatives. Over the past few years, we have invested in a number of opportunities to reduce energy consumption and carbon emissions across our portfolio, including LED lighting, which is already generating more than $3 million in annual utility savings; and on-site solar generation, which we have started to install more broadly after completing several pilots. We are on track to have almost 6 megawatts of carbon-free, power-generating capacity installed by the end of next year, providing strong returns on a $20 million investment and with more opportunity to extend solar into additional assets in future years. With that, I'll turn it over to Matt to talk about development and Columbus Circle. Matt?

All right, great. Thanks, Sean. Our development activity continues to be a strong driver of both NAV and earnings growth even this far into the business cycle. As seen on Slide 11, we currently have $975 million of development that is currently in lease-up or has recently been completed across 10 communities, with a weighted average initial stabilized yield based on today's rents and expenses of 6.1%. We believe these assets would be worth roughly $1.3 billion in the private market, generating $325 million in value creation on completion, which translates directly into corresponding growth in NAV. Slide 12 illustrates the future NOI growth we expect as we complete all of the development currently underway. On the left-hand side of the slide, you can see that at stabilization, we anticipate $60 million in NOI from the $975 million worth of assets shown on the previous slide that are currently in lease-up, plus another $103 million in NOI from the $1.8 billion in assets that are under construction but not yet in lease-up, for a total of $163 million in future NOI to come. And as shown on the right-hand side of the slide, this activity is almost completely match-funded between our recent forward equity deal, free cash flow, and cash on hand. In addition, the projected sources of capital as shown do not include proceeds from pending asset sales or condominium unit sales, which we expect to realize in Q1 2020 and which exceeds $100 million remaining to fund. With initial yields well above our marginal short-term cost of capital, this development activity is projected to contribute meaningfully to earnings growth over the next 2 to 3 years. Speaking of condominium sales proceeds, Slide 13 provides an update on our mixed-use building at Columbus Circle in Manhattan, which has been renamed The Park Loggia. As we have discussed on prior calls, we began marketing individual apartments in the building as for-sale condominiums back in April. And based on the market response to our offering, we can now confirm that we are proceeding with the condominium execution for the residential component. The Park Loggia has been the top-selling property in Manhattan since the sales launch, and we currently have 40 signed contracts, which we expect will move to settlement in early 2020 once the individual tax lots have been recorded with the city. The retail component also continues to be well received by the market, with our anchor tenant, Target, opening for business any day now. Of the 67,000 square feet of total retail space available for lease, about 45,500 has been leased so far. And we are in advanced negotiations for another 10,300 square feet on the second floor, which would leave us with about 11,000 square feet left to lease, most of which is on the ground floor with Broadway frontage. Ultimately, we expect to generate roughly $10 million in total NOI from the retail component of this project once it reaches stabilization in 2021.

Okay. Thanks, Matt. So in summary, apartment markets remain quite healthy, with most markets in balance producing consistent revenue growth of 2.5% to 3%. For the first time, as Sean mentioned, since late 2010, the East Coast is performing either in line or slightly ahead of the West Coast. We're investing aggressively in our operating platform, leveraging scale, technology, and capabilities to grow margins by driving efficiencies in leasing, maintenance, and utility costs. We expect our investments in these areas to stabilize over the next several quarters. And we continue to create significant value through our sector-leading development platform, an activity that's consistently delivered 30%-plus value creation margins over this 10-year expansion cycle and combined with our practice of match-funding should contribute meaningfully to earnings growth over the next couple of years. And with that, Vicki, we are ready to open the call for Q&A.

Sean, you highlighted the rent growth conversion. With what we're seeing today, what are your expectations for the East and West Coast from here? Do you think we'll see sustained rent outperformance from the East Coast over the next 12 months?

Yes. Nick, Sean here. Good question on that topic. I mean, there's a number of factors out there that kind of relate to the outlook for demand and supply as we move into 2020. On the supply side, if you want to think about it, where we're seeing some benefit on the East Coast going into next year for the most part was in New York City where supply is coming down, projected to be roughly in half in 2020 as compared to deliveries in 2019, 2018. So we expect a little bit of benefit there that may be muted, to some degree, obviously, by the rent regulation. The first half of next year, we're going to see some impact from that as it bleeds through. As you know, it started mid-year, so we have the back half of '19 and the first half of '20. We'll see a little bit of dilution from that. But from a pure market fundamentals perspective, if you’re going to look at it that way, New York City looks pretty good. Boston, we are going to see more supply in the urban submarkets of Boston next year. And then as you come down to the Mid-Atlantic, for the most part, things will be roughly at par from a supply standpoint. And if you pivot to the West Coast with the same question, we're expecting more supply in Northern California across all 3 markets, specifically in San Francisco, the East Bay, and San Jose, and a little bit more in L.A. So if you think about sort of the supply side of it, assuming the demand side was relatively stable, and there's a number of reasons why you'd expect it to potentially decelerate a little bit from a job growth perspective, et cetera, based on macroeconomic factors, those are the markets where we're probably going to see some change, either to the upside or the downside, based on the deliveries. The one interesting component I'd point to is sometimes it's not all just embedded in the jobs data that we see or the supply data that we see. So in the Mid-Atlantic, as an example, it's had a nice tailwind this year. Jobs and supply has been about what we expected, but federal procurement's up quite a bit and that tends to bring a lot of contractors to the region. So some of those factors have come into play. So net-net, you'd have to look at it sort of market by market. But there are good reasons to expect the East Coast to continue to perform well based on what we see. Whether it's at par or above the West Coast is yet to be seen.

Yes, I think one of the remarkable things is how closely aligned all the markets are. While the East is slightly outperforming the West, it's striking that all the markets are performing within 50 or 100 basis points of each other, which is unusual for this point in the cycle. It seems like we're nearing equilibrium across the board, which is quite notable considering how supply fluctuates during the cycle in any given market. I don't know if there's a clear consensus on whether the East or West will outperform next year, but from our perspective, the markets are essentially balanced and approaching equilibrium.

That's very helpful. And then just on the Upper West Side condo sales, for the 40 signed contracts, what's the average sales price?

Nick, it's Matt. I don't want to give too much detail, but we do have 40 signed contracts. The average price of those particular units is about $2.750 million, and they're in different parts of the building.

So just a question on some of the tech spending that it looks like you guys are ramping up on. I know you expressed this in terms of basis points of NOI growth impact. But could you maybe translate that into sort of an old-fashioned ROI? What incremental spend do you expect to roll out? And what's sort of the estimated ROI on all of that if we take all the categories together?

Yes, Rich, this is Sean. I want to provide some insight into our current situation. We're making significant progress in several areas, particularly in leasing and maintenance, which are further along compared to the development side where capital budgets are assessed on a per-home basis. Regarding leasing and maintenance, we anticipate that a $10 million investment will lead to an improvement of approximately 100 basis points in margins. This translates to a strong return on investment given the expected operating margin enhancement.

Okay. Yes, we can do that. Secondly, there was an increase in repair and maintenance expenses last quarter in a few markets. This is part of the broader discussion regarding technology and efficiency spending. Could you talk about labor expense growth, considering both the tight job market and the new supply in your markets? How do these two factors interact with labor expense growth in those categories?

Sure, I'm happy to address that. To start with, when examining each quarter, there can be significant fluctuations. We encourage focusing on a year-to-date perspective due to various factors at play. For instance, there is considerable variability in repair and maintenance spending. Late in Q2 and into Q3 typically sees the highest levels of maintenance project completions, particularly in markets like the Northeast and mid-Atlantic due to weather conditions. Seasonal patterns also affect turnover related to repair and maintenance. On the marketing front, we experienced a notable credit from our call center in Q3 of the previous year. If you analyze last year's Q3 operating expenses, marketing spending was down about 21%, which explains the sizable increase this year. Therefore, it's essential to evaluate this over a longer timeframe. Regarding labor, we've seen some efficiencies year-to-date, with payroll costs increasing by 270 basis points. Of that, approximately 140 basis points is attributed to benefits and workers' compensation, which can vary greatly due to claims activity. The remaining 130 basis points reflects organic growth associated with our field associates. Wage growth for our workforce typically ranges from 3% to 4%, and possibly higher based on ADP data, indicating constrained labor cost growth on a year-over-year basis. We have managed to maintain control over costs mainly by improving efficiencies in our office operations and innovating our operating model, resulting in a reduction of full-time equivalents. Meanwhile, merit increases for our associates remain in the 3% to 4% range year-over-year. It’s worth noting that certain markets are experiencing pressure from minimum wage regulations, which is impacting maintenance labor costs for outsourced services. Despite a reduction in turnover, labor rates in areas such as Northern California and Seattle are on the rise, leading to higher costs from vendors. This is why we are investing in our maintenance initiative, aiming for greater efficiencies in both our labor and in contracting outsourced labor, to address these challenges effectively.

A couple of things. Getting back to rent regulation, we've heard some mixed commentary with some of your peers. So I was wondering if maybe you could think about the impact on revenue breaking down California and New York City, or if it's too early to sort of think through that detail.

Rich, this is Sean. And when you say breakdown, what are you looking for? Just kind of what the expected impact is this year or next year?

I found the color in your pitch book after earnings very informative, especially regarding the offsets. I'm curious to know whether you perceive California or New York as more challenging. We view New York City as being more difficult, and you've mentioned reducing your presence there. I believe the market initially thought California's over 5% inflation wasn't a significant issue, but it seems there are challenges emerging. I'm trying to gauge how much of this offset is influenced by California compared to New York.

Let me provide a quick overview of each situation for clarity. In our last quarterly call, we mentioned that we anticipated the same-store impact in New York for the second half of 2019 to be around $1 million. Approximately 80% of that is due to the loss of fee income from application fees and similar sources. This will decrease the growth rate in the New York/New Jersey region by about 25 basis points for the entire year, while the overall growth for the same-store portfolio is roughly 6 or 7 basis points. Since this is concentrated in the second half, the actual impact will be around 10 or 11 basis points. For New York in the second half of this year, we expect a similar effect in the first half of next year until the second half of 2020, when year-over-year comparisons are likely to stabilize. The effects from the second half of 2019 will carry into the second half of 2020. Looking further ahead introduces some complexity, as various factors can change projections. Different REIT owner/operators will provide diverse insights about their assets and the potential effects. So, it’s understandable that there are varying opinions on what’s happening in New York. Additionally, regarding rent stabilization, it affects about 2,100 units, and after about a decade, the 421-a programs will expire, relieving us from that burden. As for AB 1482 in California, there are a few angles to consider. We reviewed our portfolio performance under what would have happened if AB 1482 had been enacted in 2018 or 2019. The result indicated a 20 basis point impact for both Northern and Southern California, which represents about 40% of our portfolio—roughly 8 basis points for the year. Another important aspect is how the reset on January 1, 2020, will influence our growth rates for that year. If the regulations took effect on October 1 and we had to backtrack leases to the first quarter of 2019, it would slightly reduce our embedded growth by about 5 basis points. While this may not seem significant when viewed across the overall same-store portfolio, it will appear more consequential in the regional markets. Ultimately, the impact will depend on the market's condition and whether we reach the caps. Another critical factor that is often overlooked includes short-term lease extensions and month-to-month leases, which limit our ability to generate additional revenue. This year, for instance, the fire-related rent caps in Los Angeles resulted in a loss of about $1 million because we couldn't profitably engage in short-term leasing. Therefore, all these different factors must be carefully evaluated. I realize that's a lot of information, perhaps more than required, but that is our current perspective.

No. That's, I think, the transparency that I was certainly looking for. One quick follow-up question. And I apologize if you mentioned this on your prepared remarks, maybe I missed it. And I recognize you don't give quarterly guides. But it looks like the full year guide implies some pretty healthy growth in FFO year-over-year in Q4 '19. Is there anything specific driving that, that we should think about?

Rich, this is Kevin O'Shea. We typically do see a ramp in core FFO as we progress through the year because of our developmental focus. Specifically, as it relates to the ramp from Q3 '19 to Q4 '19, the sequential growth in excess of core FFO is being primarily driven by seasonally lower operating expenses and by development NOI from lease-up communities. So those are the 2 main drivers of the impact.

I have a follow-up question about supply. You mentioned that exposure in New York City is expected to be down 50% next year. Can you provide some numbers regarding the West Coast markets you discussed? You mentioned some qualitative insights about supply, but do you have any statistics?

Yes. Sure, Jeff. This is Sean. Happy to do that. So on the West Coast market specifically, we are expecting basically flat deliveries in Seattle. But in terms of Northern California, I mentioned supply deliveries across all the market. It's about 1,000 units more in San Francisco, about 1,800 in East Bay, about 1,500 in San Jose. And then in L.A., it's about 2,800 units. A lot of it concentrated in and around downtown, Koreatown, Hollywood, West Hollywood, a little bit on the West side. And in the other markets, happy to go through some of the submarkets with you offline if that's helpful. But those are kind of really the big chunks.

That's helpful. We've observed a delay each year for the past few years. Is there a possibility that some of that will carry over into 2021? Or is the supply more concentrated in the first half of 2020?

No, it's spread relatively evenly across the quarter. Based on our historical observations, we do expect some of that to slip. Our general guideline has been a range of 10% to 15% based on past experience to give you some context. Additionally, we anticipate more delays in urban high-rise products compared to suburban woodframe ones.

And then just one follow-up on demand. I know you talked about, obviously, unemployment is low, and so job growth has slowed. But wage growth for your renter has been strong. So how are you thinking about that in terms of pushing rents? I don't know if you can give any comments on maybe what you're putting out for renewals over the next 30 to 60 days out.

Yes, this is Sean. I'd like to address that, and Tim and others can add their thoughts. Historically, there is a strong correlation between wage growth and rent growth, with job growth being the second most influential factor. Currently, we are observing that residents moving into our apartment communities are experiencing solid wage increases. For instance, we compare the income levels of those who moved in January 2019 with those moving in January 2020 to gauge the change. While we don’t have income data for every lease renewal, it’s evident that people are enjoying healthy wage growth, which aligns with data from sources like the BLS and ADP. Previously, I mentioned around 3.5% wage growth, but the ADP data indicates that sectors like professional services, financial services, and tech are seeing figures closer to 6% or 7%, which may include stock options. This healthy wage growth certainly shapes our perspective. However, with more supply in the market, renters have options, making it essential to consider the demand and supply landscape. Specifically regarding renewal offers, we are looking at increases in the mid- to high-5% range for November and December. Renewals have remained relatively stable throughout the year, mostly in the mid- to high-4% range, and I anticipate that will continue as we move through the fourth quarter.

Jeff, it's Tim. I just wanted to add that you're correct. Regarding our population, income growth has been quite good compared to the overall population's growth of about 3% to 3.5%. Another point to consider is what's occurring in the for-sale market. Affordability has become more difficult until the last quarter or two, during which Case-Shiller has been outpacing rent growth. This has supported rental demand and some of the margins. Recently, Case-Shiller reported an increase of around 2%. We're now seeing that for-sale housing inflation is starting to align more closely with rent growth. Overall, I believe we have a balanced housing market, not only across different geographic areas but also between for-sale and rental sectors. Homeownership rates are showing relatively stable movement, sometimes increasing one quarter and decreasing the next. It’s quite remarkable how balanced the housing market is right now. Given that we're about 10 years into an expansion, it’s not entirely surprising, but it is one of the most stable markets I can recall.

You guys have spent some time talking about the convergence and like-term rent change across kind of the East Coast and West Coast, but this is really the first quarter this year that we've seen that like-term effective rent change be below where it was at this time last year. And I wouldn't think some of the headwinds you've talked about to same-store revenue growth related to other incomes and lower bad debt would necessarily show up in that figure. So I'm just curious what's driving that moderation and how should we think about that moving forward.

Yes, Austin, this is Tim. I think it's just demand overall. I mean, you've seen an economy sort of downshift from 3% growth to roughly currently 2% growth. Job growth's 1.5% range now, running about 2 million jobs, versus we were in the mid-2s before. So household formation has been pretty good, but I think it's just overall economic activity being down a little bit. The supply, as Sean mentioned, has been relatively stable. Obviously, there's shifts from market to market. But overall across our market footprint has been relatively stable. I think just economic activity and job growth are down a little bit. That's probably what's impacting the margins for us.

And so it's safe to assume that's mostly on the new lease side, because you've talked about kind of that mid- to high-4% range for renewals being fairly stable, so just traffic overall is down a bit?

Yes, no, this is Sean. I mean, I wouldn't think too much about traffic because traffic is something that we can either engineer up or down, depending on how much you spend and things like that. I think if you look at really what's happening with rent change where you're seeing lift, the lift is in the Mid-Atlantic. And as I mentioned, job growth has been about the same, but there's been a substantial increase in procurement from the government. That brings in a little bit better lift than we might have anticipated. But where we're down in Northern and Southern California is more just a function of demand because the supply is pretty much what we expected. And if you see where it is, it's pretty widespread, so you can't just point to one particular market or submarket and say that's kind of driving it. It's pretty broad, which generally is more macroeconomic-oriented.

Thank you for your insights. Matt, you shared some details on the limited expenditures in your development pipeline. I'm interested in what the remaining spending will look like once you start the projects you have planned for 2019. I understand that over $1 billion is set to be completed in 2020. Considering all of this, what does your projected future spending look like?

Yes. I'll speak to that quickly. And then I don't know if Kevin wants to add anything. Obviously, we haven't provided any guidance in terms of what our starts might be next year. I think this year, we're expected to start $400 million or $500 million additional here in the fourth quarter. So some of which has been spent already, but most of which has not. So I guess if you project it out to year-end, you'd probably add that and then you'd take out spend that we would incur over this quarter on the stuff that's currently underway. So it might tick up a little bit. But as I mentioned, we also have not only condo sales, but pending disposition asset sales proceeds coming in the first quarter as well that aren't even in those numbers.

Austin, this is Kevin. One way to think about our business is that we're starting at around $1 billion a year in development, with about $100 million to $150 million allocated for redevelopment. We're investing roughly $100 million each month. While these numbers can fluctuate, a general estimate for our investment activity would be approximately $100 million a month.

This is Trent on with Nick. Matt, going back to The Park Loggia condos, you mentioned the average sales price so far is a little lower than the average targeted sales price for the building. So perhaps some higher-priced units still left to go and some softness in the higher-priced market. What kind of sales trajectory do you anticipate, whether on a monthly or quarterly basis?

Yes, Trent. Everything is going very well. Over the last six months, we've been conducting 27 visits each week, with Corcoran Sunshine handling our marketing. Their average for all the properties they're promoting in Manhattan is 7 visits a week, so we're seeing a lot of traffic. The availability of the product for viewing is a significant advantage. We're close to enabling purchases and closings, which means that buyers won’t have to wait a long time if they’re not buying off of plans, especially as we head into next year. When we initially launched, we estimated the average price across the entire building to be around $3 million per unit. However, the units sold so far average $2.75 million. As you noted, this average is slightly distorted by a few high-end units at the top of the building, and their sales timing is uncertain. Thus far, we've sold a balanced mix of units, leaning slightly more towards the lower end of the building. We aim to maintain a steady pace, believing we offer a compelling value proposition. Currently, we expect the attorney general to declare the plan effective any day now. We initially thought this process would take 2 to 3 weeks, but it’s taking about 5 to 6 weeks. Afterward, we need to have the tax lots recorded by the city assessor’s office, which is also taking longer than we anticipated. The market response has aligned with our expectations since the beginning of the year. The delay is due to the two-step process involving the attorney general and the city assessor's office, and there seems to be a backlog at the assessor’s office. Nevertheless, we are still on track for settlements in the first quarter, and we continue averaging about 4 to 6 sales per month, with no signs of a slowdown in our sales pace through October. Yes, we have Target, which is expected to open soon. Our first tenant on the second floor, in financial services, is also preparing to open by the end of the year. Additionally, we have another ground floor space leased to a high-quality credit tenant that plans to start their build-out in January. We are currently in advanced negotiations with a couple of tenants for the remaining second floor space, including one for a restaurant and another for a fitness concept. Overall, we are seeing a promising mix of potential tenancies. We anticipate that Target will draw even more interest due to the traffic it will generate, particularly since the location already experiences significant pedestrian traffic. Overall, things are moving forward well, and we are receiving strong interest. The net operating income from these leases will take a few years to fully materialize as the final spaces are leased. Yes. This is Matt again. It's probably a little too early to say. We do have one community under construction that's kind of our pilot test case for it, and we're going to see what the market response is. We're going to validate kind of what those margins look like. So the way I would think about it is it's another tool in the toolkit. We haven't really underwritten any of the deals in the pipeline to that model. But I think it could improve, particularly on larger sites where we might have multiple phases. It gives us the opportunity to segment the market a little more and provide kind of different price points and different service offerings, which can help on the development economics. And if it's validated, it could open up other sites for us over time.

Your expected development yield on your development pipeline has been trending down below 6%. I'm wondering if this is a reflection of higher cost, the mix of the project or have you changed any of your rental assumptions at all?

Sure. John, this is Matt. I mean it is a reflection of the basket that's under construction in any given point in time, some of which is product, geographic mix. So that will tend to move around a little bit over time. It is, in some respects, a reflection of we are 10 years into the cycle. And certainly, as we've said for a while, construction costs have been growing faster than rents, so it is getting harder to find deals and deals on balance might be a little tighter, although there's still very strong value creation in the stuff that we're completing as we talked about. And by the way, our cost of capital is down quite a bit over the last 2 or 3 quarters as well.

Got it. Okay. And then a follow-up on the limited service offering that you're testing out. How do you think this will impact returns? Do you foresee this being a lower-growth product with a higher exit cap rate offset by lower costs? Or do you think basically the IRRs would be pretty similar to your standard product?

It's really too early to tell, John. I mean, again, we view it as there's a customer segment out there that's probably being underserved today because 99% of the new product that's built is being heavily amenitized. And the concept is to provide the same apartment itself, high-end finishes and strong layouts, but just less of the other trappings, the bells and whistles that our research would suggest. There's lots of customers that want a nice apartment but don't necessarily value all those other things, which have a lot of first cost and a lot of hidden costs over time as well, which maybe are underappreciated by the market. So it's hard to say how that might impact valuation or cap rates. I don't see any reason why rent growth would be significantly different than the rest of the market. And it does seem like asset valuation is primarily just driven by the cash flow it can generate. So not sure I would expect anything significantly different there, but time will tell.

Is there another developer or developers out there that you are emulating for that product? Or are you the leader?

Yes. I mean, it does require some upfront investment in technology to enable it and some back-of-house service. So for example, one of the reasons we think we can do this profitably is because it really leverages our call center down in Virginia Beach. So we may not have an on-site presence for leasing. Some of that is tech-enabled, but some of that's also that they can call theCCC and interact with somebody that way. So I'm not familiar with others that are trying this yet.

John, this is Tim. What I would add is that most of the production is still coming from merchant builders who tend to be more risk-averse. If they have a customer who is used to buying a highly amenitized building, they are less likely to take risks with something different. As Matt mentioned, our customer research indicates that many of our customers are currently paying more for our existing assets than what they actually value, as they may not be using all the amenities or services we offer. We've found that they would prefer something less, but they do not want to compromise on the quality of their unit and the finishes. Therefore, it’s about continuing to segment our existing customer base and providing options that better match their values.

Great. A quick question. If you look at your retail, I think you said maybe a $10 million stabilized NOI and you cap that at 5%. So you say that's worth $200 million. It looks like your basis in the multifamily now condos is about $426 million or $2.5 million a unit. Is it safe to say that you break even on this when it's all said and done, if you value the retail at $200 million?

No. John, this is Tim. I believe our expectation, which we've shared before, is that we anticipated incremental value between $100 million and $150 million per year. So, yes, we do expect to be profitable. If we value the retail at $200 million, Matt mentioned that the average unit sold today is approximately $2.75 million, but that's not the current pricing of the average unit. Therefore, based on the current pricing, there is additional profit beyond just breaking even.

Great. Okay. And then a follow-up. On your furnished units, are you going from 0% to 5% in a couple of years? And what's the big change of heart to decide that furnished units have merit?

Yes, John, this is Sean. There are a couple of points to consider. First, as I mentioned earlier, we conduct extensive consumer research and found that approximately 10% of the market either shows interest in or would consider a furnished apartment. Anecdotally, we've had inquiries from people looking for furnished apartments. Over the last 18 months, we've tested this across various communities in our portfolio and have seen consistent demand, indicating it is a viable opportunity for profitability. We plan to form a team to scale this initiative, and reaching that 5% target may take around 2 to 3 years, depending on our growth strategy. As we expand from our current 300 to 400 units to a more substantial number, growth may not be linear; we expect to reach around 1,000 units and then accelerate from there.

John, maybe just to add a couple of things. I think there's a couple of other things that work and, one, just changing consumer preference, particularly among those under 35 who just don't want to own as much stuff as or don't need to own as much stuff as perhaps as generations past. So I think that's a piece. And I think another piece of it is, there just aren't that many companies that have the scale that we do that can actually make a business out of this. So if you're a fund that owns 5,000 or 10,000 units, you're probably not going to make a big investment into this business versus somebody that owns 80,000 or 100,000 units. So I think it's kind of a combination of those 2 things that's created what we think is an appealing business opportunity.

Sean, on Page 5, the like-term effective rent change, if you swapped out the East Coast versus West Coast and just showed urban versus suburban, what does the 2019 recent trajectory look like if you zoomed in on that?

Yes. So if you're looking just for our portfolio, John, as compared to the market overall?

Just AvalonBay suburban versus urban portfolios.

Yes. So suburban versus urban, were flat on a year-over-year basis at 2.7% when you look at it from that perspective. And that has changed, and that doesn't include all the assets because they're classified in different ways. There's infill suburban, there's suburban. So this is true definition of strictly urban versus strictly suburban and throwing out TOD and all those kinds of things. So it's not going to line up with the 3.2% for the full quarter. But if you look at the pure urban and pure suburban, the way we would define it, they're similar. Now in the past, obviously, that's been very different over the last 4 quarters, but it has converged as well. So as Tim indicated, whether you're looking at AB, you're looking at urban or suburban or you're looking across the different markets, sort of a similar pattern of conversion across all those variables.

John, I'm curious to get your thoughts on how you are thinking about the trajectory starts moving forward. Any way to tug-of-war between the improved cost of capital that Matt alluded to? And then perhaps some flashing yellow lights in the economy and just which 2 of those variables are weighing out in your mind right now? Well, John, that's one of the reasons we de-match funding. When you're match funding, it resembles your stabilized portfolio; you have the risk of the assets, like the 80,000 apartments you already own, which are fully funded and financed. The same holds true for everything we initiate from a development perspective. As we advance throughout the cycle, it emphasizes the importance of flexibility, allowing us to maintain various option contracts to either exit a deal, renegotiate, or postpone it. We currently don't have any land inventory to mention, but if necessary, we could acquire land and hold it. However, at this moment, with projected yields at 6% compared to our incremental marginal cost of capital, we believe it still makes sense, and asset values remain well above replacement costs in most of our markets. The opportunity set has been substantial, as we've been adding approximately $1 billion each year in new development rights and initiating about $1 billion as well. I think that's a key focus, especially as that pipeline may start to diminish since we're not observing significant value in the land markets.

I've just got 2 for you. Matt, you've been a veteran of multifamily development for a long time. And I just wanted to get your thoughts on how you see the regulatory environment today versus maybe 5, 10, maybe even 15 years ago across all markets, not just California. And maybe talk about which markets are the greatest barriers on a regulation standpoint versus which ones are the best.

There are some interesting dynamics at play, particularly regarding rent control. The regulations in many of our markets have contributed to supply constraints, resulting in rent growth that significantly exceeds inflation over an extended period. In California, the barriers to entry remain extremely high, especially with the CEQA process. The financial investment required for new projects continues to increase, making it challenging for developers to navigate the process. Legal challenges further complicate matters, and the barriers in California, especially in L.A. since the passage of JJJ and new labor requirements, may be even higher now. In contrast, in the mid-Atlantic region, the barriers during this cycle have not decreased compared to previous cycles. This is partly due to improved land use planning, with local governments focusing on transit-oriented development. While this trend has resulted in lower rent growth, which is not favorable for landlords, it might enhance the region's long-term economic competitiveness. In the Northeast, there are varied dynamics. In New Jersey, there’s a unique opportunity to increase supply in the inland suburbs due to recent affordable housing regulations, allowing us to secure sites in areas that have experienced limited supply for decades. We might see some additional development in that region over the next decade. Conversely, in suburban Boston, where we've had consistent success, many jurisdictions have fulfilled their affordable housing obligations under Chapter 40B. As a result, we anticipate seeing less supply in the upcoming cycle compared to previous ones. Overall, these market conditions really differ from one region to another.

One thing to note, which may be implied in Matt's comments, is that the regulatory barriers tend to be higher in suburban areas compared to urban regions, except perhaps for Los Angeles. This is certainly the case in the Northeast and California. What's notable this cycle is that urban markets have generally presented economic and financial barriers rather than regulatory ones. This has contributed to the elevated supply in our markets during this cycle compared to previous ones, as it has made financial sense to proceed. Often, there has been a better use for developments in relation to condominiums, offices, and hotels. This cycle, condominiums have represented only about 5% of multifamily supply, whereas in earlier cycles, they accounted for closer to a quarter of new supply. There are several unique factors this cycle, but it remains primarily the suburban markets in the Northeast and California that are the most challenging in terms of regulatory hurdles.

That's probably the best response I've received to that question. My second question is straightforward; I would like to break down the blended lease-over-lease rent by new and renewal leases, and also discuss pricing power in the fourth quarter, keeping in mind that it's a quarter with low leasing volume.

Yes. In terms of Q3 specifically, in terms of the breakout, as I mentioned, it was a blended 3.2%, 4.6% on renewals. And per my comment earlier, it's been pretty stable all year. We expect it to be also relatively stable in the fourth quarter. And then on move-ins, it was 1.7% during the quarter. And that typically is a metric that, from a seasonal basis, tends to drift down as you move through Q4 and Q1 and peaks as you get into kind of late Q2, early Q3, and we don't see any reason for that pattern to be any different going forward over the next few quarters.

This is Alex on for Drew. Just one quick modeling question for us. Looked like a pretty sizable quarter when it came to asset preservation CapEx. Of our run rate, the current year-to-date pace, it looks like year-to-year growth could be over 18%. Obviously, rising costs and some seasonality at play here. But I was just curious what's driving that growth. And if you have any color you could provide us on how we should expect that to trend in 4Q and into '20?

Yes, Alex, this is Sean. Similar to what I talked about on maintenance projects, there tends to be seasonality at the CapEx as well. The way I'd probably think about it from a modeling perspective is that 2019 maintenance CapEx is probably going to be in the range of 5% to 6% of NOI. There's a piece of that, that we call remerchandising that is sort of a refresh of amenity spaces and such that you could probably say has some return to it, although hard to quantify. But if we use that 5% to 6% of NOI as sort of a run rate that's about right. It will be a little bit lumpy from year to year, but that's sort of how we're looking at it.

Just 2 quick ones for me. First, upfront, I didn't hear it but maybe it got lost. Your OpEx for the year, your guidance of 2.1% to 2.7%, you're trending 2.8% for the year. So what are the items in the fourth quarter that are going to bring it down? Or is the trend sort of what it is but within your overall FFO guidance, you're able to manage the higher OpEx?

Yes, Alex, this is Sean. We haven't changed our guidance. And so as I mentioned earlier, every quarter is a little bit lumpy. Q3 was lumpy for a number of reasons related to R&M projects that are done in certain seasons of the year. I mentioned marketing was up dramatically because of a substantial credit we received last year, when marketing was down 21%. Insurance renewal bleeds through. Payroll, we continue to see good reductions in FTEs as a result of the initiatives I mentioned. So I would say, at this point, we're pretty comfortable with where we are.

It's Kevin. One more thing to consider while you assess the year-over-year growth rate in OpEx is that you need to review what occurred in the previous year. Last year, in the third quarter of '18, we observed a comp increase with year-over-year growth in OpEx of 50 basis points. This likely played a significant role in this year's 4.2%. Additionally, the variability that Sean pointed out relates not only to our expenditures but also to the events from the prior year, so it's important to factor that into your modeling.

Well, thanks, everybody. As Michael just mentioned, we're about 1.5 hours into this call. So we'll give you a quick goodbye, and we'll look forward to seeing you at NAREIT here in just about 2 or 3 weeks' time.