Avalonbay Communities Inc (AVB) — Q3 2020 Earnings Call Transcript

Thank you, Abby, and welcome to AvalonBay Communities Third Quarter 2020 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. With me today are Kevin O'Shea, Sean Breslin, and Matt Birenbaum. Sean, Matt, and I will provide comments on the slides that we posted last night, and all of us will be available for Q&A afterward. Our comments will focus on providing a summary of Q3 results, an update on operations, and some perspective on the transaction market and our financial position. Maybe just a few comments before turning to the deck. Several of the trends unique to this downturn and pandemic that we discussed last quarter played out in our performance in Q3. The appeal of urban living is, for the time being, diminished due to health concerns of living in dense environments; the shutdowns affect on retail, entertainment, and cultural venues that have long been the draw for urban centers; and civil unrest that occurred in many of our cities over the summer and early fall. Work from home flexibility has been extended through year-end by many, if not most employers, particularly those heavily weighted to knowledge-based jobs like many businesses in our coastal markets. We've experienced a significant reduction in student and corporate demand as remote learning modalities are being deployed at many urban universities and business travel has dropped off substantially. And finally, historically low interest rates are stimulating demand for existing and new home purchases, particularly for young age cohorts where homeownership rates have begun to climb. All these factors have resulted in an unprecedented reduction in apartment demand, particularly in urban centers, beyond what we typically experience in an economic downturn. And while we believe the reduction in demand is mostly temporary in nature, we also believe that it won't be restored until we substantially resolve the public health crisis from the pandemic. A meaningful recovery in our business will not occur until employers believe that they can safely bring their workers back to the workplace. Until then, business leaders are likely to err on the side of caution before reopening their workplaces, which is ultimately what will need to happen before many of their employees return to apartment living. I suppose if there's any silver lining in any of this, it's that our nation's struggle to respond effectively to this pandemic should ultimately lead to improvements in our response to future public health crises, much like we saw in the aftermath of 9/11 and the great financial crisis, when our national response led to building a more resilient system to address the threat of terrorism and financial market dislocation, respectively. We hope that in the future, our nation and our cities will be better prepared to deal with the public health crisis in a more resilient and less disruptive way. But for now, we need to play the hand we've been dealt, and we'll endeavor to provide as much transparency and disclosure as to the actions that we're taking in response and their ultimate impact on the business. So with that, let's turn to results for the quarter, starting on Slide 4. Q3 certainly proved to be a challenging quarter. Core FFO growth was down by 12%, driven by same-store revenue decline of just over 6%. On a sequential basis, from Q2, same-store revenue was down 2.2%, or about half the sequential decline we saw in Q2, as bad debt in Q3 leveled off relative to Q2 after the big increase we saw in Q2 during the early months of the pandemic. In terms of capital allocation for the year, through the end of Q3, we've raised $1.7 billion through new debt issuance and dispositions and repurchased about $140 million of shares. We started only one development so far this year, and that was through a joint venture and opportunity zone in the Arts District of L.A., where we own just 25% of the venture. Importantly, our liquidity, balance sheet, and credit metrics remain in great shape as we manage through the current downturn. Turning to Slide 5. Like we saw in Q2, the decline in year-over-year same-store revenue in Q3 was primarily attributable to a loss of occupancy and uncollectible lease revenue, or bad debt. These 2 factors drove about 80% of the drop in same-store revenue in Q3. Over the next 2 to 3 quarters, we expect to see continued declines in same-store revenue, but increasingly, the decline will be driven by pressure on rental rates as we saw effective rental rates fall by almost 6% this past quarter. These declines will have a more pronounced impact on revenue over the next few quarters as those leases begin to roll through the portfolio. And as Sean will share in his remarks, the decline in effective rental rates had been greatest in high-cost urban markets like San Francisco, New York, and San Jose. And with that, I'll turn it over to Sean, who will discuss operations and portfolio performance in more detail. Sean?

All right. Thanks, Tim. Turning to Slide 6. We experienced a year-over-year increase in prospect visits to our communities each month of the quarter. In total, visit volume was up about 20% year-over-year during Q3, which led to a roughly 10% increase in net lease volume. As you can see from Chart 2 on Slide 6, the most significant increase in net lease volume occurred in September, which is up about 35% year-over-year. And as of yesterday, traffic and leasing volume for October was up roughly 25% and 20%, respectively. Moving to Slide 7. For the first time in more than 4 years, resident notices to vacate our communities increased by a meaningful amount on a year-over-year basis. During Q3, notices increased by roughly 17%, primarily as a result of the spike in lease terminations in urban submarkets, which is depicted by the hash bars on Chart 1 on Slide 7 and a topic I'll touch on in a minute. Our leasing volume exceeded the pace of notices, however, starting in August and has continued through October. As a result, if you turn to Slide 8, you can see that beginning in September, move-ins exceeded move-outs, and physical occupancy has increased from the low point at 93.1% in September to 93.5% for October and stands at 93.9% today. Moving to Slide 9. Our suburban portfolio continues to perform substantially better than our urban assets. Charts 1 and 2 at the top of Slide 9 reflect notices to vacate our communities and lease terminations by submarket type. Notices to vacate our urban communities increased by roughly 40% during the quarter, driven by an approximately 70% increase in lease terminations, and led to a 340 basis point decline in physical occupancy from Q2 to 90.2% and a double-digit decline in rent change. For our suburban portfolio, the increase in notices to vacate was more modest, supporting better physical occupancy and rent change. The performance of our urban portfolio has been impacted by a variety of factors, including those mentioned by Tim in his prepared remarks. I'd highlight the combination of extended work-from-home policies and the civil unrest that occurred during the summer months, which impacted the quality of urban environments, as key factors driving residents to break leases during Q3 and leave urban centers for housing options in other geographies. Shifting to Slide 10 to address regional performance. Increased turnover in Northern California, the Mid-Atlantic, and New York/New Jersey impacted physical occupancy more than in other regions. In the New York/New Jersey region, the increase in turnover was primarily a function of elevated turnover in New York City, which is 87% on an annualized basis during the quarter. For the Mid-Atlantic, we experienced increased turnover in the District of Columbia and other urban or quasi-urban submarkets like the Rosslyn, Ballston, and Tysons Corner submarkets in Northern Virginia. In Northern California, annualized turnover during Q3 was 85%, driven by elevated turnover across all 3 markets: San Francisco, San Jose, and the East Bay, but was most pronounced in San Francisco and in Mountain View where Google is headquartered. On a positive note, turnover was relatively flat in New England, which is a testament to our primarily suburban Boston portfolio and was down in both the Pacific Northwest and Southern California. Physical occupancy in all 3 regions exceeded the portfolio average. And moving lastly to Slide 11. Same-store, like-term lease rent change was down 3.3%, and effective rent change was down 5.8%. Metro New York/New Jersey and Northern California are 2 of the regions I identified on the last slide with elevated turnover and, therefore, available inventory to lease produced the weakest rent change during the quarter. Rent change in New England held up the best, again, supported by our suburban Boston portfolio, which, in many cases, offers differentiated products, including larger unit sizes to those departing urban environments. So with that, I'll turn it over to Matt to address our development portfolio.

All right. Great. Thanks, Sean. Turning to Slide 12. We are starting to see a remarkable recovery in the transaction market. Ultra-low interest rates have started to bring buyers back into the investment sales market for properties that can support reasonable levels of debt service, primarily suburban assets where operating results have been less impacted by the pandemic. To take advantage of this shift in buyer sentiment, we increased our disposition plan over the summer and brought several communities to market in the past 2 months. As of today, 6 of these communities are currently under contract or letter of intent at very attractive pricing with cap rates averaging 4.4%. This compares to 4 communities that we sold earlier in the year at an average cap rate of 4.7%, putting us on track to complete nearly $700 million in dispositions for the year. Turning to our development portfolio. Slide 13 shows the rents we are achieving at the 9 communities currently in lease-up. For the past several years, we have shifted our development focus to more suburban locations, and we're starting to see some of the benefits of this strategy now as our lease-up rents are only about $45 per month below our initial underwriting, allowing for continued value creation on these assets as they are completed and stabilized. We have highlighted 3 of our lower-density northeastern communities on the slide, which feature rental townhomes and which are showing a nice increase in rents compared to pro forma. This product, which features larger floor plans, private garages, and direct entry with no common corridors, is particularly appealing in the current environment and serves as a good substitute for single-family rentals, which are enjoying very strong fundamentals. On Slide 14, we show the future earnings potential of our development portfolio. At current projected rents and yields, we expect to generate nearly $140 million in annual stabilized NOI, with only $14 million of that reflected in our Q3 results. And with more than 90% of the capital needed to complete those assets already funded, these developments should contribute significant incremental cash flow over the next several years. And with that, I'll turn it back to Tim for some closing remarks.

Well, thanks, Matt. Turning to the last slide, Slide 15. It was another challenging quarter, driven by the suddenness and continued strength of the pandemic. Weak same-store performance is being driven mostly by our urban portfolio, as Sean mentioned. Particularly in the high-cost markets of San Francisco and New York, suburban communities with larger units have performed much better. While pricing pressure continues to impact rental rates, occupancy has begun to modestly improve and stabilize in the 93% to 94% range. The transaction market, as Matt mentioned, has picked up dramatically after having been frozen earlier in the year. For those assets being taken to market, values are generally holding up at levels close to pre-COVID valuations. We continue to be cautious in deploying new capital, particularly for new development where economics are challenging and construction costs have not abated in any material way. And lastly, the balance sheet is very well positioned and is much stronger than prior downturns, which should give us plenty of financial flexibility to address the challenges posed by the current downturn. And so with that, Abby, we'd like to open the call for questions.

Maybe just on the transaction market. You mentioned kind of the difference of urban versus suburban, but that kind of blended transaction values are pretty similar to pre-COVID. Can you bifurcate that between the 2, both in terms of buyer interest as well as values for urban versus suburban of what you're seeing today?

Nick, this is Matt. Unfortunately, I can't provide that information because currently there are very few urban high-rise assets available on the market. This situation aligns with the occupancy levels and rental changes for those properties, as Sean pointed out. The assets being traded, including those we're involved with and others in the market, are primarily suburban assets that can sustain strong debt service coverage, especially with the very low interest rates available. Generally, these assets tend to be around $100 million or less, although this isn't always the case. For those suburban assets, their values are largely consistent with pre-COVID levels. While some cap rates and net operating incomes are slightly down, overall, values are pretty steady; some are a bit higher and others a bit lower. The bidding on these assets has been very strong due to abundant capital that was raised. At the NMHC event in January, many more participants indicated they were ready to buy rather than sell, which left substantial capital sidelined during the first half of the year with limited opportunities. There seems to be a build-up of demand, but it remains focused on the assets currently available. I’m not aware of many downtown urban core assets being listed in this market, making the value of those assets quite uncertain.

And then just in terms of your own appetite for sales, beyond the $440 million that you cite here, kind of what's behind that? And then if you can tie that to the share repurchase program and expectations going forward.

Sure, this is Kevin. I’ll start with the share repurchase. We typically use proceeds from asset sales for various purposes, including ongoing development spending. Regarding the share buyback, we were active in the second quarter, and our strategy remains unchanged. We plan to continue this activity in the third quarter because we see an opportunity to leverage the gap between private and public market values, especially as we navigate the effects of the pandemic. We have the financial strength and liquidity to engage in a modest buyback that we aim to execute thoughtfully, which we believe we successfully did in the second quarter and will maintain going forward. This will primarily be funded by asset sales and structured to ensure our credit profile remains strong. All of these points were true last quarter and still apply this quarter. Looking ahead, we will continue to pursue a measured buyback, primarily funded by asset sales while prioritizing our financial strength and flexibility. We have ample capacity to sell assets when needed, and we do not foresee this being a limitation for us. Tim, do you have anything to add?

No.

Can you provide insight on where the move-outs during the third quarter, particularly from the urban portfolio, are relocating? We've heard discussions about moves within the city being motivated by seeking better bargains. Are you observing a significant trend of former urban residents relocating outside the city?

Yes, this is Sean. That's a great question. We do keep track of move-outs based on forwarding addresses. There are a couple of key points I’d like to highlight regarding the data we observed. First, we define a significant move as someone relocating more than 150 miles. In New York City, the percentage of residents moving out was about 17% in Q3 of 2019, which rose to approximately 30% this Q3. In San Francisco, move-outs increased from around 23% last year to about 27% this year. The second category is regional moves, which we classify as moves between 50 and 150 miles away. In New York City, this rose from 6% to roughly 20%, while in San Francisco it increased from 7% to 10%. Lastly, there’s what we call a market move, which involves relocating more than 10 but less than 50 miles. A notable increase was seen in Boston, where this percentage jumped from about 10% to 20%, essentially doubling. It’s important to remember that local moves, defined as those less than 10 miles, are not accounted for here, but in urban settings, 10 miles can feel quite substantial. For instance, someone moving out of San Francisco might only be relocating to nearby areas like the peninsula. Overall, these are the key trends we noticed in Q3.

Okay. Those are helpful stats. And then just maybe a quick housekeeping question. For the asset sales side, regarding the properties that are on the market or under contract, do you expect those to close by year-end? Or what’s the timing there?

This is Matt. I think most of them will close by year-end. It's possible 1 or 2 might slip into January, but we would expect most of those proceeds to come in by the end of the year.

Just going back to move-outs and focusing specifically on the Bay Area, which are the highest in Northern California. But kind of where do things stand today? And are you starting to see the move-outs moderating as we head into the winter months? And do you work with residents to offer suburban market options to keep them within the network?

Yes. Alua, your questions broke up a little bit in terms of residents departing San Francisco, I think you said, and whether we're seeing that accelerate or decelerate? Was that the first part of your question?

Yes. I was just wondering if like move-outs are starting to moderate as we head into the winter months?

Yes. I mean, as you can see on the chart regarding the move-in/move-outs that we posted up there, we're starting to see volume ease as we move into the fourth quarter in October specifically. That is relatively typical in terms of seasonal patterns. But in terms of whether that's sustainable or not, it will depend on a lot of different factors and many of which Tim mentioned in his prepared remarks, so it's probably too early to conclude that it's a definitive downtrend, other than seasonally, that would normally be the case. And then I think the second part of your question was around transfers and whether we help facilitate that for residents, and we do. And as it relates to transfer activity, transfers were up about roughly 1/3 year-over-year. So we are seeing increased activity both within the same community and to another community that might be within a reasonable distance of the community they're departing. So definitely an increase in activity there, but it's not a meaningful percentage of total move-outs if you want to think about it that way.

Got it. And then just one other question. So some peers have started to get creative in the urban markets by transforming empty apartments into work-from-home spaces or building in desks into various mixes in the apartments themselves to attract renters. Have you guys done anything different to attract renters in your urban markets? Have renters been asking for different amenities like this?

Yes. And a good question. We're exploring a lot of different things that we've done a fair bit as it relates to some people who are looking for, in this environment, a short-term stay in a different geography. It may not just be in the urban environment. It could be a suburban environment where they have left the urban environment, but they are not sure when they may have to return to work in that urban environment. And therefore, they'd like to rent a furnished apartment in a suburban location that's not their sort of normal home location. So we're doing a little bit of that. And then certainly, as it relates to amenities, we're trying to facilitate food delivery and things of that sort as best we can, given the constraints to the building from a physical standpoint, trying to facilitate as best we can. So for our customers that are home in urban environments, we're trying to make sure that they have access to the amenities that they would normally enjoy just in a different way.

I wanted to come back to some of the October updates that you had put in your presentation and you discussed in your prepared remarks. It looked like there was some pretty healthy improvement in occupancy. So the question I'm trying to maybe understand a little bit better is, do you think rents have come down enough in your markets, whereby demand is starting to come back up, and you're going to start to see less bad leasing spreads going forward? So it's really a question of velocity here going forward. And do you think that you're starting to see some stabilization in that demand?

Yes. Rich, good question. A few thoughts, and then others can join in. I’d say, obviously, recent trends, particularly September and October, were favorable in terms of demand absorbing some of the inventory we had. Obviously, we had more available inventory given the turnover and the lease breaks that I mentioned, particularly in the urban environments, which did put some additional pressure on pricing. But it really is sort of a macro question as it relates to, particularly in the urban environment, people coming back into this environment because they feel comfortable about it. They need to go to school. They have to be back in the office. All those macro factors really drive that ultimate decision as to whether to return to that environment, and price is more just what am I going to choose within that environment. And as long as you're competitive, you should get your fair share of the market overall. But I think the macro factors are really the things that will tilt it to either kind of stabilize and be more positive going forward or deteriorate. Those are really the key drivers here, and I think that's yet to be told that full story until we move into it a little bit further here towards year-end.

Yes. Sean, I’d like to add a bit more on that. What we're currently witnessing resembles what typically happens during a downturn, with the housing market in a state of dynamic adjustment. We’ve seen a decline of about 300 basis points in stock, which has necessitated us to tap into the rental market more deeply. Consequently, we need to modify our pricing to attract our fair share of renters. Ultimately, the question of stabilization largely hinges on the macroeconomic environment, as Sean pointed out, along with developments in public health. This situation is particularly affecting urban centers in a distinct manner. If we receive a vaccine or a treatment that encourages employers to bring workers back to the office, we can expect an influx of residents returning to urban areas, generating new demand and aiding in stabilization. However, if this process is delayed—should vaccines face approval issues, lack effectiveness, or fail to achieve substantial distribution—then the situation may extend longer. Nonetheless, such advancements could greatly enhance the outlook, especially for urban centers.

Yes. And so just so I understand, are you suggesting that the improvement in October that was noted is more seasonal? Or are there other factors that are driving that?

I think a lot of it is price driven, honestly. Rents have continued to come down sequentially, and we've gotten to the point at which we've been able to attract sort of our fair share of the market in the 93% to 94% range in terms of occupancy. So I think that's what's driving it initially. As to whether it stabilizes, I think it's a function of some of the things that Sean mentioned and I mentioned.

Considering the future development pipeline and potential new projects, how are you approaching this aspect? While you mentioned that there won't be any new initiatives aside from the one joint venture, what are your thoughts as you look ahead? Additionally, how do you view the geographic and urban/suburban mix going forward?

Yes, this is Matt. I can take that question. Tim, you might want to add some thoughts as well. It's really a combination of examining both the bottom-up aspects, such as whether the deals still offer value creation and if the cost basis is attractive, as well as the top-down perspective regarding our available capital options, as Kevin mentioned. We may initiate one or two deals this quarter. The deals that are likely to start sooner will be in suburban northeastern markets, where, as mentioned in my prepared remarks, some of the lease-ups are significantly outperforming their expectations. These locations are benefiting from the outmigration from urban areas, and they tend to be lower risk to begin with, exhibiting less volatility in rent prices. They have not experienced the same significant increase in hard costs over the last five or ten years, which suggests there may be less reduction in hard costs in these markets. So that's where we are more likely to begin in the short term. We are still focused on growth in our expansion markets, although we do not have plans to start anything there in the next quarter. However, we might have some deals to start in those areas next year. Additionally, we are monitoring the situation with hard costs, which have not decreased; they might have plateaued in certain markets. Lumber prices remain very high, although there are signs of a slight decline. Historically, during downturns, hard costs fell significantly after the last major financial crisis, but in previous cycles, they tended to stabilize while inflation outpaced them. We are still assessing how this situation will develop across our regional markets.

I agree with everything you said, Matt. To provide some context regarding volume, we were likely operating at about $1.4 billion mid-cycle last year. Over the past three years, from 2017 to 2019, we reduced that to approximately $800 million to $900 million. Next year, we could start anywhere from zero up to around $1.5 billion, depending on the factors Matt mentioned, including the visibility in the rental and construction markets, as well as the capital markets and other uses of our capital, such as share repurchases. All these factors will determine how much capital we choose to deploy, which could range from zero to $1.5 billion over the next 12 to 15 months.

Sean, just one question for me. Could you share economic occupancy in October for Northern California and Washington Metro? Just curious those 2 markets, how pricing power is trending and how it could trend into the winter.

Yes. John, you broke out a little bit. You said occupancy in Northern California in October?

Economics.

In Northern California, I believe we are currently operating at about 92% occupancy, although this figure is affected by lower occupancy rates in San Francisco and parts of San Jose, particularly in Mountain View and Central San Jose. These are the two areas where occupancy is the weakest. Regarding Washington, DC, the occupancy rate is approximately 91% at this time.

Okay. And based on current trends today, do you expect stabilization or improvement in those markets or continued slide?

I'd say based on recent trends, I would say they stabilized a little bit in terms of occupancy and have started to trend up, consistent with the same-store portfolio pattern that I described earlier in my prepared remarks. How quickly they come back is just a function of the velocity that we see in terms of notices, which is primarily a function of lease breaks recently, and then on the demand side in terms of the velocity of leasing that comes through. But as I look forward over the next 6 weeks or so based on availability and such, I would expect both of those to drift up some.

This is Sumit Sharma here in for Nick. Maybe if you could give us a quick update.

We can't hear you, could you please speak up a bit? Juan, is that you? I can't hear you or Nick.

So sorry. This is Sumit in for Nick. We are having a speakerphone issue. Could you provide us with a quick update on the sales pipeline at Park Loggia? I understand you sold about 59 out of the 172 condos, and I would like to know if you are seeing any increase in the NYC sales market or if the weakness in the rental market is also affecting it.

Sure. This is Matt. I can give you an update. So as of today, we have 65 units that have closed. Again, there are 172 units total in the building. We closed 65, that's $207 million in sales price or about $3.2 million per unit. We also have 9 units under contract today, and we have another 7 contracts out for signature. So we have another 15, 16 deals that are pending, many of which would close in the fourth quarter. I guess I would say the last couple of months, traffic has been pretty good. Interest has been pretty steady. We're running about 3 new deals a month, which would put us at probably the top or among the top 2 or 3 performing condo buildings in all of Manhattan. So there is a lot more supply than there was when we opened the building for sales, but we're still continuing to get well more than our fair share. So I'd say the sales activity has been pretty steady since kind of the initial lockdowns were lifted in midsummer, and we're continuing to get pretty good traction.

Great. And just a more long-term question. With the pandemic and everything, how has it changed your development plans? Outside of the current pipeline, what should we consider when thinking about your development plans? When you shift from suburban to urban or even the unit mix, does that shift towards 2 or 3 bedrooms align more with your traditional unit mix?

Yes, I will address that. While there were some connection issues, I'd like to emphasize that long-term development is a crucial capability and offers us a competitive edge in public markets. As markets stabilize and strengthen, we believe development will become economically viable again. We have often stated that we are fairly neutral between urban and suburban locations, focusing on areas where the fundamentals are strongest and where there is more value. For the last 3 or 4 years, we have already started shifting to suburban areas due to better value offerings, and we have noticed a trend of millennials moving back to the suburbs as they reach a stage in life where they may be buying homes. This has led to increased economic activity, which has been further accelerated by the pandemic. Therefore, I anticipate that demand in suburban areas will continue to exceed that of urban areas for some time. In our previous call, we discussed product mix, and I'm convinced that the work-from-home flexibility will lead to changes in unit specifications. This includes the addition of an extra bedroom that can serve as an office and creating dedicated workspaces within the units. According to our survey data, most residents prefer to work from their units, though around 20% to 25% are quite interested in co-working spaces as well. Nearly all of our redevelopment and new development projects over the past 2 or 3 years incorporate significant co-working areas. We expect the types of spaces to evolve, shifting towards more dedicated spaces rather than open-table formats, which will offer people opportunities for safer and more confined areas to meet. We foresee these changes arising from the work-from-home trend, which was already in motion and will only increase moving forward. Our portfolio must adapt to this shift.

I'm here with John Kim. Just had a couple of questions. First, just on the pricing that you noted in October, was there a change strategically, either dropping the rent or increasing concessions in October versus the previous months in the third quarter just to stimulate that improvement in the occupancy?

Yes, Juan, this is Sean. You make a valid point. As I mentioned earlier, we saw an increase in inventory due to higher turnover in July and August, particularly in urban areas. This was illustrated in the second slide where we discussed notices to vacate and lease breaks, which put additional pressure on pricing. For instance, in July and August, the average concession across all leases signed in urban environments was between half a month and three-quarters of a month. Moving into September and October, this average increased to about a month for all leases signed. This indicates a pricing response to the added inventory. While we could have leased some of that inventory faster with more aggressive pricing, the rapid influx due to lease breaks required us to discount prices significantly to manage the sudden increase. Our approach was to absorb the inventory at a steady pace rather than resorting to a fire sale to move it quickly.

I was curious about the pricing differences between your urban core properties and those near suburban transit areas. Are we nearing a point where we might see a shift, with some people in suburban markets moving back to urban areas due to the relative pricing and the commute time for when we do return to the offices?

Yes. I mean, good question. I'm happy to comment on that, and others can jump in. But if you think about the markets we're talking about, New York City, as an example, think about the rent levels in New York City as opposed to kind of moving into the Westchester, Long Island or Northern and Central Jersey, it's a pretty big trade. Even though rents have come down quite a bit in New York City, it's still a big trade. So I think it's really more a function of the macro factors that we were talking about earlier in terms of people's either desire or need to be in those urban environments as it relates to either being in the office because they're required to be in the office, they need to be in the office, returning to school at some of these urban universities or just feeling comfortable in those environments that we've moved into a place where they feel better about retail establishments, restaurants, et cetera, and part of that will be driven by the health care situation and whether that crisis is resolved in a meaningful way. So I think those are the bigger issues as opposed to just purely price.

I mentioned that today, people aren't commuting, which has allowed them to take advantage of lower rents. We do expect them to return when necessary. One should consider whether life was better before or after COVID, as many aspects that made urban living appealing were present pre-COVID. Once this situation is resolved, those attractions will still be there. These mixed-use environments we're in are vibrant and close to jobs, and there has been significant investment in infrastructure. They are also more environmentally sustainable for those who prioritize that. However, the flexibility of working from home might lead some individuals to stay in the suburbs if they only need to commute a few days a week instead of full time. Thus, urban demand may not be as strong as it was before COVID, but considering the pricing changes, we expect many people to return to urban centers.

Did you note that in the New York MSA?

I'm sorry. Did you say including the New York MSA?

No. I'm just thinking, is Northern California different from New York in terms of the relative rent differential in Downtown San Francisco versus Oakland or the South Bay?

Pretty big deltas.

Yes. Those rent spreads are pretty big between the pockets of the East Bay or even moving down into the peninsula or lower peninsula as compared to being in the city of San Francisco. It's a pretty big spread. I mean I think it really is more around the quality of the lifestyle and the reasons you want to be in the urban environment, I mentioned, just not necessarily being able to stay and you don't have to be in the office.

When I first considered the market conditions, I expected AvalonBay to be in a stronger position than it actually is, given that most of your properties are located in the suburbs. I didn't anticipate that people would be relocating from New York to places like Nebraska as frequently as they have, rather than moving to nearby areas such as Edgewater, New Jersey. I realize that transfers have increased somewhat, but this still seems to be a minor factor in the overall turnover situation. How would you address the notion that once we achieve some resolution, people might prefer to return to urban environments—not necessarily Manhattan itself, but nearby areas? This could create an opportunity for AvalonBay to entice residents back to urban centers without fully committing. Do you have any insights on the permanence of these relocations and how flexible people might be in returning when they feel ready?

Yes, I think it's a really interesting question. Even before COVID, we already believed in the idea of infill urban-light and mixed-use lifestyle environments. Post-COVID, we still see this as a great opportunity, possibly even stronger when you consider affordability. Being in an infill suburb can be just a bit cheaper per square foot than being downtown, and if you can utilize decent transit only a few days a week instead of every day, that makes it more appealing. I believe infill suburbs are very well positioned. They were already strong, but as we've discussed, COVID has accelerated trends that were in place before. Urban living remains attractive, but when you factor in demographics, affordability, and work-from-home flexibility, it changes things for those marginal renters.

Yes, Rich, it's Matt. Currently, those markets are performing better than most of our legacy markets. This is partly due to their lower costs and the fact that they experienced less shutdown initially. Additionally, the assets we hold in those areas, particularly in our Denver portfolio, tend to be more suburban. When we entered these markets, our objective was to have them represent about 5% of our portfolio, which translates to roughly $1.5 to $2 billion each. We're not quite halfway there yet, but we plan to be aggressive in our approach. Over time, there's potential for that percentage to increase beyond 5%. As Tim mentioned, it appears that the repercussions of COVID are accelerating many pre-existing trends that originally attracted us to these markets.

Yes. Rich, I want to add to what Matt said. I agree with him, and we've mentioned in previous calls that this may lead us to explore new markets that could benefit from the spillover effects of areas like New York or California. These markets are also closely tied to knowledge-based jobs as large tech companies and knowledge-focused industries continue to diversify their workforces. We want to be present where their employees are. If locations like Denver and Southeast Florida emerge, we believe these are strategically important areas for us, and we will need to adjust our allocation accordingly.

I was wondering if you guys can walk through your effective rent growth month-to-month in the third quarter as well as provide October? And do you think now that you're through the peak leasing season, you could see rates improve due to fewer expirations? Are you more apt to keep rents closer to maybe September and October levels and continue to try and grow occupancy?

Yes. Austin, this is Sean. Good question. In terms of walking you through the rent change in the quarter, basically, we move from sort of mid-3s up to mid-8s in terms of the reduction in rent change as you move through each month of the quarter. And then October, right now on a blended basis, is down about 10%. And in terms of the broader question as it relates to stabilization, I mean, the only thing I'd say is that, particularly in the suburban environment, concessions have kind of leveled off in the past couple of months here. We've had good volume. So we haven't necessarily had to kind of dig deeper into the concession bag to generate that velocity. And I'd say we're reasonably comfortable with the velocity we're seeing today, which is what I expressed in my prepared remarks that you saw on the slide. So to the extent that we continue to see good velocity in pricing, we wouldn't have to dig deeper into that concession bag to the extent things fell off then we'd have to reevaluate. But based on where we think we're priced today, we feel like we're in pretty good shape. And again, I'd say on the suburban side, I think it is a little bit better than urban. So I'd say it will take a little while longer here to see how it plays out in these urban environments, if that's going to be the right kind of pricing level to continue to attract demand at the pace that we need it.

Yes, this is Matt. No, I mean I think as we were talking on one of the prior questions, we like those markets. We're looking to grow in those markets. Like I said, our objective is to get to about 5% in each. Some of that is driven by just the size of those markets relative to the size of ours. And as Tim mentioned, there may be additional markets that we add into the mix here at some point that would get that kind of total allocation to other markets like that above that 10% over time.

I have two questions. Tim, regarding development, you mentioned on the last call that your team and current development program would remain unchanged. However, you noted earlier that starts this year are significantly down, and next year could vary greatly, ranging from zero to one billion dollars. Considering this, how do you anticipate the development front will affect the profit and loss statement? Do you expect some of these capitalized costs to appear as expenses on the profit and loss statement as you maintain your team, or do you foresee other changes, particularly if you are unable to sustain the level of development in suburban markets needed to keep things steady?

Yes, Alex, the straightforward answer is that it's too early to tell, to be honest. As I mentioned on the previous call, we have actually reduced our development capacity over the last two or three years, going from approximately $1.4 billion to about $800 million. I'd estimate that the group is capable of handling around $800 million to $1 billion a year, with some flexibility depending on demand. When discussing expensing versus capitalizing, it delves into more complex matters that might require a separate call. Historically, during past downturns, we typically suspended development for four or five quarters. If this current situation mirrors that, I don't see any concerns regarding your points. However, if this downturn leads us to not initiate new development for three years, we may need to resize the group or expense some costs. But for now, it's too early to determine how that will pan out.

The 4- to 5-quarter pause is a useful reference, and I appreciate that, Tim. Moving on, Kevin, considering the operational side, whether at the property level, G&A, or on the balance sheet, where do you see potential cost savings or efficiencies that could help offset revenue declines as we head into next year?

To provide some context, we saw a year-over-year decline in NOI of about $38 million to $39 million this past quarter. When you consider the quarterly property management costs, overhead, and G&A, these costs are in line with that figure. Therefore, our overhead costs only make up a small portion of the overall situation. From my perspective, this isn't a significant issue. We have a plan to manage it throughout different cycles. There are opportunities to reduce costs, particularly in terms of overhead and incentive costs, which should naturally improve this year. Additionally, regarding property management overhead, Sean, do you have anything to add?

Yes. Alex, it's Sean. One thing, I think, that's fair to address is we were already on a path to create more operating efficiencies throughout the portfolio based on some of the things we talked about. I think it was one of the calls last year as it relates to automation, digitalization, various things like that, the great use of data, centralizing different things, whether it's leasing, renewals, and such. And we're still on that path. And if anything, I would say it's accelerated certainly as a result of what happened through the pandemic as it relates to the operating model. And we were talking about somewhere in the order of magnitude of approaching $20 million to $30 million of operational savings through those various initiatives. And we're still plowing forward on that. And probably, we'll be investing more in some of those technology initiatives over the next couple of years to help offset what we're seeing at least at the property level P&L.

Yes, Alex, I want to add that in terms of general and administrative costs, as Kevin mentioned, we have a very efficient business model. Our G&A costs are around 15 to 20 basis points of total asset value. Compared to other business models, especially in the private sector, we are quite G&A efficient. There are limited opportunities to reduce G&A expenses, and some of it adjusts automatically through the incentive system that Kevin referred to. When performance declines, incentives decrease. However, there aren't many additional positions we can eliminate, as G&A is primarily composed of personnel.

Yes, Tim, that's exactly the point I was trying to make. At the property level, the majority of expenses come from insurance, real estate taxes, and payroll, which seem likely to increase. It appears that any expense savings are minimal and not substantial. Overall, many of these expenses appear to be fixed. Is that a fair conclusion?

Yes. I would say on the payroll side at the property level, that's where the opportunity is. Those are some of the activities that we think we can automate or centralize, which could provide benefits in scale and automation, leading to real savings in terms of staffing. It's not as clear on the overhead and general administrative side, particularly when you might have a team of two handling a function for a portfolio of 300 communities.

Just a couple of quick ones. Can you talk about the profile of the residents entering the portfolio today in some of your more challenged submarkets like New York and Boston, where concessions appear more prevalent. I'm wondering if the income and credit profiles are any different and if there's any concern over future rent payments maybe a year from now.

Yes, Zach, that's a good question. We haven't changed our credit standards, but we've become more diligent in detecting fraud, especially in certain markets like Los Angeles. We have not relaxed our standards; we're still qualifying people carefully so that as we look forward, lease rents remain stable, ensuring customers can afford renewal rent increases in the future, whether that’s late 2021 or another time frame you prefer. There is always some level of risk, but we haven't eased our standards. In fact, they are slightly more stringent regarding fraud detection.

Got you. And I guess piggybacking on an earlier question about coworking and communities and with flu season around the quarter, are you guys taking any preventative sanitary measures to combat the spread within the communities, given the potential uptick with flu season around the corner?

Yes. We've done a lot as it relates to kind of promoting a healthy environment. If you look at our operating expense table, we've noted that we've spent a couple of million bucks already this year as it relates to PPE and then beyond that for cleaning and disinfectants and various other things. We have a reservation system where people have to reserve amenity time within a gym or a chill space, whatever it may be. And so we're doing a fair bit to promote a healthy environment. And for the most part, I think we're getting very good feedback through our Net Promoter Score comments around people appreciating our efforts. There's certainly some frustration that they can't just walk into the gym whenever they want, but it's very understanding as it relates to the need for a professional protocol to limit any impact at the community. And so far, knock on wood, we've been relatively lucky in terms of what we've seen at the community. So we feel good about what we're doing and continue to look for ways to promote that healthy environment.

A question is on Slide 9. As we look at that split between suburban and urban, I think it's easy to understand the pressure on the urban environment and the change in living conditions and so forth. When you analyze your suburban portfolio, though, it looks like rents there are down maybe 3%, 4% based on the chart. You are seeing move-outs up and vacate notices up as well. Where are those tenants going? If you were to sort of quantify or speculate the weakness in the suburban market, what do you think the leading factors are there? And what are the causes of turnover that you're seeing and the weakness in pricing?

Yes, that's a good question. On the suburban front, rents have decreased by about 3%. This decline is influenced by various factors depending on the specific market. For instance, in areas like San Jose, including Mountain View and certain parts of Northeast San Jose, there is less demand for residents to live in those locations due to the current policies at companies such as Apple and Google. Consequently, we are experiencing turnover pressure in these areas, although not as severe as what's happening in San Francisco. The policies are affecting demand, particularly in Central San Jose, Mountain View, and parts of Northeast San Jose, where there is an oversupply. We are noticing a decrease in rents at the higher end to compete with other properties in the existing inventory, which are more mid-range assets. This kind of situation also resembles what we're seeing in specific areas of Seattle, like Redmond. In contrast, other regions in the Northeast, such as Boston and Long Island, are performing relatively well. However, we are still navigating a recession, leading to varied choices in living situations. Some individuals are moving into suburban areas from urban centers, while others are considering different options about where to live. Overall, we're observing a contraction in household numbers, which will affect the suburban market, but not to the same extent as in urban areas. That's the broader perspective. Tim, would you like to add anything?

Many younger individuals are returning to live with their parents, with a significant increase in those under 35, especially those under 25. This reflects typical consolidation patterns seen during economic downturns. However, there hasn't been a noticeable trend of people doubling up, as many prefer to distance themselves from roommates when both are working from home. We are certainly observing an increase in people moving back in with their families and utilizing basements or other available spaces for work. As previously mentioned, parents' homes are becoming more crowded, self-storage facilities are at higher occupancy rates, and apartment occupancy levels are slightly down. These observations are indicative of the trends we are experiencing.

That's helpful perspective. Actually, that was going to be a second question, Tim, if maybe continuing on that. If you think about the demographics of those early terminations or vacates, is that skewing more to the younger cohort that can be more mobile versus the families? Or are you seeing it fairly distributed across your tenant base?

Yes, that's a valid observation. If you examine occupancy rates and related lease breaks, there's definitely increased pressure on studio floor plans. In urban environments during the third quarter, I believe the average occupancy was around 87% to 88%. So people are certainly becoming more flexible and moving back in with family.

Thank you, Abby. I know everyone's busy, a lot of calls today. But thanks, again, for joining, and we'll see you in the virtual world, I suppose, maybe at NAREIT in November. Take care.