Avalonbay Communities Inc (AVB) — Q2 2021 Earnings Call Transcript

Thank you, April, and welcome to AvalonBay Communities Second Quarter 2021 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 is a discussion of these risks and uncertainties in yesterday afternoon's press release as well as in the company's Form 10-K and Form 10-Q filed with the SEC. As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today's discussion. The attachment is also available on our website at www.avalonbay.com/earnings, and we encourage you to refer to this information during the review of our operating results and financial performance. And with that, I'll turn the call over to Tim Naughton, Chairman and CEO of AvalonBay Communities for his remarks. Tim?

Yes. Thanks, Jason and welcome to our Q2 call. With me today are Ben Schall, Kevin O'Shea, Matt Birenbaum, and Sean Breslin. For our prepared comments today, I'll start by providing some high-level comments on apartment marketing conditions and how the current operating and capital environment is shaping our actions, including our recent decision to enter new markets in North Carolina and Texas. Ben will provide a summary of second quarter results, including a detailed roadmap of results on a year-over-year and a sequential quarter basis. Sean will then elaborate on operating trends in the portfolio, where we've seen a robust recovery in fundamentals and performance since the first of the year. Matt will review performance in our development portfolio, including lease-up performance and an overview of our first Kanso community located in Rockville, Maryland, where we completed construction this past quarter. Kevin will then provide an overview of our outlook for Q3 and the full year. And lastly, Ben will provide some summary comments on how AVB is well positioned to deliver earnings and NAV growth as we look forward. Before turning to the deck, I thought I'd provide some perspective on what we're seeing in the markets and how it's shaping our actions in terms of operations and capital allocation. Since the first of the year, the recovery in the apartment market conditions has been dramatic. Effective move-in rents have fully recovered from the trough, up almost 20% over the last two quarters alone. And asking rents grew even faster, up over 20% since the beginning of the year and now stand at 8% above pre-pandemic peak. Concessions which were significantly elevated last year have fallen back to a modest level, closer to what we experienced pre-pandemic. As you might guess the speed and steepness of the recovery has been driven by very strong rental demand. In fact, Q2 traffic was up over 40% from last year. It continues to outpace last year despite very low levels of availability. The combination of strong traffic and low inventory propelled rental rates through Q2 and that has continued through July. While all regions and submarkets are improving and most are back to or near pre-pandemic levels, there's still a fair bit of variability across the portfolio. Specifically, suburban continues to outperform urban, Class A is outperforming Class B, and regionally Southern California and our expansion markets of Southeast Florida and Denver outperforming the portfolio average, while the Bay Area continues to lag the average. In addition to strong apartment markets, the capital markets are also extremely healthy and constructive for apartment investment. The transaction debt and equity markets are all wide open and are supporting strong growth in asset values, as we've seen cap rates fall below 4% across most markets and submarkets over the last few quarters. Based on the strong market sentiment, we expect capital flows to remain healthy over the foreseeable future. With this operating and capital backdrop, we have shifted to offense and have increased our planned investment activity for the year by almost $1 billion, between new development starts and acquisitions. In addition, in our release, we announced our intent to enter the Raleigh and Charlotte markets in North Carolina, as well as Austin and other markets in Texas. As we discussed over the last two to three years, we've been evaluating expansion into markets that we believe will disproportionately benefit from the growth in the knowledge economy and domestic migration, particularly in those markets that figure to see some migration from our existing legacy markets. We'll have more to share with you about our growth plans in these markets over the next couple of quarters. And lastly, as we mentioned last quarter, after completing a comprehensive midyear re-forecast, we are now providing a full year outlook in addition to quarterly guidance. While risk remains in our outlook including the impact of the virus and the Delta variant, the exact timing of eventual phaseout of eviction moratoria across our markets and the receipt of any rent relief payments from state and local governments, we believe we have enough clarity to provide a meaningful perspective with respect to our operating performance for the rest of the year. With that, now let me turn it over to Ben, who will discuss Q2 results.

Thank you, Tim. Slide four highlights our Q2 results and activity. And while we meaningfully exceeded our guidance for Q2 with core FFO of $1.98 versus guidance at the midpoint of $1.90 per share, our year-over-year core FFO figures were down 11.2% for the quarter and 14.8% year-to-date, reflecting the disruption that we've seen in our business over the last 12 months. Notably and reflecting the strong recovery that Tim emphasized, rental revenue increased on a sequential basis turning positive for the first time since March of 2020 with a 90 basis point increase on a GAAP basis and 170 basis points on a cash basis from Q1 to Q2. As Sean will delve into in more detail, rental rates improved during each month of the quarter with continued growth in July. Our development platform also continues to create meaningful shareholder value. We completed $385 million of development in the quarter and close to $1 billion through the first half of 2021. These developments are primarily suburban and are benefiting from the renter demand and increasing rents we're experiencing across our suburban communities. For our completions in the second quarter, the initial projected stabilized yield is 6.4%, providing roughly 250 basis points of spread to the sub-4% stabilized cap rates we're seeing in the asset sale market today. These completed projects along with others that are in lease-up also provide a meaningful incremental boost to earnings growth as Matt will discuss in more detail. We also started $580 million of new developments in Q2 and are on track to meet our target of $1.2 billion of new starts in 2021, which we increased last quarter from our initial target of $750 million of new starts. During the quarter, we raised $540 million of capital through dispositions at an average cost of capital of 3.7%. By match funding our development activity, primarily with these disposition proceeds, we in turn are able to reduce the capital cost risk associated with the earnings and NAV accretion as we execute on our development pipeline over the coming years. Slide five breaks down the components of our rental revenue change on a year-over-year basis with lower lease rates over the last 12 months and the amortization of concessions being the largest drivers of the decline. As it relates to concessions, at the end of Q2, we had a total of $29 million of previously granted concessions still to be amortized in our same-store pool over the coming quarters. However, concession usage has declined by roughly 85% since Q4 2020 from $1,900 per move-in to just above $300 in July. Slide six provides the factors leading to our increase in rental revenue from Q1 to Q2 with a turn to the positive being driven by higher occupancy and an improvement in uncollectible lease revenue. At a portfolio level, uncollectible lease revenue remains elevated with bad debt at roughly 3% versus a more normalized 50 to 60 basis points with the expectation that we'll continue to see elevated bad debt levels until eviction moratoria are behind us. Before turning it over to Sean for further context on our operating performance, slide seven illustrates our strong momentum in the form of like-term effective rent change, which turned positive in June and now stands at 5% in July. With that, I'll turn it to Sean.

All right. Thanks Ben. I thought I'd share a few slides on portfolio rent trends both overall and across different markets and submarkets. Overall, we've seen a meaningful acceleration in the positive rent trends we spoke about during our Q1 call. On slide eight, you can see that our average move-in rent value has grown by roughly 18% since the beginning of the year including a 13% increase since just April and is now consistent with the peak rent levels we achieved in mid-2019. Moving to slide nine, improved performance has been broad-based with every region experiencing a material increase in average move-in rent over the past seven months. If you look at our July move-in specifically, rents are now equal to or greater than the 2019 peak in every region except Northern California, which remains roughly 11% below peak. The timeline for a full recovery in Northern California will in part be based on when major tech employers call people back to work. The hybrid work policies adopted by major employers will certainly have some impact on where tech workers want to live. Silicon Valley will very likely remain one of the world's leading innovation centers for years to come. Turning to slide 10 to address suburban and urban performance trends, the average July move-in rent for our suburban portfolio was roughly 3% above the peak we achieved in 2019. In our urban portfolio while demand has returned in a meaningful way, the average rent in these submarkets fell the most throughout 2020 and is still down about 7.5% from peak 2019 rents. As it relates to the urban portfolio, we expect performance to continue to improve as people are called back to the office, urban universities resume on-campus learning, and the quality of the environment starts to look and feel more like pre-pandemic conditions. Turning to slide 11. Our average asking rent which is representative of the published rent for available inventory has increased 24% since the beginning of the year and is currently about 8% above the mid-2019 peak. Our suburban submarkets which represent about two-thirds of portfolio revenue are leading the recovery. The average asking rent in our urban submarkets is basically back to the 2019 peak and as I mentioned previously is expected to continue to grow as those environments more fully reopen over the next few months. And moving to slide 12, this chart depicts the trajectory and spread between our average asking and move-in rents. As I mentioned a few slides ago, the average portfolio movement rent has increased roughly 18% this year, but trails the increase in average asking rent which is up 24%. The average dollar spread between the two which averaged 12% for the month of July is wider than the 4% to 5% we have seen historically and is representative of the capacity available to grow move-in rents over the next couple of quarters. Additionally, if we see a seasonal adjustment in asking rents the last few months of the year something we have not yet experienced this year there's plenty of room for asking rents to soften a bit and still grow move-in rents. With that summary, I'll turn it to Matt to address development and portfolio trading activity.

All right. Great. Thanks, Sean. Turning to our current lease-up communities, you can see on slide 13 the same positive trends that we're seeing in the stabilized portfolio. We're achieving rents $155 above initial underwriting on the seven communities that are currently in lease-up which is lifting the stabilized yield on those investments to 6.1%, generating substantial value creation relative to current cap rates which are at or below 4% across our footprint. This is really a remarkable turnaround in our development portfolio which just a few quarters ago had rents and yields modestly below initial underwriting and continues to demonstrate our long track record of delivering outsized risk-adjusted returns from our development and construction capabilities. One development that we wanted to highlight this quarter is shown on slide 14 which is the first completion of our latest brand Kanso located at the Twinbrook Metro station in Rockville, Maryland. Kanso was born out of customer insight research, which was telling us that there's a large underserved segment of residents that are looking for a new high-quality apartment in a transit-served or infill location, but without all the extra bells and whistles provided in typical Class A new construction. By focusing our investment on the apartment home itself and removing common area amenities that these customers do not value like pools, fitness centers and lounges, we are able to save on both upfront capital and ongoing operating and CapEx costs which in turn allow us to provide a meaningful discount on the rent as compared to a fully programmed Avalon offering at the same location. Kanso leverages technology to provide a primarily self-service experience for residents and prospects with very limited on-site staffing supported by our centralized call center and a design with low maintenance needs to deliver on the brand promise to live simply without sacrifice. We're excited the market has embraced the concept with Kanso Twinbrook leasing up successfully at a strong pace at rents above pro forma and look forward to growing this new brand via additional development opportunities in the future. Turning to slide 15 we continue to see tremendous demand in the asset sales market and completed six wholly-owned dispositions in the second quarter at a weighted average cap rate of 3.7%. The assets sold were predominantly in the Northeast region with more than 60% of the proceeds coming out of the Greater New York area and were older than average for our portfolio with an average age of 25 years, allowing us to continue to further our portfolio allocation goals to reduce exposure to some of our legacy markets while also minimizing our CapEx profile. And by redeploying this capital into new development starts of $580 million this quarter at projected yield of 5.7% we're match funding new growth at highly accretive margins. And with that I'll turn it over to Kevin to go over our earnings guidance for the year.

Great. Thanks, Matt. On slide 16 we provide our financial and operating outlook for the third quarter and for full year 2021. For the third quarter using the midpoint of our guidance ranges, we expect core FFO per share of $1.96. On a sequential basis our third quarter estimate reflects a sequential decline in core FFO of $0.02 per share from the second quarter. This sequential decrease in core FFO per share is driven primarily by an increase of $0.05 per share in same-store residential revenue and a $0.03 per share increase in lease-up NOI offset by a seasonally driven increase in same-store residential operating expenses of $0.06 per share and a $0.03 per share decrease in community NOI as a result of recent disposition activity. On a year-over-year basis for our same-store portfolio using the midpoint of our ranges we expect NOI to decrease by 3% for the third quarter driven by an 80 basis point reduction in same-store residential rental revenue and a 3.5% increase in same-store residential operating expenses. For the fourth quarter our full year earnings guidance implies core FFO per share of $2.13, which would represent a $0.17 or 8.7% sequential increase from the third quarter estimate. This expected sequential increase in earnings in the fourth quarter is primarily driven by a continued increase in same-store residential rental revenue by a seasonally expected decline in same-store residential operating expenses and by further NOI growth in our lease-up portfolio. For our full year 2021 guidance, we expect core FFO per share of $8.02 at the midpoint of our range. And for our same-store residential portfolio, again using the mid-point ranges and looking at growth on a year-over-year basis, we expect NOI to decrease by 6.2% for full year 2021 driven by a 3.2% decrease in revenues and a 3.3% increase in operating expenses. Turning to our updated investment and capital plan, the combination of a strong recovery in revenue and earnings growth and attractive access to the capital markets has prompted us to pivot to offense and pursue increased development and acquisition activity as reflected in our current investment and capital plan on slide 17. For development, we now anticipate starting $1.2 billion in new projects this year, up from our original plan of $750 million, and we expect NOI for new development communities undergoing lease-up to be about $50 million this year at the midpoint an increase of $5 million from our original outlook. For capital activity, we now anticipate a busier year with total capital uses for development, redevelopment, acquisitions and debt repayments of $1.8 billion in 2021. This represents an increase of nearly $1 billion from our original outlook and is driven by increased acquisition activity for the year and an expected early repayment later this year of $450 million in unsecured debt that is scheduled to mature in September 2022. In terms of capital sourcing, our current plan contemplates meeting our capital needs through a combination of unsecured debt issuance and additional asset sales, although the sources we ultimately tap are subject to change based on changes in capital market conditions or our actual capital uses. Turning now to slide 18 and our continuing efforts in the area of corporate responsibility or ESG, we are pleased to report that we recently released our 10th Annual Corporate Responsibility or ESG Report reflecting our long-standing commitment to this part of our business. As highlighted in the report, we see measurable progress on our science-based emission reduction targets primarily due to our investments in on-site solar generation and efforts to improve building efficiency. We're also proud of our commitments to the communities in which we do business. These fundings to our non-profit partners to serve those in need during the pandemic. We continued our important national partnership with the American Red Cross focused on disaster preparedness and response and we initiated a new partnership with the National Urban League designed to engage with them on our diversity and inclusion efforts and provide support to their mission. All these efforts continue to be recognized externally with the CDP rating us in the A band and the Global Real Estate Sustainability Benchmark or GRESB rating us number one in the multi-family sector both globally and in the United States. In addition, NAREIT awarded us their highest honor of sustainability performance. Further, our associates remain highly engaged as reflected in our engagement scores that are in the top quartile on this important metric. And finally, our customers weighed in and we are pleased to be number one in online customer reputation. And with that, I'll turn it back to Ben for his concluding remarks.

Thanks Kevin. Turning to our key takeaways on slide 19, we're very encouraged by the continued improvement in our operating fundamentals and believe our portfolio is well positioned for additional growth, as reflected in the growth assumptions incorporated into our second half guidance. Near-term trends in our suburban portfolio continue to look very strong, and we are hopeful that our urban communities, which have been lagging the rest of the portfolio should benefit over the coming months with a fuller return to offices and universities. As Tim mentioned at the start, we also expect that our Class A communities will continue to outperform, as higher income residents and prospects benefit from the economic recovery and seek out high-quality living environments. As discussed, our development acumen and pipeline continue to be a differentiator for us, our projects in lease-up primarily in the suburbs are benefiting from strong renter demand and we've been able to quickly scale up our development activity at attractive yields relative to stabilized cap rates. As we look forward, we expect the breadth of our development expertise will allow us to shift capital to growing markets and evolve our product offering to meet the needs of our targeted customer segments. We also see our operating platform and our investments in innovation as a differentiator. In addition to the expense reductions and the margin opportunities we discussed last quarter, our technology-forward approach positions us to be able to create de novo offerings such as Kanso bringing together the best of our operating, innovation, brand and development expertise as we evolve our offerings and create a better way to live. As we head forward, we're excited about our new growth in Raleigh-Durham, Charlotte, Dallas and Austin in addition to our continued growth in Southeast Florida and Denver bringing us to a total of six expansion markets. We're actively negotiating on opportunities in these new expansion markets and expect to grow through acquisitions, our own development and through the funding of other developers where we own the asset upon stabilization similar to the growth strategies we've successfully utilized to grow our presence in Southeast Florida and Denver. This multi-pronged approach also allows us to invest capital over different time horizons with acquisitions of existing communities being naturally the most immediate and our own development being medium term in duration. We look forward to sharing our long-term goals and portfolio allocation objectives for these markets with investors over the coming months. Finally, thank you to the entire AvalonBay organization for their commitment and leadership on ESG, where our recently issued 10th Annual Responsibility Report highlighted our continued ESG leadership position across the wider REIT sector. And with that we'll open it up for questions.

Thanks. I appreciate the comments on the new markets. How large do you expect each market to be once you get to scale, so either from a unit perspective or as a percentage of total NOI?

Hey, Nick, this is Ben. I'll take that one. We're not putting out a specific target at this point. As I mentioned, it's part of what we'll discuss with investors over the coming quarters and also how that ties into our overall portfolio allocation approach. But we do see this announcement as a meaningful one. We are actively engaged with specific opportunities currently on both the acquisition side and on the development side. Just for some context, we've been growing in Southeast Florida and Denver where we've set a target of 5% for each market as a goal for our overall allocation. Our rough use of the Texas and North Carolina have the potential for a similar type of allocation. Overall, we're excited for opening up these new growth opportunities in these new four markets and leveraging our skills across investments development and operations over the coming years.

Hey, Ben, it's Michael Bilerman speaking. It sounds like you've been quite active in these markets sourcing opportunities. Can you provide some details on how much is under contract or at an advanced stage? I’m curious if it’s around $1 billion that you’ve targeted in terms of potential acquisitions or developments, just to give us a sense of how quickly you’ve been able to engage in these markets.

Hey, Michael, it's Matt. I can provide some details on that. Things are still in flux until they finalize, so I won't get too specific. However, we are actively working on deals in three of the four markets that Ben mentioned. Those three deals likely total around $500 million, not quite $1 billion at this point. We are also continuing to seek more opportunities and anticipate that some of this activity will close in the third quarter.

And then just finally, I know a couple of you have talked about the growth opportunities in those markets in terms of people coming from your existing legacy markets as well as just job growth in those markets. And so how should we think about sort of the initial funding of these? Is this going to be a dilutive exercise or you sell assets or raise equity or other forms of financing that you'll benefit from the growth going forward? Or do you think you can do this on a sort of non-dilutive basis maybe even accretive as you go forward?

Hey, Michael, this is Kevin. Regarding our approach to entering new markets, it will likely be measured, as Matt mentioned, similar to our previous rollouts, with some variations. We aim to make progress in this area. Additionally, our capital engagement will also be measured. Unlike others, due to our active development focus, we have the option to partner or develop independently. Engaging in new markets in this manner will pace our capital deployment and align it with investments that positively impact our cost of capital. We do not intend to approach this in a dilutive manner. As for acquisitions, we have been actively enhancing our capacity by divesting assets in non-core areas and reinvesting in Southeast Florida and Denver, which we expect to continue. This strategy appears marginally accretive as we're transitioning assets, selling in lower cap rate markets for similar cap rates but with better growth potential. Hence, our past activities are likely a solid indicator of our future actions, and from a funding perspective, we are prepared to pursue this on an accretive basis.

Got it. Thanks for that color.

Good afternoon, everyone. I wanted to follow up on Michael's question. Do you see any potential for a larger acquisition of a private apartment REIT or private apartment owner in these markets, or even a public apartment REIT? I'm not trying to push anyone into a deal, but there seem to be some interesting synergies on both general and administrative costs as well as portfolio strategy if you're considering a move into these markets. I'm curious if you've contemplated this and what aspects may be practical or impractical.

Yes, M&A is always a possibility, but it's not our primary strategy for entering these markets. To take a step back, we are not necessarily looking to rush in. As Kevin mentioned, we're focusing on a measured approach to enter these markets. Our decisions are based on the strong long-term fundamentals we see, along with structural advantages that will make these markets attractive for the next several decades, similar to how our legacy markets have performed over the past 20 to 30 years. Therefore, we are not driven by the need for M&A or excessive transaction activity in these markets. We're also aware that we are learning as we enter these areas, and there are significant risks associated with engaging in M&A or high transaction volumes in the early years while we gather market intelligence. This strategy is similar to what we implemented in Southeast Florida and Denver, and it's how we intend to deploy capital in these markets as well.

I appreciate your response. I wanted to revisit the idea of base effect versus earnings power for the apartment REITs. From our perspective, the recovery is occurring sooner and faster than we anticipated, and we have been quite positive over the last nine months. However, I am curious about your discussions with your tenants regarding supply and demand. It seems that occupancy is at a very healthy level, with significant demand returning. You mentioned that all your markets, except for Northern California, are close to 2019 levels. How much do you think you can increase rents in this market? Are we looking at a relatively elastic demand profile, considering the large demand coming from Gen Zs and Gen Ys in comparison to the limited supply of housing? What are your thoughts on this?

Yes. Rich this is Sean. I'll take a first shot at that and then anybody else could jump in. In terms of the kind of demand profile and how it plays out how long it could run that's a function of a lot of different variables that would take us quite a while to get through. But still on the demand side things have been quite robust as you noted. The trajectory of the recovery whether you look at asking rents you look at move-in values you look at occupancy all of them quite healthy even by historical standards in terms of coming out of a downturn, in terms of the speed of the recovery and the order of magnitude both have probably been a little bit surprising for everyone. When we look at where we're clearing the market today on rents we kind of put that slide in the deck. It shows where asking rents are relative to move-in values. In the near term I guess what I would say is that, demand has been quite healthy. We have not seen signs of weakening at this point whatsoever and have seen very healthy week-by-week growth in both those move-in values and asking rents. People have asked about the seasonal effect has demand been pulled forward, etcetera, etcetera. We don't see signs of that yet. But what we do feel good about is that spread between move-in rents and asking rents being at 12% even if there's a little bit of seasonality that comes upon us in the fourth quarter or the variant creates some disruption and delays we're starting to see a little bit of that. There's still plenty of room in the short run to see move-in rents continue to grow and maintain the recovery. In the longer term, it's a broader question around just overall housing demand and supply which is a function of what happens with the job and income growth and various other factors associated with the demand side. And then on the supply side just overall housing production and multifamily housing production specifically. And at least on the supply side, our markets we feel pretty good about particularly for legacy markets the outlook for supply coming down over the next year or two potentially by a pretty decent amount. We'll be able to refresh our numbers by the end of this year. But we could be seeing a double-digit percentage decline across the footprint and supply as we move into 2022. It would certainly further support healthy demand and rental rate growth as we move through 2022. So that's kind of the near-term and the kind of maybe medium-term outlook. And then yes, Tim or others may want to jump in in terms of the longer-term outlook.

Yes, I’d like to add to what Sean mentioned about the supply outlook. There are some one-time factors driving demand, along with structural changes that have been accelerated by the pandemic. Unprecedented federal stimulus and excess savings created during this downturn may be contributing to some household demand. A significant portion of this demand is coming from the 25 to 29 age group. Furthermore, we believe there has been a housing shortage building over the last decade. Coupled with federal stimulus and a broader trend of people wanting more space, as individuals who used to share a living situation now seek their own households, this is likely increasing demand. Additionally, the nature of this recovery appears to be K-shaped, where our renters and tenants are experiencing a V-shaped recovery. From our perspective, this recovery feels steep. However, some segments of the population are being left behind, particularly those in service-oriented jobs compared to those in technology or financial services, which we typically focus on. This structural aspect may stimulate household formation, especially within our target segments.

Thanks, guys. That’s helpful. I may have some follow-up questions offline, but I’ll jump back in the queue.

Good afternoon, guys. Thanks for taking the questions here. I just want to go back to the movement into the four expansion markets mentioned on this earnings cycle. And maybe help us understand, obviously a lot of your peers have been in some of these markets for a long time, and so might have had a view on the different positive attributes, some of which I think were mentioned on this call. But maybe help us understand, what changed directly due to COVID in terms of your view of these markets if it's migration patterns and so forth versus what you sort of knew about these markets prior to COVID that's led to the decision to expand there?

From my perspective, COVID hasn't changed our outlook on the markets. Our view is shaped by expectations for performance over the next 20 to 30 years. Some of the Sunbelt markets have gained from migration during COVID, moving from some of our legacy markets. While some of this migration may be temporary, some appears to be permanent, and this trend was already underway to some degree. In markets like Southeast Florida and Denver, we realized there are limits to how many expansion markets we can handle at once. It was significant for us to enter Southeast Florida and Denver about three years ago, and we've seen success there, which has boosted our confidence in entering additional markets. If COVID hadn't occurred, we might have expanded into these markets sooner. The last 16 months have shifted our focus toward other priorities, but right now, we believe we are well-positioned to continue growing, whether through exploring new segments, mixed-use developments, or broader geographical opportunities.

Okay. That's helpful color, Tim. And then, I want to go back to a comment, I guess from the last earnings call where Matt, you helpfully broke down the development costs across hard costs, soft costs, labor, land and so forth. And I guess talking about lumber price inflation if so 90 days ago, and you actually explained that that's not really what people should be focused on. But labor expense could sort of drive the equation as we think about ultimate yield on development. And so, help us understand what movements are you seeing in labor costs in that context right now? And where do you expect that to be, let's say, over the next 12 to 24 months?

Yes, we're definitely seeing a reduction in the excessive prices in the lumber market, which is encouraging. However, as we've discussed over the past couple of quarters, overall cost inflation is primarily driven by labor, followed by commodity costs. While lumber prices have decreased, prices for steel, drywall, and other materials we frequently purchase are rising. This creates pressure for us. We don't have direct information on what our subcontractors pay their workers, but we can observe it through the bids we receive, and we are currently involved in a lot of activity. For the development projects we initiated recently, our total capital costs are estimated to have increased by 5% to 10% compared to our earlier projections from the end of last year. This increase has slightly lowered our expected yields. We anticipate a development yield of around 5.7% on the $1.2 billion worth of projects we aim to start this year, down from approximately 6% a year ago. We have experienced some downward pressure on yields, and with cap rates decreasing, it suggests that our margins remain strong. On the transaction side, we're seeing record-breaking trading prices for assets each month, which boosts our confidence to continue with construction despite the 5% to 10% increase in our costs. This dynamic is also beginning to influence our net operating incomes and the anticipated rent increases we previously mentioned. Nonetheless, our rental underwriting for development remains quite conservative, indicating that there may still be some potential for rent increases ahead.

Great. Thank you.

Hi, everyone. I guess a question on development. I was wondering in terms of the incremental development starts that you announced and even just thinking about how you're thinking about development going forward. How much is that going to be weighed towards suburban projects? I know that is a lot of the current pipeline. A little perspective there would be great?

Sure. This is Matt. I'm just looking at the list now. So of the – looks like one, two, three, we got 10 development starts planned this year and one of them is urban two of them are urban. One is kind of a residential urban neighborhood in Boston and Brighton. It's a relatively small wood frame deal and the deal we just started this quarter in Merrick Park which is in Miami, but really in Coral Gables not Downtown Miami. Those are the only two that are urban. So it's still predominantly 70%, 80% suburban. And as I look at what we're likely to start next year, it's more of the same. That's where we're finding the development economics are working better. And there's still more supply coming in urban submarkets relative to suburban submarkets. Again, when you look out maybe two, three, four, years from now that equation could well change and we're mindful of that as we look at the land market and where that might be in the future. But certainly over the next year or two the starts are going to continue to be the vast majority suburban.

Okay. Great. And then just one other question is in terms of – we just look at let's say Metro New York for – Metro New York, New Jersey as your region for example and I know you don't give the development rights page anymore, but if you go back to last year that is where the bulk of your development rights are. And maybe you could just give us a feel for – because it is – it's over $2 billion that you listed as capital cost for that metro for those development rights the feel for suburban versus urban. And my other question was in terms of – in the supplemental you list the average rents right now for New York City and suburban and they're shockingly almost the same. And so I'm just wondering, if there's a concession impact there or something we should think about or have suburban rents really almost now gone to the point of New York City rents in your portfolio?

Yeah. I mean, I can speak to the first part and Sean may want to speak to the second part a little bit. So as I mentioned, we're – today, we have about $3.1 billion in development rights. It looks like about 25% of that is Metro New York. So compared to when we used to have the schedule it has come down quite a bit or we've been adding more in other regions. And of that so maybe $800 million $900 million of it is in Metro New York. And of that at least two-thirds of it is in the suburbs. I think we have one urban development right on the coast in Jersey, but everything else is – a lot of that is Inland New Jersey, Long Island type of locations. In terms of the existing rents in the portfolio a very different kind of unit. I mean, our average unit size in the suburbs is – I don't know the number, but it's probably over 1,000 square feet. So the whole dollar rents may look the same but the rents per foot look pretty different. And frankly that's where we're seeing a lot of success. So we're trying to add more rental townhomes for example in New Jersey or empty nester-targeted product on Long Island. So the unit sizes and the target customers are quite different.

And Nick just in terms of additional context as we look out over our development pipeline over the next couple of years, we took our overall starts for this year up to $1.2 billion. We think over the next couple of years in that $1.2 billion to $1.5 billion type of range is achievable plus the opportunity for additional development starts in our expansion markets as we get moving heavier in that direction.

Yeah. Hey, everyone. On the expansion markets, can you talk about the path towards getting to that sort of 5% number that you called out? Because obviously Southeast Florida, I think maybe 1.5%, Denver is 1%. So is that like a 10-year process that's largely development at this point? Or sort of what's the time scale?

Matt mentioned that regarding Southeast Florida and Denver, their current portfolio weighting is somewhat higher than the reported figures, but they are approximately halfway toward their goal of 5%. They are currently at around 2% to 2.5%. The acceleration of this process could be achieved through acquisitions, and they are actively seeking to make those moves. They are trading assets from legacy markets to reinvest in these areas, while development projects generally take longer to realize. Their strategy encompasses acquisitions, development, and funding other developers, each operating on different timelines, which offers some diversification in timing. They are actively staffing up in these regions and plan to establish a local presence. However, it is unlikely that any of these markets will reach 5% or more of their portfolio within the next two to three years, as it is expected to take longer.

Hey, Austin, it's Kevin. You raised an interesting question, but it's somewhat speculative. It starts with our intended uses and the expected return profile, and then it goes back to sources. We have three primary markets: unsecured debt, suburban asset sales, and common equity. Currently, all three markets are attractive, as Tim mentioned earlier. One key factor in how we gather our sources is pricing, and right now, all three options are appealing for funding growth. When debating which source is most attractive, I would rank unsecured debt first based on historical pricing metrics, followed by suburban asset sales, with common equity third. However, opinions can vary, and the specifics of the assets and our balance sheet situation greatly influence this. Another factor is our ability to increase leverage. The positive news is that with our revenue and NOI growth, and our moderate leverage currently at 5.3 turns, we can increase leverage when it makes sense to support investment activities. Additionally, we need to consider our capacity to absorb capital gains before any special distribution. Recently, we've utilized that capacity to acquire assets in our expansion markets and to fund development activities. We have numerous options available right now, so there’s no immediate decision required for our capital plan for the second half of the year. What we intend to do is access the unsecured debt and asset sale markets to support our current needs. If more opportunities arise, that’s how we approach it. The good news is we have favorable access to capital and the ability to invest in profitable development, placing us in a strong position to enhance earnings growth. This is a significant advantage for AvalonBay.

That makes a lot of sense. Appreciate the thorough and thoughtful answer, Kevin.

Thank you, April. I know it's been a long call and thank you all for being on today and just hope you enjoy the rest of your summer and stay well. Thank you.