Avalonbay Communities Inc (AVB) — Q3 2021 Earnings Call Transcript

Thank you, Kathy, and welcome to AvalonBay Communities third 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 includes 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, and we encourage you to refer to this information during the review of our operating results and financial performance. And with that, I will turn the call over to Tim Naughton, Chairman and CEO of AvalonBay Communities, for his remarks. Tim?

Yes. Thanks, Jason, and welcome. For our prepared comments today, Ben will provide a summary of third quarter results, an update on Q4 and full year guidance, and provide some thoughts on why we believe AVB is well positioned to outperform. Sean will then elaborate on operating trends in the portfolio, where we continue to see strong momentum and healthy fundamentals that should support robust growth as we move into 2022. And then we'll conclude with an overview of development activity where development economics remain compelling and then offer a brief look at our new expansion markets, including our rationale behind our decision to enter them earlier this year. And then we'll all be available for Q&A after prepared remarks. But before turning the call over to Ben, I did want to take a minute to acknowledge that I expect this will be my last earnings call, as I plan to step down at year-end as CEO, when I'll assume the role of Executive Chairman as we had previously announced last December. I spent the last 32 years at AvalonBay and its predecessors. Over the last 20-plus years or so, I've had the opportunity to interact with many of you on this call on a regular basis. I just want to say that I appreciate your support for and engagement with the company and me over that time. And for the investors on the call, I simply want to thank you for entrusting us as stewards of your capital over the years. It's something we've never taken for granted. I know that will continue to be the case in the future under the leadership of Ben and this executive team. I look forward to being able to touch base with many of you more directly and hopefully in a little more personal way over the next couple of months. And with that, I'd like to turn the call over and place it in the very capable hands of Ben Schall and the rest of the executive team here today. Ben?

Thank you, Tim. We wanted to start the call today as a team and an organization by expressing our gratitude and acknowledging Tim for his contributions to the company and the industry over the last 32 years. AvalonBay would not be the company it is today without Tim's strategic leadership, which is deeply intertwined with the company's history and evolution into one of the preeminent real estate companies in the U.S., its exceptional track record of value creation and its inclusive culture focused on continuous improvement. In addition to overseeing AvalonBay's tremendous growth and positioning us as an industry leader, Tim has also had a major influence on the evolution of the multifamily industry and the broader REIT sector during his career. And throughout all of these accomplishments and successes, one of Tim's most admirable attributes as a leader and a person is that he never made it about him. His focus has always been on others, the positive impact he could have on people, the impact that AvalonBay could have in our communities, and how he could lead by fostering and reinforcing our evergreen culture and strong organizational values. On behalf of all of those that have been part of AvalonBay and all of us at the company today, thank you, Tim.

Thank you, Ben.

As the next section and before turning to the presentation, we wanted to emphasize upfront a number of factors that we believe position AvalonBay for outsized performance over the coming quarters and as we look towards 2022. Our operating fundamentals continue to show very strong momentum with rents now above pre-COVID levels in five of our six large coastal regions with the strongest performance in our suburban communities, which comprise over two-thirds of the portfolio. Our resident base, with concentrations employed in knowledge-based industries, are in high demand in today's labor market, setting the table for future rent growth as wages continue to rise. For the segment of our resident base who would typically be seeking to purchase a home after a period of time with us, this alternative is challenging given the general lack of availability, further supporting our retention rates and demand fundamentals. We also expect our portfolio and market allocation to generate strong growth over the coming quarters. Looking back over the last 18 months, while we've experienced an unprecedented trough and then an equally unprecedented recovery, our rents today are only 7% above October 2019 levels, equating to roughly 3.5% growth per year. With an economy in growth mode, limited availability, low turnover, significant loss to lease, and with one-third of our portfolio in urban areas that are recovering but still held back by the pandemic, we expect strong operating tailwinds as we head into 2022. Our execution on our operating model initiatives continues to pay dividends with our investments in technology and innovation, offering enhanced value to prospects and residents while also allowing us to improve operating efficiencies. Through these initiatives, we expect to improve margin by roughly 200 basis points, with $10 million of this improvement already captured and with an additional $25 million to $35 million to be captured over the next couple of years. Finally, we're also creating outsized value creation and earnings growth from our development platform with returns trending above pro forma, leading us to ramp development activity with very attractive spreads between our development yields and market cap rates. We are in growth mode, which is further supported by our access to a historically low cost of capital given the strength of the capital and transaction markets, all of which sets up for a strong end of this year and meaningful growth in 2022. Turning to the presentation and starting on Slide 4. The rapid pace of recovery continued in the third quarter with core FFO coming in at $0.10 above the midpoint of our prior Q3 guidance and flat on a year-over-year basis. The outperformance relative to guidance was driven primarily by same-store revenue, which produced a 4% sequential increase in revenue on a cash basis. Our growth orientation is reflected in our ramp in development starts with just under $1 billion of starts through the end of Q3. We've also completed $1.1 billion of projects so far this year at an attractive yield of 5.9%. In addition to development, we are growing through acquisitions, and Q3 marked our first acquisitions in our new expansion markets of Texas and North Carolina totaling $275 million. Subsequent to quarter-end, we closed on an additional acquisition in Fort Lauderdale, Florida for $150 million. Funding our growth with low-cost capital, primarily from asset sales and incremental debt proceeds, including a recent $700 million 10-year unsecured bond at a fixed rate of 2.05%, the lowest coupon and lowest spread in AvalonBay history and also our first green bond. Turning to Slide 5 and given these strong operating trends, we have raised our guidance for Q4 and for the full year 2021. Q4 FFO guidance has been raised to a range of $2.19 to $2.29 per share, an $0.11 increase over our previous Q4 guidance at the midpoint. This improved outlook is driven by our improved revenue expectations with residential revenue now projected to increase in Q4 by 5% on a year-over-year basis. In addition to occupancy and rate trends, the same-store revenue outlook assumes approximately $12 million of additional rent relief payments in Q4, relatively consistent with what we received during Q3. Other activity incorporated into our updated Q4 guidance includes $250 million to $300 million of dispositions from our Northeastern markets at an expected cap rate below 3.5% and $300 million to $350 million of acquisitions in our expansion markets, one of which is the Fort Lauderdale community with the others under agreement.

All right, thanks, Ben. I thought I'd share a few slides on the portfolio rent for the quarter and into October, both at the same-store level and across different markets and submarkets. Overall, we have continued to experience a significant rebound in the business. If you look at Slide 8, like-term effective rent change turned positive in June and has accelerated materially over the last few months. It is now running at roughly 11%. If you turn to Slide 9, you can see what's supporting the improvement in our rent change, which is the growth we've experienced in average move-in rent value. Our average move-in value has grown by roughly 24% since the beginning of the year, including a 9% increase since the end of Q2, and is now about 7% above the level we achieved in the fall of 2019. Moving to Slide 10. Improved performance has been broad-based, with every region experiencing an increase in average move-in rent over the past quarter. As noted in the chart, the recent flattening of move-in values reflects a normal seasonal pattern although the seasonal adjustment has only been about one-third of the amount we typically see moving from the summer into the fall. Rents are now equal to or greater than 2019 levels in every region except Northern California, which has seen roughly 20% growth in move-in rents this year but still remains roughly 7% below the level we achieved in 2019. The timeline for a full recovery in Northern California has been delayed in large part by major tech employers extending their return to the office date into early 2022. At the other end of the spectrum, the Southern California region has experienced strong growth in movement values, supported by very healthy job growth, including significant growth in the content-producing segment of the media industry. Limited supply and a very tight sale market support this growth. Turning to Slide 11 to address suburban and urban performance trends. The average October move-in rent for our suburban portfolio was roughly 12% above the rent we achieved in October 2019. In our urban portfolio, while demand has returned in a meaningful way and rents have recovered significantly, move-in rents are still slightly below what we achieved in October 2019. To provide a few examples, in Boston and New York City, urban move-in rents are now 1% above what we achieved in 2019. But the District of Columbia and San Francisco are lagging with move-in rents that are 3% and 13%, respectively, below what we achieved in 2019. Given the continuing adoption of vaccine requirements and steady vaccination rates, we expect urban office occupancy rates will continue to rise as we move into 2022, which is one of the opportunities we expect to benefit from next year. In fact, moving to Slide 12. The macro environment should support healthy fundamentals in our markets over the next several quarters. Starting at the top left of Slide 12, while the labor market continues to improve, we are still almost 5 million jobs short of where we started. The demand for labor continues to be robust, which is putting material upward pressure on wages, a key driver of rent growth. Chart 1 shows job, wage, and total personal income growth for the professional services sector of the economy, which is where most of our residents are employed. As noted in the chart, we've only experienced positive year-over-year growth across all three categories since Q2 of this year. As many businesses are finding as they attempt to recruit and retain professional services employees, the market has only strengthened since Q2. In Chart 2, office usage hit a trough in Q2 2020 at the onset of the pandemic. Since that time, while we've seen steady improvement, the gains have been modest. As we look forward into 2022, gains in office usage should support additional rent growth, particularly in our urban and job center suburban submarkets. And touching on Chart 3 and 4 regarding the housing market, price appreciation in the for-sale single-family market and relatively stable multifamily supply both support a healthy near-term outlook for rental rate growth. With that favorable macro outlook as context, turning to Slide 13, we also see terrific tailwinds in our portfolio as we move into next year. Beginning in the upper left of the slide, the chart number one shows we are starting from a position of strength, with turnover trending lower and strong, stable occupancy, which brings with it unusually strong pricing power. Turnover has declined this year. It was down about 1,000 basis points or 15% in Q3 relative to what we would experience in a normal year like 2019, and occupancy has been running above 96% for several months now, a point at which we can continue to push rents. In Chart 2, given the very healthy rent change we've experienced a month, we'll be starting 2022 with built-in revenue growth of roughly 3%. The strongest starting point in the last cycle was roughly 2.25% at the beginning of 2012. In addition to the baked-in revenue growth in Chart 2, our loss to lease is currently running at roughly 14% and is depicted in Chart number 3, providing plenty of opportunity to benefit from moving existing leases to market when they expire. Moving to the bottom of Slide 13, there are three other somewhat unusual tailwinds that should also benefit revenue growth as we move into 2022. In Chart 4, the amortization of concessions associated with previously signed leases should burn off as we move through the next several quarters. In Chart 5, a reduction in bad debt, which we won't revert quickly to the pre-pandemic average but should begin to abate as the eviction moratoria expire and our legal remedies become more widely available to us. Finally, on Chart 6, continuing receipts from the emergency rental assistance program for our same-store portfolio. We have received $14 million from the program, with $11 million of it coming in the last quarter. Since less than one-quarter of the roughly $47 billion authorized by the federal government has been distributed as of September 30, we expect to receive additional funds in Q4 this year and in 2022. So with that summary, I'll turn it back to Ben to address development and our new expansion markets.

Thanks, Sean. As shown on Slide 14, these strong operating trends are also translating into outperformance for our six development projects currently in lease-up with lease rates up $180 per unit and projected yields up 30 basis points to 6%, driving further value and earnings. Turning to Slide 15. Our total current development portfolio is poised to deliver meaningful incremental NOI and NAV growth over the coming quarters. Specifically, these projects are projected to generate $145 million of NOI upon stabilization, of which only $26 million is in place today on an annualized basis. These communities are slated to generate $1.2 billion of net value above our costs, or close to $9 per share of NAV and meaningful earnings growth. As further highlighted on Slide 16, our industry-leading development platform has created significant value throughout various cycles with consistently strong spreads between development yields and market cap rates, which today sits at a spread of roughly 210 basis points. As we look forward over the coming years, our existing development rights pipeline totals $3 billion of potential projects lining us up well for a strong pace of continued profitable development. Turning to Slide 17. Our four new expansion markets, in addition to our continued growth in Southeast Florida and Denver, provide us with meaningful additional growth opportunities as well as the ability to optimize our overall portfolio over time. This slide provides the high-level framework we utilize to evaluate markets that drive portfolio allocation decisions across our existing markets and our expansion markets. At the top of the list, our focus remains on being a best-in-class developer and operator in markets that over-index to knowledge-based employment, which we expect to experience outsized job and wage growth. We also continue to believe that markets with a high cost of home ownership create an attractive rent versus own backdrop for our product offering. While our expansion markets generally have lower home prices than our existing markets, the rise in home prices, particularly in certain submarkets in these areas, create similar positive dynamics for future rental growth. We remain closely attuned to the regulatory environment in each of our markets, with local land use restrictions creating certain favorable barriers to new supply in our existing markets, providing opportunities for our development teams to leverage our long-standing relationships to unlock development opportunities. These coastal markets have, however, seen an increase in landlord-tenant regulations, and our expansion into new markets is partially driven by our desire to diversify our regulatory exposure. Finally, the fourth factor highlighted here, public infrastructure and cultural amenities is our proxy for the overall quality of life that large knowledge-based employers and our type of customers will continue to seek out. This thematic framework is, in turn, supported by our proprietary market research, which shapes our market and submarket capital allocation decisions as we drive long-term value. Slide 18 highlights the characteristics supporting growth in our recently announced expansion markets and what we believe positions these markets well in the long term. As we enter these markets, our focus is on creating long-term value by exporting our development and operational acumen as well as our culture to an expanded set of opportunities. And to wrap up, we believe that we are well positioned to outperform as we head into 2022. A favorable macro backdrop, including continued job and wage growth, declining affordability of for-sale housing, a full return to offices, particularly benefiting the one-third of our portfolio in urban environments, and a relatively stable supply forecast in overall AvalonBay markets should provide a strong tailwind. Our embedded growth in lease, along with the benefit of concessions and bad debt normalizing over time, should be key drivers of revenue next year. Our operating initiatives are on track to deliver significant margin expansion and serve as a driver of earnings growth over the coming 2 to 3 years. Our development platform is also poised to deliver meaningful value and earnings growth with a development rights pipeline of $3 billion, and with development yields substantially above stabilized cap rates and our cost of capital. Finally, our expansion markets provide a broader set of opportunities to leverage our platform for growth. We're excited for the growth opportunities ahead of us. And with that, I'll turn it to the operator to open the line for questions.

First of all, congrats on a really good quarter. It looks like you're showing real inflection here. I wanted to maybe take a step back and think about '22 and '23 in the context of that loss to lease. Maybe you can help us frame can you get all of that loss to lease back in '22? Or is some of it going to move back into '23? We've heard some different commentary from some of your peers. So I'm wondering how you guys think about it.

Rich, it's Sean. And good question, of course. Yes, what I would say on the loss to lease is in a normal year, anywhere between 15% to 20% of our portfolio is somewhat constrained in capturing that loss to lease or the delta between the existing rents and the market rent based on the regulatory environment that's in place. The typical examples are rent rates in New York, D.C., we have an asset in San Francisco, one in L.A., et cetera. In the current environment, given the COVID overlay, that total percentage of the portfolio that is somewhat encumbered for the short run is probably closer to about one-third of the portfolio, where there are some rent caps in place in various other jurisdictions that limit the ability to capture that. The question is when some of those additional or incremental restrictions expire, which is TBD at this point in time. The one that's probably the most significant is the state of emergency cap in California, which is constraining, for the most part, renewals in places like San Diego and Orange County, which have experienced pretty robust growth. So the way I would think about it is you have the incremental piece that I talked about, so call it totally one-third that is probably constrained, at least in the near term, how that sort of burns off from one-third back to 15% to 20% during 2022 is TBD. And then also just factoring in the distribution of lease expectations is the other fact that you have to consider as you run through your model.

I think I understand that math. And maybe this is a question for Ben. I wanted to understand a little bit better how you're considering development. In the past, development early in the cycle has been a big driver of your growth. How are you thinking about that this time? Is it any different than past cycles?

Our approach is similar, Rich. You've seen that with our ramp of activity over the last six months. We definitely see it as a differentiator for us and a driver of alpha. Matt can maybe talk some more about our pipeline of activity, but our track record and our development franchises in our existing markets gives us full confidence we'll be able to continue to unlock value. And now we have the expanded set of opportunities in the growth markets widening our total opportunity set. Matt, do you want to talk some more on the development pipeline?

Sure. Just to give a little more color on the development pipeline. We've started close to $1 billion so far this year. We are on track to start probably another $350 million here in the fourth quarter. When you look at the breakdown of the most recent starts this year, it's a nice mix geographically: about three-quarters suburban, one-quarter urban, and maybe 25% of our starts this year are actually in our expansion markets in Florida and Denver, and then maybe a little less than one-third in the Northeast and close to half on the West Coast. As we look out to next year, we'd like to be able to start somewhere in that $1 billion to $1.5 billion range, depending on how things shape up. But as Ben mentioned in his remarks, we have a $3 billion development rights pipeline. So we really started putting our foot back on the gas for new business development over the last couple of quarters, and we've got probably over $1 billion worth of new development rights in addition to that $3 billion that's working its way through the system now. So we will start some in this fourth quarter, but I'm hoping that at the end of the year, the development rights pipeline will actually grow to somewhere at or north of $3.5 billion. So we have a lot of opportunity in front of us.

First of all, congratulations, Tim. Maybe just following up on development. Curious what sort of inflationary pressures you're seeing. Obviously, it's coming through on the rent side, but I would imagine on the construction side for the new starts. How do you think about looking at those yields versus cost?

Sure. Nick, it's Matt. There's definitely inflation, and like you said, it helps on the rent side and it hurts on the cost side. What we've seen is the deals that we are starting this year have total development costs probably 10% to maybe even as much as 15% higher than where it would have been a couple of years ago. If NOIs are trending up, you do get some leverage on that. The third part of the equation is asset values, which, of course, have been trending up more than the 10% or 15% costs have been going up. So when you combine the higher NOI with the lower cap rates, the value creation and the spread is probably wider than it was before. The yields probably pre-COVID, our development rights pipeline yields were maybe in the low 6s. Now they're in the high 5s. If you look at the stuff we're starting this year, it's pro forma to around 7% to 8%, and that's where kind of the new business we're signing up or the stuff we might start next year based on today's economics looks to be as well.

And then you mentioned the regulatory side of the equation when you're looking at different markets. How do you think about regulatory risk in some of these expansion markets? Obviously, it's more favorable right now than some of the coastal markets, but how do you try to handicap any changes going forward in the future there?

Yes. Nick, it's Sean. Good question. When you talk about the regulatory environment, there are pros and cons to it. Part of the reason we've been so successful in creating value through the development pipeline in our coastal markets is that there is a very difficult regulatory environment to work your way through to actually get development entitled and delivered into those submarkets. So it's been to our benefit historically. Obviously, the more active the jurisdictions become as it relates to landlord-tenant and rent-oriented things become slightly riskier for us. In terms of the expansion markets, there are not as many constraints on development, although there are places within those regions that are a little more sensitive to development and have somewhat more constraints. Still, in general, the regulatory environment is slightly more favorable in these areas. In terms of evaluating the risk on the landlord-tenant side and the rent side, it is a jurisdiction-by-jurisdiction assessment. For example, if you think of our legacy markets, we feel pretty good about Washington State overall, not so good about the city of Seattle. So when you go through some of these markets, for example, in Texas, you look at overall, feels pretty good generally speaking about that environment. Austin, there are some more regulatory constraints in suburban environments as it relates to land use and the watershed and things like that. So overall, we think the regulatory environment is certainly to our benefit in those markets, but there are places where you have to still work with and overall, the landlord-tenant and the rent control side, we think the risk is definitely lower than our legacy markets but it's not without any risk the way I describe it.

And likewise, all the best to Tim in the next phase of his tenure with AvalonBay and beyond. So I just want to follow up on Nick's question there. I guess, look, if you bake it all together in terms of your outlook for job growth, supply growth, regulatory impact one way or the other. I mean, if you had to sort of gauge which group of markets is going to have superior rent growth over the next 3 to 5 years, again, taking all those factors into hand, where do you sort of peg your core coastal markets versus those expansion markets in that regard?

Yes, Rich, good question. I'm not sure we're prepared to call it a lead horse just yet. The way I think about it is kind of the way you described in terms of looking at job growth, supply growth, all the macro factors that we all consider. The reason we're going into these markets is while we certainly see more supply growth in these areas, say, in the 3% range, in Denver and Southeast Florida, they also produce a lot more jobs and have benefited from much more significant in-migration. Conversely, the coastal markets have typically benefited historically from immigration, but what we're seeing is overall, we expect a very significant portion of our portfolio to still be in our legacy coastal markets. For all the reasons that Ben talked about in his prepared remarks related to knowledge-based workers growing. It’s growing in our legacy markets as well. It might not grow at the same pace at the same time, but over the long run, we feel good about the rent growth we’ll see across both the coastal and expansion markets.

And then maybe just a different twist on the development question, but this isn't so much a question on inflation as it is the impact of labor and supply chain constraints on the timing of new deliveries, whether we're talking AvalonBay's projects or even competitive supply. What trends are you seeing in those factors?

Yes, Rich, it's Matt. I mean, we have not yet seen a lack of availability or supply chain interfere with our ability to deliver apartments. We've had spot issues here and there, but right now, we're struggling to get appliances in one asset, and so it might delay deliveries by a month or so. But we haven't seen it in a more widespread way. I think there are certain commodities, drywall, on allocation right now in some markets. I think it has impacted the for-sale inventory and ability to deliver some. For us, it's a place where we benefit by being our own general contractor and having repeat relationships with our subcontractors. The bigger constraint right now on getting units turned and delivered has been the local jurisdictions and their staff, a lot of these jurisdictions are still remote.

Looking at Slide 9, it doesn't seem like you've seen some of the seasonal falloff that other coastal names have. So the same chart for other people kind of peaks in August and goes down in September and October. I'm curious if there's an underlying reason you can point to as to why that would be the case.

Yes, Brad, good question. It is correct that we have seen a more modest seasonal adjustment than we typically would experience historically. If you go back 2 or 3 years kind of pre-pandemic and look at where September rents are relative to peak rent during the summer across various regions, the rate of decline has been far less than historical norms. So it could be timing differences among different companies. It shall be a submarket-by-submarket issue, but as it relates to our portfolio, we feel good about the fact that the rate of decline has been less than what we've seen historically. Yes, in terms of Q3 in line with the guide then. The fourth quarter OpEx guide is really quite low, but the overall guidance went up. I was curious if you could reconcile that. Was the original fourth quarter expectation that OpEx would be down and then there are pressures on top of that? Or any help there.

Brad, this is Kevin. We do expect same-store OpEx to decline materially sequentially into the fourth quarter.

And Tim, let me extend my congratulations to you on a glorious career and good luck on the next chapter. This is for the team. As we think about potential interest rate hikes or a series of them going into 2022, how do you all think about the spread that you laid out in slides between projected stabilized yields and total cost of capital? I think you guys noted that it's about 210 basis points, and it's fairly wide. How should we think about that spread in the event of a higher cost of capital?

Matt, I can start and others can chime in. I'd say, first and foremost, we try and lock in that spread, that we're generally sourcing the capital when we start jobs. If there is a big change to the cost of capital, we try to match that. I'd say you have to ask yourself why rates are rising. If it's an inflationary environment and NOIs are also rising, then hopefully you can preserve most of that spread. If rates are rising because it's an increase in real rates as opposed to nominal rates, then that does put downward pressure on the margin.

Chandni, this is Kevin. Just to maybe add to Matt's point, the relevant point with respect to our activities is that we are substantially match-funded against our investment commitments when we start those developments. So at the moment, if you look at our current book on the way of development, we are nearly 80% match-funded. From a liquidity point of view, as you can tell from our lease, we have $300 million of cash on hand and nothing drawn from a $1.75 billion line of credit. In terms of leverage, we're at five times against a targeted range for net debt-to-EBITDA of five to six times. Our EBITDA is rising, and therefore we have increasing leverage capacity as well. Overall, we are in terrific financial shape and have tremendous financial flex.

The last piece I would add is just that at the macro level, interest rates can have an impact on asset values but also be very mindful of fund flows. The correlation of asset values over time tends to be more correlated to fund flows. We expect fund flows into the real asset space and particularly in the multifamily space to remain strong.

My second question is slightly more housekeeping in nature. Could you all provide an update on what percent of leases are receiving concessions today? And what that average concession, if at all, is looking like?

As it relates to the third quarter, about 10% of the new move-in leases that we've signed received a concession, and the average concession was about two-thirds of a month's rent for that 10% population of move-in pieces.

Sean, I'm not sure if you can glean this from your leasing data, but just curious about one aspect of rent or behavior. So as the impacts of the pandemic fade, are you seeing any structural shift in the propensity to have roommates?

Good question, John. At the portfolio level, it has not changed materially going through COVID, but has dipped a little bit. In terms of sort of recent quarter leasing activity, that one I have to follow up with you on. I don't have that off the top of my head. But the overall percentage of the population with the third quarter was down maybe 150 basis points from historical averages. So not a material move. But it doesn't mean that it hasn't changed in certain submarkets.

No, I appreciate the details. My last question is a bit more focused on the long-term regarding the required capital expenditure to operate an apartment portfolio. In the short term, we face supply issues, but there are also longer-term regulatory challenges like balcony inspections in California and green emissions. My direct question is whether you anticipate a significant change in the capital expenditures necessary to manage an apartment portfolio.

Good question. I can take some of that, and there's some ESG things that Matt can talk about that are potentially on the horizon. There are definitely some issues, but I wouldn't call them broad-based. The inspections in New York City are ongoing, and the balcony issue in California has come at some expense but mainly is an inspection issue. So yes, people are spending a little bit on inspections, but it's not mandated that you have to make repairs in a very short timeframe. Over a longer period, it may move the needle a little. The bigger issues are more on the construction side as it relates to green ESG efforts that come through various jurisdictions.

Yes, John, it's Matt. I'll just add to that. I think that's right. If you look back over the last 5 or 10 years, it's probably the thing driving CapEx more, that we're putting more into these buildings, the amenities are a lot more elaborate. And when it comes time to redevelop those, it’s a little more expensive.

Last quarter, we spent time discussing our new concept called Kanso, which is targeted to a customer segment who do not place a lot of value on additional amenities. There are aspects here in terms of upfront and go-forward operating expenses that provide benefits from the growth opportunity with that brand.

This is Larry Valeria Lee calling for John Kim. Just a question on dispositions, like where they were located this quarter? And then just moving forward, where are you looking at kind of term exposure?

Sure. This is Matt. We didn't close anything this past quarter. We closed a number of dispositions in the second quarter. But as Ben mentioned, we have about $300 million that we expect to close here in the fourth quarter. All of that is in the Northeast, where we've been heavily over-indexed in terms of our disposition activity. A couple of years ago, we sold a significant chunk in New York City into a joint venture, and we've been balancing that out with more dispositions in the New York suburbs. As we look forward, we're going to continue to rotate capital out of our coastal regions into these expansion markets, and it will probably continue to be disproportionately in New York, other parts of the Northeast, and maybe over time in the Mid-Atlantic and a little bit in California as well.

Okay. Appreciate the color. And kind of moving to Southern California, it doesn't appear to be softening seasonally like your other markets are. How sustainable do you think that this is?

That's a good question. It hasn't softened as much, and we've seen a little bit of softness. It's probably hard to tell, but it is going to be less than historical norms. A lot of the travel and entertainment businesses are coming back online, and the content producers in the media space have been very active producing content. The outlook for Southern California is pretty good given low expected volume of multifamily supply next year, very healthy job growth, and a tight for-sale market.

And my last question was around the Kanso product. Do you see more opportunities to develop this? And if so, do you think it will be harder to push a brand there versus your typical product with more amenities?

This is Matt. We are certainly out there looking for opportunities to grow the Kanso brand. Market research indicates that there is a large untapped segment of customers that are looking for what Kanso offers. I do think there's a great opportunity out there. I don't see any reason to think that rent growth in the Kanso product would be materially different than the submarket to which it's part. More modest price points typically have higher rent growth over a cycle.

Just to add on to that, the rent-to-income ratios are pretty similar to our portfolio in the Suburban Maryland market. If you consider equivalent rent growth and the higher margins from lower operating costs, the NOI growth could potentially be even stronger to the extent we have similar rent growth.

There's been a lot of discussion this quarter around the embedded loss to lease across portfolios, and the benefit is you're able to capture that mark-to-market. However, you highlighted the fact in the presentation that rents are 7% above pre-pandemic levels across the portfolio or up around 3.5% in the past couple of years. Do you think as we get through to the back half of next year that pricing power could then exceed the inflationary level given some of the positive variables like the strong single-family housing market, personal income growth, and the fact that rent-to-income ratios aren't overly stretched today?

Yes, the key point is if there is room beyond the existing loss to lease. The macro environment is such that there is good pricing power. As Ben pointed out in his prepared remarks, a number of things out there from a macro standpoint should continue to benefit rental demand in both our urban and suburban submarkets. That 7% is a blended number, but in the urban submarkets, it's still slightly below 2019 levels. Urban occupancy rates and job center suburban occupancy rates in the offices are still very low and have had modest improvements, so should there be incremental pricing power, I think the answer is yes.

Last quarter, you had ranked kind of the most attractive source of proceeds, and with debt and dispositions, I think were at the top of the list. Here recently, you dusted off the continued equity program with a small issuance. Any change in the preference or ranking today of willingness to use equity as you think about growing the development pipeline over the next year?

Austin, yes, it hasn't changed tremendously. If we had to prioritize, asset sales would be at the top, followed by unsecured debt. Common equity would be not far behind. The broader message today is similar to a quarter ago, our three primary markets for capital—asset sales, unsecured debt, and common equity—are attractively priced and available to support funding our investment activity on an accretive basis. I think where we stand today is we can look at all those choices. We're in a good place from a financial flexibility standpoint.

And Tim, congrats. The leadership at AvalonBay has been constant, and you're no small part of that, so good luck in the future. The first question for me is on Northern California. Your peer Essex thinks that's going to be the best growth story in their portfolio in 2022. Part of that is tech, returning their employees back to the office next year. How impactful is that into your thought process towards Northern California for next year? It’s possible that Northern California could snap back in a way that could be the leader in your portfolio in 2022.

Yes, Rich, good question. The potential opportunity there is given that it is the market that has not yet recovered to pre-COVID levels. If you believe all markets would revert back to their pre-COVID levels and continue to grow, that is the region that has the most room for recovery. To the extent demand comes back in a way that supports that, it could certainly be a leading market as you move into '22 and beyond. You have to move through lease expirations to capture the benefit, but you can see a more meaningful acceleration based on its current position.

Great. And then second question is on the expansion markets. It's quite clear why you're doing it, but as it relates to how it impacts the stock, 12 of the 15 development projects are in your core gateway markets. Assuming you won't associate AvalonBay with the Sunbelt until you have a reasonable amount of your business in those markets, what's the timeline where you can get 5%-ish in each of those expansion markets where you're at 25% or 30% of the total portfolio outside of core gateway markets so you're truly tethered to what happens in the Sunbelt as it relates to stock performance?

Rich, this is Ben. I would guide you towards our experience in Southeast Florida and Denver as a decent proxy. We've put out a target of each of those being 5%. We're at a point now with our teams on the ground with those franchises building where we are starting to see some accelerated activity, and increasingly our development is growing. So as we think about the four new expansion markets, we're looking at acquisitions, our own development, and the funding of other developers. Of those, we expect to start some here in the fourth quarter and see our development rights pipeline grow to somewhere at or north of $3.5 billion.

And congrats, Tim. Hopefully, it means more golf in your future. And I also want to say congrats to Bill McLaughlin, your Development Head, on his retirement as well. Two questions there. First, on the development part. You guys do not trend your rents, so when you have in your development page your 5.9% yield that's based on escalated costs but rents as they are. As you underwrite new projects, given how rents have grown, do you expect the yields that we see in the supplemental to come up, meaning our rents outpacing the cost of construction, timing delays, et cetera, where we will start to see higher yields in the supplemental? Or we're not yet there yet?

Yes, Alex, it's Matt. You're right. When we start a job, it's based on today's rents and today's costs. We have an excellent track record of delivering on the cost side. The rents will stay where they are for the first year plus until we have them at 20% leased, so the materials we discussed earlier, regarding rents running above pro forma, are based on projects coming to market. The first thing is jobs that are on the schedule that were started some time ago that haven't yet been marked to market should provide some lift. For new business being signed up today, we're seeing yields in the mid- to high 5s.

And the second question is, in your expansion markets, like in Dallas, I think your entry is out towards Grapevine area and, at $275 a door, would suggest pretty efficient pricing. Charlotte sounds like it's a little bit more infill at $350 or so. But based on your experience in coastal markets and then looking at companies like Mid-America and the Sunbelt, is your Sunbelt focus more on the outer rings? Or do you think that you will target infill?

I think it's a little bit of both, Alex. Ultimately, we'll have a diversified portfolio. We're trying to balance out development, particularly in these Sunbelt markets where historically more of the rent growth has come in moderate price points. The Charlotte acquisition was a little different, but we're trying to get a good mix of suburban and urban to capture all the growth opportunities. So we like the position. The acquisition in Grapevine or Flower Mound is in line with what we've done in Denver and what we've mostly been buying in Florida.

And Tim, also, it's been a pleasure. Good luck on the next phase of your career. My question here is on the technology platform and how you feel that can help you manage some of the chunkier, controllable expenses across the platform, given the inflation and costs that we're seeing. Maybe you can just make some comments on the benefits that you outlined. The $25 million to $30 million you project for the next few years, what's the key driver there and some of the core assumptions?

Yes, Haendel, good question about technology and inflation. Most of what we're focused on relates to digitizing the business and creating a self-serve model for customers. The impact on the P&L will show up predominantly in payroll, with some efficiency in R&M. We are digitizing the application lease and move-in process so a customer can complete that entire process without talking to anyone from our staff. The same applies to maintenance activity, lease renewals, etc. Most of it is focused on digitizing the business and leveraging data science to make different types of decisions, particularly around lease renewals.

Got it. Got it. Appreciate that. And incremental investments on that tech platform from here, or has the money effectively been spent? Or how much more are you looking at in terms of the required investment?

Yes, the total investment expected for activities on the technology front for the next 2 to 3 years is an incremental roughly $20 million to $25 million. We've incurred some costs to date, about $7 million related to our automated leasing agent, which has already resulted in an 18% reduction in the frontline sales staff at our communities. There are still some investments to come.

Got it. Got it. One last one, if I could, on the rental assistant payments year-to-date. I appreciate the color you provided there. I'm curious what's left in that receivables bucket? What's the remaining opportunity for, say, next year, and how much has been reserved against that?

Haendel, maybe I'll start, and Sean may want to jump in. As it relates to the rent relief payments we received, we received $11 million in the third quarter. It's difficult to predict. We assumed in Q4 for our same-store portfolio about $12 million of incremental rent relief payments. However, we've only received about 30% of the total pot that we've applied for. We've applied for about $24 million in rent relief and have received about $6.5 million or so to date, so there's a significant opportunity to come.

Given the 210 basis point spread between your development yields and the cap rates that are very low, and despite the cost inflation and sourcing being favorable, what's your medium-term outlook on the supply notwithstanding the timing of specific markets, how that plays out? It seems like development is clearly winning out in this market and can create some supply down the line.

As it relates to total supply, this is Sean. Our supply expectations for 2021 has come down for the year as a result of various factors. Our expectations for 2022 are similar, with some markets showing an uptick, including New York and Seattle where there's been heavy volume under construction. In markets like Boston, Northern and Southern California, and Denver, we see a decline in supply next year. A heavy influence on the supply side here is in urban submarkets. We still expect about 100 basis point spread between the percentage of stock delivered in urban environments versus suburban.

To your point about spreads and development being profitable, supply tends to respond more quickly in Sunbelt markets than in our coastal markets. So you've seen that this year applies at a level or a little bit down in those areas. But I think what we're seeing is a relatively muted supply response in our urban markets beyond what's currently underway.

Really appreciate the color. And earlier today, there's discussion about potential cost inflation and labor pressures driving some problems and lease-ups for some developers. Does this seem like a reasonable expectation for potential opportunities to take over struggling lease-ups in the future for acquisitions?

We haven't heard that. We haven't seen any lease-ups having particular issues. We’ve seen assets being sold during lease-up, but not at discounts to us that are compelling relative to stabilized assets.

I had a question on maybe your Northern California strategy going into the fall/winter months. It seems like that softening starting in August was the delay in the return to office and something a lot of people are pushing back to maybe January 1. Do you think we might see a turn higher as we get closer to January 1? How are you guys thinking about that?

Yes, Joshua, just to be clear, when you say turn higher, are you talking about occupancy, rents, or the overall fundamentals of the business?

Yes, I'm looking at Slide 10 of your presentation that would be what I would be focused on.

As it relates to Northern California in general, the potential opportunity there is given that it is one of the markets that has not yet recovered to pre-COVID levels. To the extent you see demand come back that supports that, it could be a leading market as you move into '22 and beyond. The question is the pace at which that occurs and flexibility of people with work from home policies. Overall, we expect it to come back, the pace will be dictated by those policies as we look at vaccination trends and requirements.

Thank you, Casey, and thanks, everyone, for being on the call today. I know we've been at it for a while here and look forward to seeing or talking to you at least virtually at NAREIT here in a couple of weeks. So enjoy the rest of your day. Thank you.