Equity Residential Properties Trust (EQR) — Q3 2016 Transcript

Thank you, Cynthia. Good morning and thank you for joining us to discuss Equity Residential's third quarter 2016 results. Our featured speakers today are David Neithercut, our President and CEO; David Santee, our Chief Operating Officer; and Mark Parrell, our Chief Financial Officer. Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the federal securities law. These forward-looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events. I'll now turn it over to David Neithercut.

Thanks Marty. Good morning everyone, thank you for joining us this morning's call. As we discussed over the last several quarters, 2016 will not turn out to be a year we had originally expected due to elevated levels of new supply in both San Francisco and New York City which combined made up a large share of our initial growth forecast for the year. And as a result after five years of extraordinary strong fundamentals, revenue growth this year will now be more in line with long-term historical trends. Good news however is that exceptionally strong demand continues unabated across our markets with current occupancies remaining at or near 96% and lower exposure on the horizon. Turnover across all markets when excluding same property movement has actually decreased for the first nine months of the year compared to the same period last year. Move outs to buy single-family homes remain a non-factor in our high-cost housing markets and our recently completed development properties are absorbing units significantly faster and at rates above or closer to our original expectations. Furthermore, while our markets have experienced the slowdown in the growth of high-income jobs, the absolute number of new high-income jobs remains relatively strong and our preliminary indications suggest that the trend may be reversing. Perhaps more importantly for the first time since recovery began, there are abundant times and wage growth occurring in all industries across the country, which is obviously a very good sign for the apartment business. So as we look forward to what we see as peak deliveries next year, our teams across the country will work very hard to care for our existing residents, welcoming prospects, and turning them into new residents, and we remain extraordinarily excited about the outlook for our business, portfolio and the company. So with that said, we'll let David Santee go into more details on what we’re seeing across our markets today.

Okay, thank you David. Good morning everyone. Today I'll update you on our Q3 results, discuss the current state of each market in which we operate, as well as providing additional color on 2017 deliveries. As David said, demand for quality apartments remains pretty robust with occupancies in our markets averaging 96% or better and resident turnover continuing to decline. Year-to-date turnover net of same property transfers decreased 30 basis points versus the 10 basis point increase, and the gross turnover that we reported demonstrates the strong customer satisfaction that we continuously strive to deliver each and every day and the great locations our portfolio continues to enjoy. Renewal rates achieved for the quarter continued to be well above historical averages at 5.3%, while new lease over lease pricing was plus 90 basis points. Combined results were in line with our revised expectations at 3.1%. Moving on to the market in Seattle, new lease over lease growth averaged 4.9% for the quarter while renewals achieved were 8.1%. Seattle continues to distinguish itself as the epicenter of cloud computing services, with Amazon remaining the catalyst for the rapid downtown expansion of both jobs and new apartment deliveries. Through August, Seattle, Bellevue, and Redmond realized job growth of 3.5%, allowing 7,200 apartment deliveries this year to be easily absorbed with virtually zero pricing pressure. Now with 7,000 new deliveries expected in '17 and job growth well above the national average, we see Seattle as our best revenue growth market next year. Again, easy job openings at Amazon serve as a proxy for demand. Last week there were 8,000 openings in Seattle, almost double from the same time last year, 3,300 of which are for high-paying software developer positions. This concentration of intellectual capital is forcing well-established tech companies to expand their presence in Seattle to better compete for talent. Microsoft, the region's second largest employer, recently committed to a significant investment in a new artificial intelligence group and most recently announced record operating results. With cloud computing in its early innings and Boeing, the area's largest employer, having a seven-year backlog in airplane production, Seattle is poised for continued growth as rents are the lowest of all the markets in which we operate, likely delivering strong revenue results that are slightly lower next year. Then in San Francisco, while operations were quite volatile during the summer peak leasing season, recently the market has been more stable across the key drivers of revenue growth. Occupancy has improved to 96%, compared to the low of 95% that we saw only a few months ago. The percentage of residents renewing is at peak levels and contrary to some reports indicating that rents are down double digits, our San Francisco portfolio's average asking rents are down only 1.4% versus the same week last year. Growth in higher-paying tech jobs is not as robust as in 2015, but the growth is nonetheless positive and while VC capital investment has slowed, the actual amount of VC funds available for investment has increased. All the fundamentals are still in place for the market to absorb 2017 deliveries. However, elevated supply and a slower pace of VC investment that drives the tech segment will continue to have a negative impact on pricing power in submarkets with the most deliveries. Achieved renewal rates for the quarter in San Francisco were 6.2%, while new lease over lease rates averaged minus 30 basis points. The modest increase in turnover is accounted for by same property transfers. Netting this out, year-to-date turnover has actually declined by 70 basis points on top of the improvement we saw last year. In 2017, we’ll see the market deliver 8,400 new apartments, with deliveries less concentrated than in 2016. In the downtown areas, some will see a 50% decrease in delivered units, with the balance spread across Mission Bay and the Dogpatch areas. The mid-Peninsula will also be more dispersed, with only 1,600 units spread across all directions of San Mateo and Redwood City. San Jose and Santa Clara will see the majority of deliveries in South Bay and become less geographically competitive with our same-store portfolio. Based on current delivery estimates, the 2017 supply appears to be more front-loaded in the year, meaning most of the supply will begin leasing up during periods of peak demand. San Francisco remains ground zero for innovation, and tech stalwarts continue to expand their footprint. As artificial intelligence and the Internet of Things continues to grow, we expect San Francisco to remain a leader in tech and overcome any short-term challenges with supply. Time and time again, San Francisco has proven to bounce back faster and stronger than it has in the past, but we would expect San Francisco to deliver revenue growth in 2017 that is much lower than in 2016. Dropping down to LA, job growth continues to be very strong but is dominated by lower-paying hospitality and leisure sectors. However, as downtown LA focuses on its Renaissance efforts and Silicon Beach continues to develop, a higher-paying professional services sector is expected to drive job growth through 2020. As non-traditional entertainment content continues to grow, Southern California is poised to capture this additional investment as well. Demand for apartments continues to be strong, with occupancy across our LA portfolio at 96.3%. Renewal rates achieved for the quarter were 6.8% and new lease over lease growth was 2.5% on lower turnover for the quarter. Based on current estimates, LA will see peak deliveries of 10,000 units in 2017, with over 80% of these units spread across three sub-markets: Downtown, Hollywood will represent 50% of the 80%, Glendale-Pasadena, 20% of the 80%, and then Koreatown mid-Wilshire at 14% of the 80%. To date, deliveries in the urban core and west LA have had a modest impact on revenue growth, which today is in the 3% to 5% range. As LA continues to build out the urban core, downtown is becoming a more attractive lifestyle choice that has not existed for many years. With virtually no units delivered in the current year or next, East and West San Fernando Valley, Ventura County, and Inland Empire continue to show signs of accelerated revenue growth, upwards of 6% to 7% for the current month billings. For 2017, we would expect greater LA County to deliver modest renewal revenue growth, pressured by the level of new supply in the urban core. Orange County, with 96% occupancy today, achieved renewals for the quarter of 7.6%, the strongest across our portfolio, with new lease-over-lease growth of 4.4%. After taking a breather from elevated deliveries in 2015 and for the most part 2016, Orange County is expected to deliver 5,700 units in 2017, with about 50% concentration in the Irvine and Newport Beach sub-markets, and the balance spread from Anaheim up through Huntington Beach. With almost 65% of our portfolio in South Orange County, we would expect slightly lower revenue growth as a result of the concentration of deliveries in urban areas, where we have 35% of our revenues. San Diego has extremely strong job growth in the first half of the year and seen strong demand for apartments with very little supply. San Diego is distinguishing itself as the life science, medical device, and tech manufacturing center, and continues to have high-paying jobs in these sectors, albeit at a slower rate. Second only to Orange County, achieved renewal rate growth for the quarter averaged 7.4%, with new lease-over-lease growth of 4.4%, again on lower turnover. San Diego will deliver 2,300 units in 2017 which appear to be disbursed equally between downtown and the I-15 corridor on lower expected job growth. The I-15 submarket is already showing modest deceleration, and we expect revenue results in '17 to be somewhat lower. Jumping over to Boston, as we previously stated, 2016 would be a window of opportunity in the urban core and especially Cambridge where deliveries were few. Today that has played out where we have seen modest deceleration and revenue growth with more pressure on rents in the suburbs than downtown. New lease over lease growth of 1.6% for Q3 was the strongest quarter since Q3 of '15. Achieved renewal rate growth was 4.9%, again on lower turnover. As Boston continues to position itself as a major tech and biotech hub, along with the endorsement of the GE headquarters relocation, the future of Boston and professional services job growth is very bright as the professional services sector moves from 35% of jobs created to 45% of new jobs created this year. In the near term, Boston is expected to deliver approximately 6,200 units in 2017, split evenly between Downtown Cambridge and then North and West Suburbs. Given the concentration of the new supply to our portfolio, we see continued deceleration across the market and expect revenue growth to be lower than in 2016. New York for the quarter achieved an average renewal rate of 3% and minus 2% on new lease-over-lease growth, again on slightly lower turnover. With the trend toward affordability over neighborhood loyalty, prospective renters are proving to be more flexible in where they choose to live. To date, 55% of the 2016 deliveries have been absorbed. Concessions have yet to become widespread and appear to be more targeted to specific unit types at stabilized communities. The Upper West Side and West Side down to Chelsea are currently the weakest neighborhoods in our portfolio and are delivering slightly negative revenue growth for the current month. The New York MSA will see 14,000 units in 2017, and to clarify, these units are identified and vary considerably based on the competitive boundaries defined by our portfolio. It will not match the higher MSA numbers provided by third-party data providers. It should be no surprise that Brooklyn will deliver the lion’s share of new units, where we have less than 8% of total New York Metro revenue, followed by Long Island City, where we have no presence. Midtown West will deliver a good portion as Hudson Yard comes online, and then the Hudson Waterfront, specifically Jersey City. These four submarkets will account for a little more than 70% of all deliveries, with the balance spread across various Manhattan neighborhoods. While there have been lingering pressures on the financial services sector, high-paying tech jobs and venture capital continue to migrate to the area. Some believe that Brexit could bring back additional financial services jobs, which would be a positive development. While supply pressures are driven largely by the expiration of the 421a program, the lack of any existing replacement legislation will create a scenario in the near future of significantly reduced supply. With expectations for more affordability in any future legislation and increasing concession costs, it's hard to imagine deliveries that come close to historical norms. Given all these factors and the deceleration we see today, we see New York as our worst-performing market with a high probability of revenue growth turning negative during the year. Last but not least, the DC metro area continues to improve, coming off of its best job growth since 2008. Out of our 10 submarkets, we have currently delivering accelerated revenue growth where our current month of growth exceeds year-to-date growth anywhere from 100 to 300 basis points. For the quarter, renewal rates achieved were 4.6%, the strongest in the last seven quarters, and new lease-over-lease growth was plus 20 basis points, again the strongest in seven quarters with flat occupancy and turnover. With expectations of future job growth being very favorable and over half of the 10,000 units being delivered concentrated in the Southeast and Southwest submarkets, we would expect continued favorable absorption and accelerating revenue growth in the submarkets in which we operate. Like LA, living in Downtown DC, ten years ago was not a consideration for most as more apartments come online, more restaurants and activities are creating an urban environment that did not exist previously, bringing in suburban renters who find downtown more attractive due to the existing traffic congestion and commuting costs in the region. We expect the accelerated revenue growth that we see today to continue into next year. In closing, 2017 revenue growth will certainly be lower than in 2016. Job growth and job sector dynamics will dictate the ability of each market to absorb these levels of elevated supply. The degree of management sophistication and discipline will determine how we price it and the overall impact on revenue growth. With occupancies still in the 96% range, demand remains strong, but elevated supplies not supported by the necessary job growth will face varying degrees of pricing pressure in the near term. So with that said, I will turn it over to Mark Parrell.

Thank you, David. Today, I will be giving some color behind our same-store expense growth in the quarter and on normalized FFO guidance, and I’m going to move on to talk a bit about our recent debt deal. On the same-store expense side, we moved our annual same-store expense range to 2.8% to 3.2%, which centers our range back to the midpoint of our original February guidance range and to the high end of our July guidance range of 2.5% to 3%. This is a relatively modest change for us; a 25 basis point change in annual expense growth is about $1.5 million. Our same-store expenses through June 30 grew at a rate of only 0.9%; therefore, as we mentioned on the second quarter call, we always expected our second-half expenses to grow at a considerably higher rate, somewhere in the mid 4% range in order to meet our July guidance range of 2.5% to 3%. In a moment, I will give some detail on payroll expenses and on leasing and advertising expenses, which were the two main drivers of our change in expense guidance. But first, I want to mention one of the bigger drivers of our overall same-store expense growth this year, which is the recent adverse legal decision regarding the calculation of property taxes for several of our properties in Jersey City, which I noted on our second quarter call. The same-store impact of this decision was an increase in our 2016 annual real estate tax expense of $1.6 million. We were aware of this when maintaining our same-store expense range of 2.5% to 3% back in July, but still thought that we could stay within that range. Overall for 2016, we expect property tax expense to grow by 6%. So getting back to the change in same-store expense guidance, on the payroll side, costs in the third quarter were about $1 million more than we had originally planned because we ran our properties in the third quarter at higher employment levels to keep them competitive in some of these challenging markets. We also made aggressive efforts to retain our field personnel in the face of the great demand for them in our markets as new supply gets delivered and needs to be staffed up. In the leasing and advertising lines, we incurred promotional expenses at the high end of our expectations, mostly in New York and San Francisco, in response to higher supply in these markets. This heightened spending of about $1 million included about $670,000 in gift cards given to new residents and the payment of broker commissions on a few high-rent units. We did anticipate some gift card usage in the third quarter, but the order of magnitude was higher than we expected back in July. We also spent a bit more on internet listing services in the quarter. Please remember that higher occupancy in 2015 allowed us to reduce such spending in the comparable quarter. We expect additional promotional spending to continue in the fourth quarter, though at a lesser pace. So just an accounting note: the accounting rules require that we account for gift card spending as an expense. However, if we accounted for the cards as a reduction in revenue, the impact on the Company’s results would have been a reduction in quarterly same-store revenue of 12 basis points which would have reduced our reported 3.4% quarterly same-store revenue growth number to 3.3%. The impact on our full-year same-store revenue as a result of the gift cards we gave in the third quarter (the ones I just discussed) and that we expect to give in the fourth quarter will be even less, about 5 basis points, if they were treated as a contra to revenue. So now I’m going to switch over and talk about move-in concessions on our same-store portfolio and those we do treat as reductions in revenue. Again, on the same-store portfolio in the third quarter, we gave approximately $190,000 versus $235,000 in move-in concessions we provided in the third quarter of 2015. In terms of the sensitivity of our revised guidance range or expense range, leasing and advertising and payroll are the two likely pressure points that can move our annual expenses to the higher end of our new range of 2.8% to 3.2%. On the leasing and advertising side, we expect less gift card spending for the rest of the year due to the lower turnover we expect in the fourth quarter and our strong current occupancy. If we are incorrect in these assumptions, our expense growth could be pressured. Another possible pressure point is the payroll cost continuing to escalate due to wage pressure or service levels required by heightened competition in our markets. On the revenue side, we have left our midpoint of 3.75% unchanged and David Santee has already provided you a bit of color on that. We just fine-tuned a few other guidance numbers, so we'll just talk about that for a minute, and we continue to see normalized FFOs remain within our prior range, and we've narrowed that range as we customarily do at this time of year. Our current annual normalized FFO midpoint of $3.08 per share is nearly identical to the $3.10 per share midpoint of the range we originally gave you back in February, as reductions in same-store NOI were offset by changes in transaction timing and amounts. Now just a note on our debt deal. On October 12, we closed on a $500 million 10-year unsecured note offering with a coupon of 2.85% and an all-in effective rate of approximately 3.1%, which includes underwriter's fees and the termination of a small interest rate hedge we had. There is great demand for this debt, and we printed the lowest tenure in our history and one of the lowest ever by a REIT, and we thank our unsecured bond investors for their support of the company. Proceeds from this issuance were used for working capital and general corporate purposes. Our projected combined line of credit and commercial papers amount outstanding for those two combined at December 31, 2016, is now anticipated to be $130 million versus the $430 million we previously estimated back in July, and that's due to proceeds from the $500 million debt deal, reducing line usage, offset by a net $100 million reduction in disposition proceeds that we now expect in 2016. So I’ll now turn the call over to Cynthia for the question and answer period.

Thanks everyone. I think the primary worry for your company and some of the other multi-family REITs remains New York City and San Francisco and how bad these markets can get in 2017. You gave some commentary on it, but I was hoping to get some more parameters on how you're thinking about the downside for same-store revenue or rent growth in these two markets next year.

I believe we probably said, and we intend to say at this junction Nick, and we'll save more in detail, more color than we actually give, more complete guidance on our next quarter conference call. I think David was pretty clear about directionally what was happening in the supply and what has been happening in jobs, etc., and what our expectations would be directionally, but we won’t go any further than that at this time.

Okay. And then could you just remind us for those markets what the assumptions are for fourth quarter this year same-store revenue growth?

I'm sorry. Do you mean the overall or by market?

For San Francisco and New York separately what were the assumptions for fourth quarter this year?

I am going to talk just for a second about the overall assumption. So our guidance is wise about a 3% fourth quarter same-store revenue number, about a 4.5% or so same-store expense number in the fourth quarter. I am not sure if we have market-by-market numbers right here in front of us and we don’t.

Okay. And then just going back to David, if we think about multi-family valuations in the private market, do you think cap rates have changed in the past year for your core markets, particularly in New York or San Francisco, if rent growth has come down? Do you think, if you were to sell assets in those markets today versus a year ago, has the pricing changed?

I think it's tough to tell, Nick. I am not sure if there has been sufficient price discovery, but if there has been some modest change in cap rates, I am not sure that it’s had a big impact on value. We've had, even in San Francisco, we'll still have strong decent NOI growth on a year-over-year basis so any modest change in cap rates does not necessarily mean value has decreased. We've certainly seen fewer players in the marketplace looking for assets, but I will tell you not a week goes by when Alan George is not showing me some deal that traded at some very strong price across these markets. So we're watching it closely. Certainly revenues not growing at the same rate, bottom lines are not growing at the same rate that they had, but by and large they'll continue to improve and grow. There continues to be a need or demand for yield, and so when you do trade, they continue to trade at a fairly strong pricing.

Okay. So given that's the case, valuations seem to be holding up in the private market and your stock is at a big discount to NAV, what point does the Board think about selling more assets, doing a stock buyback to exploit that arbitrage in pricing? And also, did the asset sales year-to-date and the special dividend delay any sort of process you might have had to sell assets this year and do a buyback to force that discussion until 2017? Thanks.

In response to the answer to your second question, no, I can tell you that very specifically, as the Board, we talked about large portfolio sales and the special dividend distribution back to shareholders. We spoke very specifically with the Board that this did not preclude any other steps we might take to address the discount that you mentioned. So those actions were not precluded by what we did. In terms of when does the Board take action, there is no bright line; every situation will be different. But I can tell you that on this most recent call, and the call even before that, we discussed that at the Board level. The Board just believes that this activity would require probably a bigger discount than what many on the street might suggest. We have a significant amount of gain built into most of our assets, and there is just not a lot of capacity after doing things on a debt-neutral basis and distributing gains to buy back much stock with any proceeds. Regarding borrowing to buy back stock, there are relatively few opportunities, and we want to ensure that if and when we take action, it will be at an appropriate time. We will continue to monitor this regularly with the Board, and when it makes sense to do something, we would certainly be willing to do so. We've done it in the past and will certainly do so in the future if the circumstances allow for it, but I cannot tell you exactly when we will see an opportunity.

All right. Thanks, David.

Thanks. Given the operating environment is at an inflection point, how do you think about setting the 2017 same-store revenue growth guidance range? Historically, you've had a pretty tight range of 75 to 100 basis points for that initial range. So how wide could that be in 2017?

Well, I guess I won't say how wide it could be, but I'll tell you it will likely be lighter to your point. We acknowledged that by now operating in fewer markets. There is a risk of more volatility in our results and that we will likely provide wider guidance than what we have been able to do in the past. In terms of how wide that will be, will be the same, and you will certainly see when we share those results with you with that guidance on our next earnings call.

Thanks. And then just appreciate the details on the concessions and the gift cards. But from an operating standpoint, how do you think about incentivizing with free rent versus using gift cards or other basic incentives?

Nick, this is David Santee. As we've always said even in the last downturn, we are very committed to our net effective price. Again, that is our preferred method of pricing because it provides complete transparency; it's easier to manage from here. So that will always be our tried and true method. Occasionally, you get into some submarkets or different owners that do different things that cater to certain niches in our prospective base, and we try to stick to our guns as far as net effective pricing, but at times we find we have to match the market. And I think that's been our philosophy for the last seven or eight years, and that will be our philosophy going forward.

Thanks. And just finally on supply, I appreciate the detailed walkthrough by market. But if you step back and think about all of your markets blended together, what are your expectations for next year’s supply deliveries of the urban versus suburban sub-markets? I think we heard from one of your peers yesterday that they think there will be two times the amount of supply in urban submarkets as suburban?

Well, I guess I would say that we just – we don’t necessarily look at it as urban versus suburban. We look at it as what set of properties are in a reasonable and conservative geographic area that could potentially compete with us. Probably New York is a great example where we have nothing in Long Island City, which will have a lot of new supply, and the price point may be very attractive and could draw people from Brooklyn or Manhattan or elsewhere. All in all, the numbers for 2017 are around 65,000 units. I would say a very high percentage of those are in the urban core.

Thanks.

Hi, good morning, guys. I want to go back to one of the prepared comments related to San Francisco. I think when David Santee was giving the market detail there, I thought I picked up on some comments around potential stabilization there. Is that accurate, just in terms of how new and renewals are trading today, or is that just a function of lower turnover at this point in the leasing season, a shift in timing of supply, or some other factor?

Well, I guess I would say stable relative to what we experienced over the past four or five months. I would say certainly not – the market is not moving back up; it’s kind of moving sideways right now. But we started off with going from rents that were up 5%, 6% that within a couple of months went down to negative 2%. We saw occupancies that were well above 96% fall off over a 100 basis points in the peak leasing season, which is not a time when you would expect lower demand. The market just zigzagged for most of the summer, and so today our exposure is right back where it was; our occupancies are for the most part right on top of last year. We don’t see any crazy pricing mechanisms in the market; the newbies are continuing to offer one, one and a half months free rent, and we expect that. But for the most part, I would really just say that the market appears to be more disciplined today, instead of stable; it’s just more disciplined today than it has been over the last four months.

All right, would you say then that properties that are in lease-up currently, the market overall is just getting a little more rational, in that sense? So it would indeed be a positive change that we could sort of extrapolate from here or anything else?

Yes, I mean you had a very large concentration of assets in the SoMa area, which really trickled across, as well as South San Francisco. Going back to the original underwriting, the market rent growth in San Francisco outpaced underwriting or new assets. Even looking at our own assets, the market went well above what we underwrote on our new deliveries. So owners had a lot of flexibility in pricing. There hasn’t really been any high-rise, brand-new vertical assets with great views delivered in San Francisco for years. So there was some element of price discovery, and I feel like some could have probably achieved higher rents when you look at the pace of lease-ups. I think you'll see, obviously, less of that type of product in 2017, probably more podium, traditional development that you see down in San Jose, and pricing should – we expect and hope that it would be more reasonable than what we saw last some years.

All right. That's actually very helpful color. Second, and final question, it's another twist on the 2017 question. But would you guys be able to rank order your markets next year, just in terms of top to bottom, strongest versus weakest?

Okay. In Seattle, we would expect it would be the best. I think Southern California markets would probably rank in the middle. Boston would probably be below that and there would be a wide range between SoCal and Boston. Actually, we want to put D.C. before Boston; I’m sorry. So D.C. would be between SoCal and Boston. D.C. continues to improve, with great acceleration and job growth. Boston will be at the bottom and probably only slightly above our worst market, New York.

Great. Thank you.

Good morning. I noticed that you guys are offering some 24-month leases in New York and in the Bay Area. What was the uptake on that? And is that something that you're going to continue to offer going into 2017?

So we've tried that in different ways; we had a better take rate with no step-up, we've tried it with built-in step-ups. I think our customer is educated enough to know what's going on in the market. When we built-in the step-up (meaning a 2% or 3% increase in year two), our take rate fell to basically zero. We had probably a 15% take rate when we did that in D.C. when we expected rates to fall, and that is what we're seeing today, a 15% take rate. We will continue to experiment with that, but monitoring so that we don't become overly committed.

And in the Bay Area, how is the performance of your East Bay assets versus the overall Bay Area versus San Francisco?

The East Bay is obviously performing the best. When we look at it, I mean obviously we are not – if not accelerating, year-to-date East Bay is at 7.5% revenue growth, while the current month buildings are at 5%. So the East Bay is still hanging in there; obviously, Berkeley is helping that as well.

And then a question for David Neithercut. You mentioned the challenges of doing a stock buyback due to the gains. What do you view as your most attractive use of capital going into 2017?

Right now, we are complaining our developments. We've made a significant amount of money and will make a significant amount of money on the developments we have yet to complete, and much of the free cash flow we have for the next couple of years will be used to complete that, and we expect significant returns. In fact, we have a page in the most recent investor information we put up on our website that shows how we’ve performed throughout the cycle. After that, we have not started much development at all, so the development spend will slow. We continue to do very well with our redevelopment, with kitchen and bath rehab spending that's been up $50-plus million per year, which we have been realizing strong low-to-mid double-digit returns for the foreseeable future, and we look at those as great uses of capital.

And then as kitchen and bath spend has been elevated this year versus last year, have there been any markets that you've been particularly focused on with that, or has it been broad-based?

It’s been rather broad-based.

Okay. And do you have an estimate on what contribution that's been to revenue growth this year?

Year-to-date, it’s 10 basis points; and remember it varies around that. It can be zero to 20. It doesn’t move the meter that considerably.

Just to be clear, when we talk about this program, because others talk about programs they call rehab or whatever. We’re spending depending on the property $10,000 to maybe $14,000 per door on kitchen and baths. This is not the $30,000, $60,000, or $80,000 per door total renovation that some people undertake. We may remove that from same-store. And if we did, we have done that very limited; we removed that from same-store ourselves when we do something of that magnitude.

Thank you guys very much.

Good morning. I was hoping you could comment a little bit on the performance of A’s and B’s you're seeing across the market, and maybe specifically between New York and San Francisco?

Well, I guess I would say that San Francisco, especially all of our communities down the Peninsula, are mostly A's. I am not sure it’s about A’s and B’s; I think it’s more about location, supply, and pricing of that supply. So there is no definitive answer to your question.

And across the portfolio? Any comments you could make about A versus B?

Again, it’s submarket by submarket. We can tell you that one submarket may be performing well, as David just did about downtown San Francisco versus East Bay, but that’s more submarket versus submarket rather than A versus B.

I mean a lot of it has to do with market momentum. I mean, you look at our D.C. portfolio in the District. We have high-end buildings that we bought in the last downturn that were built to condo specifications that are doing just as well as the 30-year-old Charles E. Smith portfolio up Connecticut Avenue. So again, it’s probably more about location and the impact of supply.

Okay. Great. Thank you. And you made some comments earlier about concessions and gift cards. But if we combine those two, what was the change from 2017 to 2016, and do you have those numbers for New York and San Francisco?

Well, I gave it. It’s Mark Parrell, for the whole portfolio a moment ago. And it would have moved the number 0.10, so 0.10 lower; we actually have lower concessions than we had last year, so that isn’t going to make any difference. The concessions right now are $100,000 a quarter. They’re just not that material; they were more significant in the first quarter of this year.

And that includes the gift cards, or that's a separate bucket?

Gift cards are accounted for under leasing and advertising. Concessions are accounted for the month they’re given as a reduction in revenue.

But if you combine the two, because they're essentially kind of getting to the same ends?

You have combined the two because the same-store revenue numbers are reported on a cash basis, and the deduction is already made for the concession. So all you need to do is subtract the gift cards which was the number I gave earlier.

Got you. Okay, thank you for that. And just one quick question on kind of 2017 and how we should be thinking about renewal spreads versus new and how you're thinking about things today or maybe for the fourth quarter, and how that may trend going forward?

Well, I guess I would say kind of going back to the last downturn, which is probably the best comparison. We were still able to maintain positive renewal growth. Most recently in D.C., which is probably a market that many markets could mirror in the next year, we were able to achieve a high 2s to mid-3s on renewals. So regardless of what the markets do, we should be able to achieve favorable renewal revenue growth.

Thank you.

Good morning guys. A few questions away from San Francisco and New York, if I might. David Santee, I think when you were talking in your prepared comments about D.C., you mentioned, I think, 8 of 10 of the submarkets there showing strong growth or accelerating growth. Can you just talk a little bit about those two that aren't, what are they, and is that just all supply related?

Yes, it is. Let me get to it. Give me one second.

Well, let me ask David Neithercut a question while you're flipping ahead. David, you sold the Berkeley land parcel. It looks like you've got $115 million in the supplement of land for development in the future. How many projects is that? Or are we likely to see any of that starting in the next couple of quarters?

It’s possible. We've got some land sites in Boston that are really highly valued and have remained as valuable, and we could carve out of existing deals to create development potential. But we’re going to watch this all very, very closely, Rob. We started very few projects this year after running about $1 billion average in 2013 and 2014; we've cut that by almost two-thirds in 2015 and cut it by another two-thirds in 2016. We’re down considerably, so we’re going to keep an eye on all that and I’m not saying that we’re not going to start anything, but whatever that starts will be, at least for the present time, de minimis relative to what we have been doing.

Okay. And then one for Mark in terms of what’s the $0.05 difference between the fourth quarter guidance on a NAREIT and a normalized FFO basis?

So that’s the – we moved, Rob, from the third quarter the sale of a piece of land that’s in the Northeast, so that’s the $0.05 difference.

Okay. And back to David Santee on D.C.

Okay. The two markets that are not accelerating are the Bethesda-Chevy Chase market, which represents about two or three properties for us, 9% of revenue, and then far out Fairfax, which is 5% of revenue. So the bulk of our revenue in D.C. is accelerating.

And that's just because those two sub-markets are getting hit with supply, or is the demographics moving away from that? What are you identifying as the primary issues there?

So Fairfax, I would say, is probably more supply; Bethesda is probably more of a demographic issue.

Okay. All right. Perfect. I appreciate it, guys.

Hi, Thanks for taking my question. Most of them have already been answered, but just curious on the financing side. You guys clearly have one of the lowest costs of capital of all REITs, and I think the most recent bond deal is indicative of that. But on the working capital side, how do you guys think about using the mix of your line and commercial paper? And are there specific instances in which you would be compelled to use one over the other?

Hi, it’s Mark Parrell. Thanks for that question, Tom. So right now, we have about $200 million of commercial paper outstanding and nothing outstanding on our line of credit. I'll tell you the main reason we use the CP program is that it's cheaper right now, which is vastly cheap. CP is priced at LIBOR plus 30 basis points; on the line of credit, it’s LIBOR plus 95. We are saving more than half a percent on that. So the way we think about using the CP is as an adjunct to our line of credit, and when it is cheaper for that market for some reason or better for some other reason, we will utilize the CP capability we have.

Great, thank you very much.

Good morning. Two quick ones from me. First of all, again back to New York and San Francisco. In regards to underlying trends for renewals, I think everyone gets the fact that for new leases, rental rates have come down a lot. Could you just talk a little bit about what you're seeing with renewals? Has the situation with new rents caused existing tenants also to start to become more aggressive about asking for concessions or lower rents when they come up for renewal? And how do you see that playing out going into 2017?

I think what we've seen over the eight or nine years that we've been tracking this is that, number one, most residents are just programmed to expect some kind of increase from their landlord. Our expenses go up every year regardless of what happens with revenue. The other thing we see is that the two things that people don't like most are negotiating or conflict and moving. So we see a vast majority, as long as we send out reasonable requests, a great percentage of people will check the box and choose to renew so that they don't have to relocate and deal with the hassle of moving. There are always a very small percentage who are holdouts, and those are the pros that you have to work with.

Okay. But as a subset of people, where there may be some pressure, but again it's just a small subset.

Yes, the majority, again, assuming we're reasonable. It's played out the same, we've tracked it year after year; it's a pretty solid trend.

Okay. Great. That's helpful. And then just another quick one, just in the Bay area and San Francisco again, a lot of conversation around increased rent control initiatives showing up on the ballots during the election season. Can you talk a little bit about what you're seeing from that perspective and what could be the potential risk to your portfolio out there?

Sure. So in terms of work exposure, we have about three properties, 6.4% of total NOI in San Francisco only. So it’s a very small percentage of the total portfolio. I would tell you that the details are unclear. For example, Mountain View has two separate items on the ballot; one is put forth by the council and the other is a voter initiative, both of which have two different approaches to any potential outcomes, so that's all that I can tell you today. We will just have to wait and see what the outcome is on the election and ultimately what the fine print will be.

Okay, much appreciated. Thank you.

Good morning, guys. Do you think increased regulation of Airbnb could lead to another step down in demand? As you look to formulate your guidance, is this something you might contemplate? And it looks like you guys might be doing some pilot programs with Airbnb. Do you have a sense of how much overall room demand you get from Airbnb?

This is David Santee. I guess I would say that the legislation that occurred in New York City is a benefit to us. Historically, the state would fine the building owner if any transient rentals were discovered, and transient rentals mean anything less than 30 days. On the other hand, they do allow sharing as long as the owner is in occupancy, so I am not sure how that gets policed, and so I would say, to what extent it affects Airbnb, I am not sure. But we do have one pilot program at one property; we are continuing to learn and understand how to build out this platform for transparency and control. This would not be a huge money maker for any owner or property; this is more about transparency and control, managing something that is already happening and will happen regardless.

Okay, excellent. Do you think as a percentage of demand, it would be relatively small, the people that rent an apartment and then sublet it for various nights on Airbnb? Do you think that's a smaller part versus the people who may be every once in a while wanting to rent out the other room they have? Do you think that's a bigger part of the picture?

Yes, I mean I don't know; I guess I don’t understand Airbnb that much. I know they put out what percentages of people that rent out entire spaces and what percentage of people rent out rooms. I would say if a large percentage of people are renting their entire space in New York, then that's going to be a problem for them.

That is one of the benefits of the pilot – to have the transparency to prevent that.

Yes, that's exactly what I was trying to get at. So you don't have any subletting going on in your apartments for the sole purpose of running an Airbnb business.

We do not allow those people. So we do not allow anyone to rent an apartment from us for the sole purpose of running an Airbnb business.

This is Ronald Camden on Richard Hill's line. Thank you for your time. Just two quick ones from me. One, going back to D.C., you mentioned bringing in suburban renters to downtown. Just curious, which suburbs are they coming from? And is there a way to quantify that for us so we can get a sense?

Yes, we did that a year or so ago when we saw tremendous absorption of units despite virtually zero job growth. We just picked a handful of properties and looked to see where people's previous addresses were when they applied. It was clear that a lot of people were moving from around the gateway and choosing to live in the city. I used to work at 1500 Mass Avenue, downtown D.C.; we moved the office from Tysons Corner, and I can tell you people were moving out near Culpeper. It can take them two hours just to reach the bridge to cross the river and then another hour to get across the bridge to the office. So, if you ever lived in D.C., you know it’s very difficult to navigate, and there is every reason why someone would want to move from the suburbs into the city today.

Great. That's helpful. And then the last one when I look at, taking a step back, looking at the portfolio of Southern California with same-store revenue growth above 5% compared to New York with the supply issues you mentioned. When you think of longer-term steady-state growth, what do those numbers look like? Do they get to 3% to 4% type range? Where do you see a sustainable number for those two markets? Thanks.

I guess I won't talk specifically about those markets but just in general. In the markets where we have chosen to invest our capital and in others, you can find the presentation we put on our website that shows over an extended time period, revenue growth in these markets and increased underlying asset values in those markets compared to other markets. So like I said about those specifically, but just long-term, we expect outperformance of these coast and gateway cities where we have invested relative to more commodity-like markets in the country in general. We have several slides on our website that address that for you.

Great. That's all for me. Thanks so much, guys.

Thank you. The first question, sorry if I missed this, but did you give the new lease growth and renewal growth that was finalized for the third quarter for the company-wide?

Yes, that was 3.1%.

Separately, the new lease and then the renewal?

Okay, so renewal rates achieved were 5.3% and new lease pricing was plus 90 basis points for combined number of 3.1%.

Perfect. And do you have the assumption that's baked into the 4Q for those same numbers?

No, we do not.

Separately, with regard to the development pipeline, just cost to go vertical, any insight you can provide on what you're seeing for labor and material costs and all-in costs of vertical construction, and how you think that might trend over the next 12 to 18 months?

Well, across our markets, we are looking at growth in hard costs anywhere from 2% to as high as 6% and 7%. That's on top of 3% to 7% growth from a year ago. So, we are looking at continued increases in cost, a lot of that driven by labor and this is just another reason why we believe we are going to see a reduction in starts and reduction in new deliveries going out, because land prices are up, hard costs are up, and those yields are roughly low. We expect solid middle or single-digit growth going forward on top of last year’s light growth.

And David, if you do get a pullback in supply, whether that's capital-driven or for some other reason, do you think there is an opportunity for that to alleviate some of this burden and lessen that cost increase?

Well, I guess costs are just being driven by what's going on in new supply. Labor costs are being driven by what's going on across many different areas. In Boston, for example, labor has been impacted by a casino that’s currently under construction. So it’s not simply and only exclusive to multifamily. If there is a reduction, you would expect to see a modest reduction in construction overall, and we could expect to see that growth rate moderate.

That's helpful. Appreciate it, guys.

Well, thank you all, appreciate your time today. We look forward to seeing many of you in Phoenix, and go Cubs.