Equity Residential Properties Trust (EQR) — Q1 2017 Transcript

Thanks, Chris. Good morning and thank you for joining us to discuss Equity Residential’s first quarter 2017 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. And now I will turn it over to David Neithercut.

Thank you, Marty. Good morning everybody and thank you for joining us for today's call. As you will hear in just a moment from David Santee and Mark Parrell, the first quarter came in pretty much in line with our expectations. Occupancy remained quite high, particularly on a seasonal basis, clearly demonstrating the continued strong demand for rental housing in our core markets. And we saw retention improve over the first quarter of last year while achieving renewal rates of 4.3%, clearly demonstrating the benefits of remarkable customer service and the dedication of our teams across the country. As expected, new apartment supply continues to pressure new lease rates, causing our portfolio to produce negative lease over lease growth in the first quarter. Fortunately, the apartment demand is proving sufficiently strong to absorb this new supply while maintaining healthy occupancy levels in existing assets across our market. In fact, our own lease up activity in southern California, San Francisco, Seattle and Washington DC is going exceptionally well where we are leasing units at a pace well above our original expectations and net effective rents are generally at or above what we had originally projected. I will let David Santee go into more detail about how our markets performed in the first quarter and where we sit today going into the extremely important leasing season, and then Mark Parrell will give some color on operating expenses.

Okay. Thank you, David, and good morning everyone. I want to spend a few minutes reviewing our performance across our markets and our positioning as we head into the primary leasing season. Our goal in 2017 is to focus on retaining our existing residents to drive the new lease growth and thus far our teams have delivered. Meeting with the local teams and making sure that we all understand the dynamics in every market is crucial for how we run our business and I spend a great deal of my time with the properties for that reason. Over the past several months, my senior team and I have traveled to all of our markets for meetings that included everyone of our employees in each market to ensure that our highly collaborative team members understand our strategy and tactics. As part of these meetings, our sales folks and managers attended an in-depth renewal negotiation workshop focusing on sharing best practices in order to better feel prepared in the coming months. Our reported Q1 results leave us well positioned as we enter the early stages of our peak leasing season. We are pleased with how the quarter played out, given the elevated deliveries across many of our markets. Our revenue growth of 2.6% was driven by pure rate growth as renewal rates achieved for the quarter were 4.3%. More importantly, the percentage of our residents who renewed with us increased from 57% in Q1 of '16 to 60% for this quarter. And this was on a pool of units up for renewal that is about 3% larger than last year. Already, we are seeing good results as our renewal rates achieved in both April and May are up 4.7%. As David said in his remarks, this is a great indicator of the terrific work being done by our teams across the portfolio. Now while renewal rates achieved thus far are encouraging, the peak leasing season has many potential risks, either through elevated supply or uncertainty in part of the economy. We know that summer is around the corner and following the expected normal seasonal pattern, inventories will begin to build and occupancies will start to moderate. Our team will continue to work hard, lease by lease, to deliver for our shareholders. Now moving on to the market, I will give you some color on what we are experiencing today and describe where we are on the delivery cycle for new units. Additionally, I will provide a renewal and lease over lease results for the quarter as well as color on our average net effective new lease pricing. And just to clarify, our lease over lease results are the net change when we compare old lease rents to new move-in rents for the same unit. These results are influenced by the old rent as well as the term of the previous lease and are not always indicative of current market conditions, especially early in the year. Our net effective new lease prices better represent the year-over-year trend in a market and are prices the customer uses in making their leasing decisions. So starting with Seattle. Renewals achieved for the quarter were up 7.1% and lease over lease results were up 4.1%. Both well within expectations for the quarter. Net effective new lease pricing was strong and has averaged approximately up 7% versus the same quarter last year. Both rate growth and occupancy for the quarter was good and demand remains healthy. And while a greater percentage of the new deliveries will occur in the back half of the year, we continue to expect Seattle to be our top-performing market for the full year. At Amazon alone, the open positions numbered within 9,000 jobs, many of which are high paying and the recent news of the Boeing layoffs and overall downsizing in their engineering function, specifically in Seattle, should have minimal impact to our portfolio as we have minimal exposure north of town. San Francisco has been stable thus far despite the level of new deliveries that are heavily weighted in the first half of the year. Renewal rates achieved in the quarter were up 3.9%, lease over lease results were negative with 1.7%. Net effective new lease pricing growth was up 2% throughout the quarter and remain at that level. Tech job growth remains muted in San Francisco but there is growth. DC investments appears to have bottomed in Q4 of 2016 and may be improving. With new apartment deliveries more dispersed across the market than in 2016, we believe that San Francisco should be better positioned this year to absorb these deliveries in a rational manner. Southern California, which makes up about 26% of our total NOI and is expected to deliver nearly 60% of our total revenue growth in 2017, is on track. Orange County and San Diego are leading the way with plus 5% revenue growth for the quarter. LA is feeling the effects of peak deliveries in Q1 while Orange County will see peak deliveries in the back half of the year. As expected, the far north and east LA submarkets are very strong as most of the new supply is concentrated in the urban core and closer in submarkets like Pasadena and Koreatown. Renewal rates achieved for LA were plus 5.7% for the quarter and lease over lease results were positive 60 basis points. Net effective new lease pricing growth averaged just under 12% versus the same quarter last year. Orange County and San Diego achieved 6.6% and 5.2% renewal rate growth respectively and lease over lease results were up 1.7% and 60 basis points respectively. Net effective new lease pricing remains at expected levels as we enter the peak months of peak demand and average 5% for Orange County and San Diego combined. April renewals results for the three markets are showing seasonal strength with LA achieving growth of 7.1% and Orange County and San Diego achieving growth of 6.7% and 6.3% respectively. So moving over to East Coast and Boston. Most of the Q1 revenue growth was driven by 110 basis point improvement in occupancy, as quarter over quarter turnover declined by 260 basis points with fewer deliveries pressuring the market than we experienced in the second half of 2016. Renewal rate increases achieved for the quarter were 3.7% and lease over lease results were negative 5.4% and in line with our original forecast. Net effective new lease pricing increased in average by 2.5% for the quarter. With peak deliveries reoccurring in the urban core in Cambridge in Q2 of this year, we expect Boston to perform to expectations for the balance of the year. However, Boston has always been greatly influenced by the high percentage of students, especially in the urban core. With the uncertainty around current immigration policy and the strength of the dollar, we are paying close attention to demand from international students as we began the student season churn. In Boston, our renewal rate growth achieved thus far for April and May are 3.4% and 4.6%, with less than 16% of May renewal offers still open. Net effective new lease rents remain positive but are moderating as inventory is growing as students get their notices to vacate and new deliveries open their doors. New York has remained disciplined thus far considering that more than 10,000 new units are currently in lease-up in the market. Half of these units were delivered in 2016 and the other half delivered in Q1 of this year. Deliveries will continue to grow throughout the year peaking in Q3. Upfront move-in concessions were basically the same in Q1 of 2017 versus 2016 and net effective new lease pricing, and that includes concessions, continued to hold, down only 1% versus the same period last year but on an expected lower occupancy. It's no surprise that Brooklyn and the West side are under the most pricing pressure as the largest amount of new deliveries are occurring in these submarkets. On the flip side, the East side and Jersey Waterfront are still delivering positive revenue growth approaching 2%. Renewal rates achieved in New York for the quarter were positive 2.3% and lease over lease results were negative 6.2%, both of which are modestly below our expectations. Net effective new lease pricing has averaged negative 1% for the quarter. April renewal rates achieved came in at 1.7% while May results are currently at 2.7%, with only 9% of offers still outstanding. Given that the growth in higher-paying jobs is weaker than one would hope and the market continues to see elevated deliveries, we are pleased by the pricing discipline that we have seen in the market thus far. Across the board, concessions appeared to be limited to lease-ups as standard operating procedure, while stabilized community concessions are very targeted based on unit price exposure. For instance, for the quarter, our move-in concessions averaged $575 per move-in or about 4.5 days of free rent per move-in. Washington DC has performed to expectations despite modestly depressed demand due to the federal hiring freeze and uncertainty about the future of many government agencies. Renewal rates achieved were up 4.1%, lease over lease results were minus 4%, which was slightly below our expectations but mitigated with an increase in occupancy. Net effective new lease pricing averaged up 2% for the quarter. April renewals, which are essentially closed, delivered 4.5% rate growth, and in May, with only a few renewals open, we are achieving 5% growth. Given the political uncertainties and new deliveries that are extremely weighted in the first half of the year, we would expect the softness in the net effective new lease pricing to remain under pressure for most of the peak season but offset by improving renewal increases as the back half of the year would see a sharp fall-off in new deliveries. So the theme for us in 2017 is renewals. It's about working hard to keep our current residents happy with their choice and more importantly, keeping them living in an EQR community. And so we have taken the time to strengthen the skills that our employees need to meet the challenges of elevated supply. As a person who began his career as an assistant manager of a 1,500 unit property in Washington DC, I never forget the challenges that our people face. In no other industry does your customer live with you 24/7, 365. I would like to thank all of our employees for what you do each and every day. I am inspired by your spirit, always motivated by your energy and humbled by your commitment to excellence at Equity Residential.

Thank you, David. It's Mark Parrell. I want to take a few minutes this morning to discuss same store expenses. Our same store expense growth of 3.9% in the first quarter was primarily driven by increases in real estate taxes, on-site payroll, and repairs and maintenance. This was slightly higher than we expected due to the impact of the California storm cost that I'm going to go over in a moment. So here is some quick color on some of the bigger expense line items. We saw a 4.2% increase in real estate taxes driven by assessment increases in Boston and Seattle. Also, the burn off of 421(a) tax abatements in New York added 1.8 percentage points to this quarter's number. For the full year, we continue to expect real estate taxes, which make up about 42% of our total operating expenses, to increase between 4% and 5%. Moving on to on-site payroll, these expenses increased to 4.6% in the first quarter. For the full year, we continue to expect an increase of between 4% and 5% as we face the higher property level wage climate with our employees in high demand in a very competitive market. And David Santee just mentioned our laser focus on renewals and as a result of that, we have also added staff in some markets to provide even better service to our residents and to support tenant retention. Payroll expense this quarter was also impacted by the California storms as our property staffs worked longer hours addressing storm damage. Now I'm going to turn to repairs and maintenance where we saw a 6.7% increase in that line item in this quarter. As you saw on the news, mother nature made up for several years of severe drought in California with heavy and consistent rains which resulted in increased roof repairs, tree trimming, and similar costs. These costs totaled approximately $570,000 in the first quarter which drove this number up to 6.7% from about 3.7%. Now on to a less material expense line item, leasing and advertising expense, which in the quarter increased to 12%. The increase in the quarter was driven by increased resident referral fees, including broker fees and more spending on resident activities to keep our customers engaged. These expenditures were generally all budgeted and expected. Last year, we reported an increase in this line item due to promotional spending, including the use of resident gift cards primarily in New York. We have budgeted about $700,000 in gift card spending in 2017 but thus far card use has been minimal. We still expect leasing and advertising expense for the full year 2017 to be flat compared to 2016. I will now turn the call over to David Neithercut.

Thanks, Mark. On our last call, we indicated that following the year in which we sold nearly $7 billion of assets that 2017 would look quite tame on the capital allocation front and that we would transact if and when we found an opportunity to redeploy disposition proceeds into a higher return asset pool. That remains the case. Although the one asset we did sell in the first quarter was a holdover from last year. This was a 304 unit asset built in 1970 and located in Milford, Massachusetts. For the handful of you that don’t know where Milford, Massachusetts is, that’s about 40 miles west of Boston. This leaves us with one remaining asset left to sell, also an older property in Massachusetts, in Franklin, Massachusetts, also well west of Boston. And those are just significant as a holdover from the large portfolio that we undertook to sell in 2016. Although we did not acquire anything in the first quarter, guidance for the full year continues to assume $500 million of acquisition activity funded by a light amount of disposition activity at a negative spread of 75 basis points. We are underwriting a handful of possible acquisitions at the present time that we think would make for great new investment opportunities for us but only at the right price. It remains to be seen where these deals will actually trade. We will continue to hang around the hook, ready to play if it makes sense to do so and track the potential opportunities as they occur throughout the balance of the year. So with all that said, Chris, we will be happy to open up the call to Q&A.

In terms of same store revenue guidance, would you Mark, consider keeping an eye on the most volatility that would either result in you ending up towards the high end of same-store revenue guidance or towards the bottom end?

This is David Santee. Given that Southern California is going to deliver almost 50% of our expected growth for 2017, we are obviously laser-focused on the results coming out of those markets.

Thanks. And then you mentioned the lower turnover. What do you attribute that to? Is it something that you are doing from a strategy perspective or is it something that you think is happening across the markets overall?

Well, I think if you just look at our industry, I think there is an overarching trend that residents are just more confident in the future. There was a Freddie Mac study that said people are staying longer. I think we have seen that over the past years. People just like where they live. They don't want to move from their lifestyle. Most of these communities are not two-storey walk-ups. They are much less transient. And I think we are seeing the benefits of that.

I think residents, Nick, they get comfortable with the staff. We create an essential family and neighborhood in the building. They grow accustomed to the amenities that are nearby and their inclination and desire is to stay. We do everything we can to encourage them to do that and we are very pleased with the results that the team is delivering out there.

So I am going to start with a question on expenses. Just to make sure that I have got this correct. I am having trouble squaring, I think, the couple of statements that real estate taxes and payroll, which are the two biggest expense categories. I think you said you are going to grow 4% to 5% for the balance of the year and I just want to square that against the 3% to 4% expense guidance which was unchanged after the first quarter results.

Yes. It's Mark. It's 4% to 5% for the whole year for those two line items. For payroll, it's 4% to 5% for the annual expense number, and it's 4% to 5% for property taxes for the whole year.

Okay. Thanks, Mark. I guess that begs the same question though. I mean if the two largest expense categories are growing greater than the guidance range, where do you make up for it on the other side, I guess, is the question.

Well, for the utilities, which we see as pretty low number in the 1% to 2% range and it's 14% of our expenses, is one of the line items where we are going to see a benefit.

Okay. That helps. Second question from me. This goes back to what David Santee referred to in the prepared comments. There was a comment about sharing best practices. It sounded like on the revenue management side of things, in the face of new supply and maybe changing the game plan a little bit versus what happened in 2016. I am just wondering if you can provide a little more color as to what some of those specifics might be going forward.

Well, I don’t know that we are changing our game plan. This is more about, a lot of our leasing folks, these are entry level positions, it's probably the highest turnover position in our industry. And it's just included as we enter the peak leasing season each year. The fact that we had a sales meeting before peak leasing season is not necessarily new. We do this every year. What is new is the fact that myself, our senior leaders here, we went out, we spent time with these folks. We heard their concerns. We discussed our opportunities, especially with our service employees. They are a critical piece of the renewal puzzle and this was all about giving them the support they need to be as successful as they can over the next several months.

First, I guess, on New York. Obviously, a lot of concern with all the supply that’s coming. Can you give us a sense for now much of your portfolio in New York you think is actually exposed to the high, luxury segment of the market where all the supply is being delivered?

I would say most of it. The question we still need to answer is whether Long Island City will become a new value destination and attract people from Manhattan or Brooklyn looking for lower rent. It's probably easier to refer to areas with lower exposure, like Jersey City and the Upper East Side. However, more than 30% of our revenue comes from the West Side, which is where most of the new deliveries that will compete with our properties are being introduced.

Okay. And then, David Neithercut, I had a question on you and the board's capital allocation views right now. So in March, I think, you are doing your annual NAV analysis to the board. I am wondering what the conclusion of that analysis was and specifically how you are weighing external growth versus buying back your stock.

Well, we talk about this on a quarterly, at the board level, and we have for quite some time taken a more cautious approach with respect to capital allocation. As you know, we throttled back our development considerably and following the large disposition that we did last year and even last year we did not acquire a great deal. For the past several years, our free cash flow has gone to fund our development pipeline which has been an extremely profitable and successful pipeline. That has been communicated with our board in our most recent meeting but that spend will begin to reduce and beginning in '18, you know that commitment to that business will not be at the magnitude that it had been over the past few years and that capital could be used for many different uses, including stock buyback, if we thought that was appropriate to do at that time.

Okay. I guess just a follow-up. Are you also thinking about other options, maybe to free up some more capital. Whether it be selling some of the recent New York City developments or maybe even raising your leverage a bit, sacrificing your A-minus credit rating. Because you are, maybe not getting that much of a benefit from it right now versus if you went down a notch. I mean how do you think about some of those approaches which would create even more capital to reinvest somewhere else?

Well, I mean we did sell an awful lot of assets last year and did return a significant amount of capital to our shareholders. So it's not as though we have not been thinking about that kind of thing. In terms of selling assets, we believe that many of the assets that have been recent developments really will be value creators for the company over an extended time period. Assets that may not be as important to the long-term strategy of the company as demonstrated by that which we sold last year and the meaningful gains they will produce, because of the requirement of distributing those gains that produce a lot of excess cash flow. We have, as you note, our balance sheet is probably in the best shape that it's ever been. Mark and his team has spent a lot of time with the agency getting to know about what we have been doing there and that number has come down. And we have communicated to that side of the investment community that we are not unwilling to use that capacity if and when it makes sense to do so. We fit in the ranges in the bottom half in which we have operated since we went public back in 1993. So I guess I would tell you that we have had these discussions and we will not be afraid to use that capacity if and when it makes sense to do so.

David Santee, can you tell us where San Francisco renewals are for April and May?

Yes, I can. I think said those in the prepared remarks. San Francisco for April at 4.8% and May still has about 42% to be worked, so it's at 4.2%, so that number should close May much higher.

Okay. And then what's your positioning on renewal offers for June? Are you guys looking to raise them or hold them to where, probably not just in San Francisco, to where you have been sending them out for May?

Well, so a lot of the West Coast markets are on our 30-day notice requirement markets. So we haven't issued many of those renewals yet. But I can tell you, on the East Coast where we have to issue those about 75 days in advance, those are, let's see, on par with May.

Okay. And then I don’t know if you mentioned, David Santee, in your prepared remarks, the portfolio-wide lease over lease growth for 1Q, on the new renewal growth.

The lease over lease, that is minus 2%.

Minus 2%. Okay. Thank you. And then David Neithercut, in the transaction market we have observed a slowdown in total transactions in recent months. I don’t know if you have seen the same thing, I assume so, and then what you would attribute this to or any difference you have seen either as a seller or as a buyer on your counterparties behavior?

Well, I think you have seen, and everyone has sort of seen, it's just a widening of the bid-ask spread, which is not, shouldn’t come as a surprise, when there is some question about where interest rates are going, where you are seeing some of the softness on the new leasing and this new supply. So you continue to have owners and sellers who think the properties are worth a certain price and you have got buyers sort of saying I am not so sure. So there has been a slowdown of transaction activity for quite some time and certainly we have seen very little in the first quarter away from value-added products for which the remaining is a fairly good bid.

Just a quick question on the job growth on the West Coast, in particular Southern California, given its importance to your growth. What are you guys seeing on the grounds in terms of job growth creation, both there, maybe if you can comment on kind of what you are seeing in Northern California as well? Do you see signs of improvement or more softening than you had expected when you set guidance earlier in the year?

I guess I wouldn’t categorize it either way. I mean it's kind of where we thought it would be. I think the better news for LA specifically is that the number of high-paying jobs that are being created are in the places where we are developing new apartments, specifically in the urban core. But LA has always been very broad-based, many product types, many different municipalities. So I think it's too soon to say anything either way as we are on track and we will meet the expectations.

Okay. And then do you guys have a view on how the investment community should be thinking about the permitting numbers, like the latest month data in March, trailing 12 months was up over 20%. Do you see that as a risk to the expectation that supply would come down at some point in '18 and '19?

Our expectations are notwithstanding recent permits. Based upon the intelligence that we gather from our teams with boots on the ground in the markets in which we operate suggest that generally '17 will be a peak and that we will see new supply reduce from there. We are certainly aware of the permitting activity. We know historically, 85% or so percent of those trends are starts, etc. But our belief is with land pricing where they are, with construction financing becoming more difficult to get, with the new supply that’s coming into the marketplaces today, we just continue to believe that we should see new supply come down from this peak level that we are going to experience in 2017. By definition, if 85% or so conversion of permits in the starts, that means there is some things that must be left. You know I don’t know what the range is, what the dispersion is around that number but I certainly would believe that there would have to be years in which it would be below 85% and certainly would expect that number to decrease. Our guidance is around, we are looking at everything. Any of the variables, any of the players. Mark Parrell, I would ask him to just jump in. Well, he has been on the finance side, what he is sort of seeing and hearing about the debt side. But between land prices, construction costs continue to go up, the challenges that the markets are seeing would result in reducing supply and sort of compressing rent growth. Just making it become even more challenging to sort of pencil and we don’t see any reason why we shouldn’t come down from the 2017 peak.

And just on the development financing side, I mean we are constantly following banks, talking to loan brokers, talking to developers that are out there in the private market. And it certainly was an inflection point back in December of '15 when the bank regulator issued its letter. There is a pretty significant view from the banks at that point that they weren't going to increase their partner lending. So what we think is going in the apartment lending generally is that spreads are higher, 300 or so over LIBOR is pretty common. That advanced rates moderated into the 60%-65% advance rate. So you need to come up with a good amount of equity. And thus all the things that David Neithercut mentioned about higher land cost, higher construction cost coming to play and just make the deal harder to pencil for what is now a pretty big size equity check that needs to be written. Now with the bank financing market is allowing though is as these deals roll off, so in other words become stabilized and are often refinanced with Fannie Mae or Freddie Mac, that does create capacity at these banks to re-up and to do loans. So we don’t see precipitous declines, to be honest, in bank volume as a whole. We don’t see it going up either as it relates to apartment lending and over time we think that will cause the moderation that David referred to.

Okay. Great. And then one last one from me. How should we expect occupancy to trend for the balance of the year?

This is David Santee. I think we expect, I think I have mentioned that in my prepared remarks, we would expect occupancy to kind of begin to moderate a little bit through the summer months, just due to the level of activity. And then steady off in Q4 that will follow a normal seasonal pattern. There is still good demand. We don’t see any really material changes expected.

I wanted to get a little bit more questions on maybe New York City. So on new leases, I think you commented new leases were down negative 6%. Curious if you just maybe give us some look as to what you think the glide path might look like, sort of given what seems to be some new supply. So said in other words, when do you really start to see that stabilize.

Well, I guess I would say that peak deliveries in New York are most likely to occur next year. So 15,000 units this year of which only five have been delivered. And then another 17,000 units next year. So that’s kind of, we have kind of the deliveries mapped out on a graph and for this year those deliveries peak in Q3. But, again, some of the deliveries in Q4 will obviously carry over into '18 as well. So I think David said in his prepared remarks, looking at new lease prices, they will probably continue to be under pressure, but on the other hand these lease over lease numbers that I quote, I mean more often than not they are always negative. It's just one of those nuances in our business. And what's not factored in that number are the fees. Most of these people that move in November, December or January, February. These are people that are forced to move. These people are the ones that typically have to early-term their lease. We are charging significant fees for the privilege of doing that. And those do not show up in these lease over lease numbers.

To elaborate on that, lease rates tend to decrease throughout the year. For instance, if a customer leases a unit from us in July or August and needs to vacate in the first quarter, we will likely lease that unit at a lower rate. As a result, we expect the first-quarter lease comparisons to be negative. This new supply adds to that negativity compared to previous years. However, it's important to recognize that even in a rising market, experiencing negative lease comparisons in the first quarter is not unusual.

Congrats on the quarter. I know it's a very tough backdrop but the execution looks pretty good. Quick two questions from my end. The first one is, 1Q is a seasonally slower quarter. You still put up same store NOI growth above your guidance of 0% to 2%. From your comments today it sounds like things are incrementally getting better. So I am just curious why maintain the guidance of zero to 2% for same store NOI growth in 2017? Kind of what are you expecting in the back half of the year that could be negatively impacting that number.

Let me just start by, sort of you have answered your question I think when asking it. And that is, transaction activities accrued up to now are just now getting into the primary leasing season and when the rubber meets the road. So we are trying to give you a sense of what we have seen in the first quarter but as David said, David Santee said in his prepared remarks, we recognize that the heavy lifting is yet ahead of us.

Recognizing that this is the peak year of supplies in your market except New York, can you provide some color on where you think supply will be in 2018 versus 2016.

Sure. Basically, these are numbers which as of today most likely will be built because if you are vertical, you are already moving there. So we are looking at across all of our markets about 54,100 units.

So is that higher or lower than last year?

For '18 that will be lower than this year '17.

The question was, how does that compare to '16?

Okay.

John, we are looking at over 200,000 units in '17. One thing to just think about this supply, when it gets delivered is at a point in time it takes a long time to lease up. So even '16 deliveries are complications for us today and '17 deliveries will be complications in '18. I know there will be fewer deliveries in '18 than in '17. So we are watching very closely, as I said earlier, we have got our guys, our investment officers, development folks, our management people on the ground. They are on track on all the stuff. And when David gives you that number, so I make it clear, that this is the number of supply that we are looking at within sort of the markets that we draw, that we believe to be competitive with our product. That was not intended to be a number for the entire marketplace but only that which we believe there is product that would be competitive with our portfolio set.

Okay. Great. Thanks. I have a question now on your utilization of two-year lease terms. Are there certain markets where you are using this more? And how much growth do you typically bake in to that second year of lease term, if any?

So I would say really the only place where we are using two-year leases are primarily in New York. We are obligated to offer two-year leases and I think our belief was that we have done thus far year-to-date, it's about 15% of total move-ins. Again, we have very low volume in the quarters, so 15% of a very low number is again a very low number. So it's not a material part of our leasing strategy.

And is that second year typically flat or is there growth in that second year?

I would tell you that in experimenting, obviously we have had more takers when there is no increase baked-in, but depending upon what we expect as far as deliveries in 2018, we may offer two-year leases with no increase baked in.

Two questions for us. First, on the last call you guys mentioned the CapEx and the need to obviously be more competitive with the new supply. Have you guys sort of qualified how much you think your CapEx spending could change? And I am not just talking sort of light apartment upgrades but sort of to make those properties as competitive as they can be with new supply. Have you guys sort of quantified what you think it's going to be over the next few years versus your historic run rate, especially as you commented, focus on turnover and keeping tenants in place versus having them jump for better deals elsewhere?

So Alex, we had talked in the last call about a number as a percentage of revenue for the same store set of around 7% for all CapEx spending where rehabs replacements were all shooting match. This year we are into low 8% range. Again, talking to the team it seems like 7%, 7.5%, somewhere in that range is the right number for us. So that equates to about $2,300 per unit versus the $2,600 we are spending this year. So again, from our point of view, we don’t feel like our assets have a great deal of deferred maintenance such that we require some sort of catch up. But we are trying to make our assets just a little bit more attractive by accelerating some things we would have done in out years to this year to make the leasing season all the better for us right now. So I guess I don’t feel like the run rate has changed past this year.

Can you share your thoughts on the new 421(a) discussion? It seems from my initial impression that it might not be beneficial for areas like Manhattan and trendy parts of Brooklyn and could actually be advantageous for current landlords by limiting supply due to its terms. Given your closer perspective, how do you view its impact on your portfolio in Manhattan and Brooklyn? Do you believe the new 421(a) will promote development or, due to the terms, might not necessarily contribute to it?

It's David Neithercut. We have concurred with your conclusion. Our team in New York has underwritten some transactions and applied the new affordable New York to those and their takeaway that while there are some nuances between the two, there is not really a dramatic change from the private programs. We think that the, to your point, that the big condo land in New York City and all and the rising construction cost would continue to make Manhattan and the Brooklyn markets that you mention, very restrictive for new apartments going forward and that this affordable New York program will likely promote and encourage some rentals but that is more in the outer boroughs. But we do not see it as something that’s going to have a meaningful impact on bringing new development into the Manhattan and of course in Brooklyn markets.

I guess, first following on those comments about why New York, particularly increasing next year. Can you comment on the makeup of that supply, and by that I mean should we see a shift from Manhattan to the boroughs in New Jersey? And in turn does that mean less direct supply for you, the bulk of your products in Manhattan proper?

This is David Santee. I have kind of misplaced my New York delivery. But regardless, there is no hold on of supply in Jersey City or East Manhattan. I mean a lot of the supply this year and next will be centered in kind of Northeast Brooklyn, Long Island City, continuing the upper Westside, the Westside, and then a smattering of midtown down to lower Manhattan. I mean that’s where all of the development is located both this year and next.

Okay. So you are not seeing a concentration shift of any kind?

No. I mean, we need to clarify what we mean by concentration. With Long Island City being just a train stop away, it will be interesting to see if that attracts people from Manhattan. There is definitely some movement happening. Neighborhood loyalty has decreased compared to what we were used to five to ten years ago. We are hearing about people relocating from lower Manhattan to Jersey City and from Jersey City to the upper Westside. Ultimately, it boils down to the lifestyle that individuals are aiming for.

Hey, Tom. We don’t provide quarter-by-quarter same-store revenue numbers. Generally, the number will be lower throughout the quarters and will start to level out towards the end of this year on the revenue side. On the expense side, many of the quarter-over-quarter numbers depend on our comparable periods. Our comparison period at the beginning of this year is much tougher compared to the first half of 2016, while towards the end of the year they become easier. We had relatively high expenses for same-store in the second half of 2016. So, when we sum this all up, we still feel good about our ranges, which is why we didn’t need them. However, each quarter will experience a lot of volatility based on its comparable period.

First question, I was just hoping you could maybe clarify your comment on supply. I think earlier when you talked about the peak in supply in '17 and your analysis, you were speaking of it, it sounded like more from a start to endpoint from a capital availability and construction cost and so forth. So just wanted to clarify, when you think about supply and talk about '17 unit peak. Is that starts completions or lease-up pressure?

That’s deliveries. We would have like a year in which a product is delivered, and I am glad you asked the question in that manner to us because we do track this. There is not, obviously, not simply in the year or quarter in which a property is delivered. And delivered means essentially complete. But our team is out in the field tracking very closely when those units will first be available for occupancy. And it really did become competition days prior to that. So there is a difference between when something is "complete", and when it actually is competition and we track the latter on a quarter.

Okay. That’s helpful. And so as we triangulate against the national numbers which are showing both permits and starts being strong double-digits. So far this year I think even over the last six months, inputs the way, I guess, that’s happening outside of your market concentration as you look at it?

Yes. I mean we are certainly aware of what those national numbers are and we are tracking those assets in our markets that we believe are competitive with us. And then just to add a little loan color side. Some of the feedback we have gotten from the banks and the brokers and the like, as it relates to our urban markets is that the banks are more interested in making loans in areas in the suburbs, where there is a little bit less construction over the last year or two. Just again seeing the numbers decline a little in the urban core is discouraging. Also, they would suggest the hardest loan to do right now is a syndicated urban loan. So a very large $100 million-$150 million loan. From our perspective that’s particularly good news because that’s the kind of competition that David Santee and his team are facing most of these larger urban assets that do require pretty significant syndicated construction loans.

And just to double back on the deliveries in New York. Basically, the easiest way to describe this is, where the concentrations are today, they are even more concentrated next year. So this year, Brooklyn is 3,700 units, next year Brooklyn is 4,500 units. Queens this year, the Long Island City is 3,000 units, next year that is 5,700 units. So next year just between Brooklyn and Queens, that makes up 10,000 of the 17,000 units.

Not for Q2 to date. Just for the quarter.

Just for first quarter. Okay. We can follow up there. And then also just to clarify the comments you made on Boston. With new leases under pressure, I think you said 5% in the first quarter. And I thought you said that was going to moderate through the year but then I also thought you said that the supply was front half heavy. So maybe you could just clarify how you are seeing supply play out through the year and the trend in Boston.

Yes. The supply is currently increasing and is primarily focused in the urban core and Cambridge. At the same time, students, who are a significant portion of our residents in those two areas, are starting to give notice as the school year ends. Therefore, the upcoming months will experience a surge in leasing activity as we work to prelease for fall 2017.

Actually I was going to ask some questions on the international students, but I guess I will go to my next one. Looking at New York, when do you see that market reaching equilibrium when you factor in all the lease-up and maybe some, just maybe take a little bit longer to lease some of these projects.

The discussion is not just about supply, but also about demand. As I mentioned, products delivered in 2018 will continue to influence leasing in 2019. It might take into 2019 for things to stabilize unless we see a significant increase in higher-paying jobs in New York, which we haven't observed in some time.

Yes. Fair enough. I hope for that as well. And then looking at the increased retention ratio, is that something that’s coming as a surprise and do you expect that to continue?

Well, if it is one quarter, while it was a more turns in the first quarter '17 than it was in the '16, it's still not a lot relative to the churn that we all experience throughout the whole year. As David mentioned, the overall spending we have spent and not just recently but over the last year, spent a lot of time training our people. Making sure they appreciate how important renewals are and the service expectations that we expect for them to deliver, to do that. And so we have every expectation, every hope that retention will remain strong because we have got our focus on it as David in his prepared remarks.

Could you summarize a couple of points that were mentioned but not directly addressed? In New York, you indicated that supplies are moving from the urban core to the suburbs, particularly in the sunbelt. Can you confirm that? Can you provide a direct answer to that question?

In the sunbelt. No, I...

From the urban core into the suburbs and the sunbelt.

I don't have any information about what's occurring in the sunbelt. However, Mark Parrell mentioned that the lending community seems to prefer smaller loans in the suburbs rather than larger deals that require syndication in downtown areas. But I can't provide any comments on the situation in the sunbelt.

Fair enough. And then one question was answered, things are turning out the way you thought they would be turning out. And I am wondering if that’s actually a good result. By that I mean, if you compare how you feel today versus how you felt in the fourth quarter when you were doing this call, would you say you feel incrementally better that things have actually stabilized and met your expectations and hence maybe you feel better about the future as well when you think about supply starting to decelerate next year? Could you make that type of statement today or no?

I guess it's hard as we see here around the eve of the primary leasing season recognizing that we have the least amounts of actual transaction activity in the fourth quarter and in the first quarter. But we have talked about some markets like San Francisco maybe having found the bottom, having reset to a level, that David in his remarks mentioned, that in San Francisco we hope that the position, they have got more rational pricing as new products come online. But we just do want to emphasize that work is yet to be done ahead. Because most of the leasing we will do will be done in the next 90 days and we will have a better perspective of how it's going and we view the shape up when we visit with you at the end of July.

Okay. And then just on New York, you mentioned, I think Santee, you called a disciplined. So do you feel like just specifically about that market despite all the commentary about supply, do you feel a little bit better going into the heavy leasing season in New York because of that discipline that you are sensing in this past quarter?

Yes. I certainly feel better but that doesn’t mean things can't change very quickly. You know we look at our fully committed concessions, May looks very good and we will see how that plays out. But again, we still have to deliver, we are in the midst of delivering another 10,000 units on top of 10,000 units that are currently making lease-up.

I just wanted to understand the delta between the offers you send out for renewals and the actual rates you end up looking. What's happening to that delta? Does it continue to kind of expand? Is it starting to close up? I am just kind of trying to get a sense of how tenants are reacting to the renewal offers that they have given?

So we use March as an example since that’s closed out. Typically that spread has been 180 basis points. We closed March at basically 190 basis points. So I would say for the most part all the market spreads are holding as we expected with a little wider spread in New York City.

Well, I thank you all for joining us and look forward to seeing many of you in New York City in June.