Equity Residential Properties Trust (EQR) — Q1 2023 Transcript

Good morning, and thanks for joining us to discuss Equity Residential's first quarter 2023 results. Our featured speakers today are Mark Parrell, our President and CEO, and Michael Manelis, our Chief Operating Officer. Bob Garechana, our Chief Financial Officer, and Alex Brackenridge, our Chief Investment Officer are here with us as well for the Q&A. Our earnings release is posted in the Investors section of equityapartments.com. Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the federal securities laws. 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. Now I will turn the call over to Mark Parrell.

Thank you, Marty. Good morning, and thank you all for joining us today to discuss our first quarter 2023 results. We had a very good quarter to start the year with same-store revenue results exceeding our expectations. And while same-store expense growth was higher than we projected due in large part to California storms, that still left us with first quarter net operating income and normalized FFO better than we expected. In a moment, Mike will take you through our first quarter operating highlights. The strength of our revenue results points to the durable nature of our business in the face of volatile economic conditions. We continue to see substantial demand from our affluent renter demographic and moderate levels of supply in most of our major markets, with the new news in the quarter being the rapidly improving regulatory conditions in California. Based on these continuing positive business conditions and the good prospects we see for our business going forward, during the first quarter, our board raised our common share dividend by 6% on an annualized basis. Despite headlines and layoffs, demand feels solid. The unemployment rate, particularly for the college educated, remains very low, which gives us a good feeling about the employability and earnings power of our affluent renter customer. In our portfolio, we are not seeing increases in residents downsizing their units or giving us their keys because of job loss. In terms of competition from homeownership, monthly costs and down payment requirements remain high in our markets, especially relative to rents, making renting a high-quality Equity Residential apartment a better value. Only 8% of our residents who moved out in the first quarter bought a home, and that's down from 12% in the first quarter of 2022. On the apartment supply side, as we have discussed with you on previous calls, we expect 2023 national apartment new supply to run at record levels. But we generally feel good about the level of direct competition that supply will pose to us, given our market mix and importantly, the location of supply within markets relative to our properties. In our coastal markets where we still have 95% of our NOI, we see very manageable competitive new supply in most markets, with Washington, D.C. being the exception, though D.C. is holding up remarkably well so far. In the Sunbelt markets, including the Dallas-Fort Worth, Austin, and Atlanta markets in which we are increasingly investing, and in Denver, we are seeing higher relative supply and more impact. We anticipated this when we acquired our Sunbelt and Denver properties, and these properties are generally tracking consistently with our underwriting. As we look to expand our portfolio in these markets, we expect that these new deliveries will present buying opportunities for us. Mike will also discuss first quarter same-store expense growth, which was higher than we expected, especially in the repairs and maintenance and other on-site operating expenses lines. We think this growth was inflated for discrete reasons that will pass, and we continue to be comfortable in attaining our full-year same-store expense range in part due to lower than previously anticipated real estate tax growth, combined with modest on-site payroll expense growth. We have created at our company a culture and system that uses technology and centralization to improve the customer and employee experience and to contain our payroll costs. While the transaction markets remain unsettled, we did do a couple of deals to start the year. We sold a small collection of 25-year-old properties that totaled 247 units in Los Angeles for about $135 million in advance of the transfer tax increase. Also, after the end of the quarter, we purchased a newly developed property in Atlanta for about $79 million that is currently in lease-up. The property is located directly on a portion of the Atlanta beltline that is being improved and paved. The beltline is a desirable amenity to our demographic and has been a catalyst for economic growth and densification across the area. The property's economics benefit from various tax credits and when fully stabilized next year, we expect to attain a 6.6% acquisition cap rate. Removing the tax benefits, which will burn off over time, we see the stabilized fully taxed acquisition cap rate at 5.7%. We also love our basis in this property, which is at $288,000 per unit, and we see that as a 15% to 20% discount to current replacement costs. Alex Brackenridge, our Chief Investment Officer, is here with us to answer your questions on the transaction market. And with that, I'll turn the call over to Mike.

Thanks, Mark, and thanks to everyone for joining us today. This morning, I'm going to review key takeaways from our first quarter 2023 operating performance in our markets, along with same-store operating expenses. As Mark mentioned, we produced very good same-store revenue growth of 9.2% in the first quarter. These results were ahead of our expectations, primarily due to continuing improvement in delinquency along with continued healthy fundamentals in the business. Before I get into more details on these topics, I want to emphasize that as we sit here today, the early stages of the leasing season and its setup remain strong. With year-to-date pricing trend improvement just above 3.25%, which is where we would expect it to be at this point in the year and is also consistent with expectations underpinning guidance. During the quarter, we continued to see good demand and strong resident retention that produced low turnover, stable occupancy, and solid pricing power. Despite some recent negative job headlines, our average resident remains in great financial shape. With rent income ratios during the quarter for new residents continuing to hover around 20%. The resident lease breaks due to job loss and transfer activities to reduce rent, often early indicators of resident economic threats, remain below pre-pandemic levels and in line with seasonal expectations. A resilient labor market, along with a large number of young adults choosing the exciting attractive lifestyles our markets provide, along with the convenience and cost benefits of renting continues to result in application volumes that are on par with the same period last year and continue to grow as expected into the leasing season. Couple this with the favorable supply position and lack of single-family home ownership competition that Mark outlined, and we should be positioned for another good year. Results to date support the view we shared on our February earnings call that we expect pricing trends for this year to follow a normal, albeit slightly muted seasonal trajectory. Given the difficult comparison periods for 2022 for the back half of the year, along with the return to normal rent growth patterns, we expect that the first quarter will be our highest reported same-store revenue growth with more moderate but still above historical growth in subsequent quarters. While there may be some uncertainty about the economy, including increasing layoff announcements, as I said previously, we are not seeing this impact our day-to-day operations. While we acknowledge that we are generally a lagging indicator, so far so good as we head to our primary leasing season. Now let me spend a few minutes talking about our market performance. Let's start with the East Coast. New York and D.C. are both exceeding expectations, while Boston is in line. New York was by far the top performer for the first quarter with same-store revenue growth of over 19%. With very limited and isolated supply, the outperformance in this market is consistent across all submarkets. Occupancy is currently 97.5%, and all demand indicators continue to flash green, making this market the expected top performer for the year. Turning to D.C., performance has thus far been a pleasant surprise with the market continuing to absorb significant new supply while still delivering good revenue growth. Similar to New York, occupancy is strong, and so far, all submarkets remain resilient in the face of new supply. Now for the West Coast, Southern California continues to post good numbers. And most notably, we are starting to see improvement in delinquency, particularly in Los Angeles, which has the heaviest concentration. As the eviction moratorium expired, we are seeing more of our delinquent residents figuring out the best option that works for them, which is either paying rent or moving out. This activity started to pick up pace late in the first quarter, which was sooner than we expected and has continued into April. While these move-outs are pressuring physical occupancy, it will benefit our financial results later in the year as we have good demand in the market to replace these residents with new residents that will pay their rent. Our remaining two West Coast markets of San Francisco and Seattle have posted respectable quarter-over-quarter revenue growth with good demand, but pricing power remains less than desired, especially in the urban centers of both of these markets. The San Francisco market is performing in line with our expectations, which already assumed a slow recovery. Use of concessions, mostly in the downtown submarket, remains common along with limited pricing power. Meanwhile, the South Bay submarket is demonstrating signs of improving pricing power and stronger occupancy with less widespread concession use based on a combination of factors that includes a greater variety of stable employers who are committed to the area, coupled with just a better overall quality of life. Heading to Seattle, the overall market continues to demonstrate a lack of recovery, which wasn't completely unexpected, but is behind our forecast. Similar to Downtown San Francisco, Downtown Seattle lacks pricing power with concessions being used on over 70% of our applications. The East side, which we felt may hold up a little bit better, is still outperforming downtown, but is a little more challenging than we thought based on supply pressure, layoffs, and overall just less hiring in the submarket. Amazon's May 1 mandatory return to the office date has potential to be a catalyst for this market. Finally, in our expansion markets, which currently make up a little less than 5% of our same-store NOI, revenue performance has mostly been in line with our acquisition performance and guidance expectations. As we expected, we are being impacted by heavy new supply in Austin, Dallas, and Denver. Meanwhile, Atlanta remained strong with double-digit revenue growth for the quarter. Now moving to expenses. We reported same-store expense growth of 7.2% in the quarter, which was slightly above our expectations. We had always expected Q1 growth to be higher than our full-year guidance range, mostly because the growth during the first quarter of 2022 was so low, but also from pressure on a few specific items that outpaced positives in a few other expense categories. On the favorable side, we continue to benefit from good performance in real estate taxes and payroll, along with utilities, which were still elevated but lower than expected. On the unfavorable side, incremental costs in repairs and maintenance and other on-site costs and higher-than-anticipated insurance costs drove higher-than-expected first quarter same-store expense growth. For most of these costs, we had anticipated an increase but not quite to this degree. Elevated repairs and maintenance were in large part due to increased outsourcing in the quarter much of which stemmed from our own internal teams in California, focusing on the aftereffects of the severe rainstorms, which resulted in incremental outside vendor assistance. Higher legal and administrative costs related to faster progress in response to the expiration of the eviction moratorium, the benefit of which can be seen in our bad debt net. Insurance expenses were higher due to tougher conditions than the already challenging environment we assumed on the renewal of our property insurance policy, which was completed during the first quarter. Despite this pressure, we remain comfortable with our existing guidance range on the full-year same-store expense growth. At this point, we expect slower full-year growth in real estate tax and utilities than we initially expected to offset the overages experienced in other categories in the first quarter. Lastly, I want to spend a minute on our focus on innovation and the technology evolution of our platform. In 2023, we have a positive NOI impact of just over $10 million included in our guidance with about two-thirds of that coming on the expense side primarily in payroll and repair and maintenance. This benefit will mostly be realized in the second half of the year, which will contribute to lower expense growth for that period. On the revenue side, we will continue to focus on other income items like WiFi, parking, and pricing optimization. We will also leverage data analytics to create opportunities to expand our operating margins. Our vision is to augment pricing and renewal strategies by combining our growing data science capabilities with streamlined execution while delivering self-service solutions to our customers. We will continue to leverage our mobile platform to create opportunities to share on-site employees across multiple properties. With a fully centralized and mobile operating platform, we are in a strong position to create a seamless customer experience with a platform that continues to allow us to innovate, experiment, and rapidly scale what works across the portfolio. This uniquely positions our company to continue to create additional revenue streams while managing expenses to maintain and grow margins even in an inflationary climate. I want to give a shout-out for our amazing teams across our platform for their continued dedication to their residents and focus on delivering these terrific operating results. With that, we will turn the call over to the operator to begin the Q&A session. Thank you.

Just looking at your same-store revenue guidance, it looks like you're expecting roughly 4% growth for the rest of the year, maybe a bit higher if you're accounting to be better trends in bad debt. But just curious whether it's sort of the majority of the drop-off happens in 2Q and then sort of stabilizes? Or if the drop-off is a little bit more ratable through the year?

Bob mentioned that the decline is more evenly distributed throughout the year because the 2023 guidance is largely influenced by the events of 2022 rather than the business's core growth trajectory. They still expect a sequential leasing component, but starting in Q2 and extending into Q3, there will be challenging comparison periods from 2022. Therefore, Q1 will be the peak, followed by a steady but above-average rate of growth for the remainder of the year.

Got it. And then I think you said you expect the peak leasing season to play out as it normally would. But I also thought I heard you say that rent growth might be a bit more muted for its history. So just trying to tie those two statements together? I'm just trying to understand if market rents are sort of growing as they normally would during the peak leasing season.

Yes. Eric, this is Michael. So I think there's two factors. One, the way that the rents are moving, and I said, albeit a little bit muted, that's more indicative to when we think about normal rent patterns of pricing trends. We came into the year with our guidance expecting the sequential build. We just didn't think we were going to see kind of outsized momentum anywhere near the pace that we saw last year. And in terms of the setup right now, I guess I would just say the portfolio is sitting at 96.1% today. We've got great momentum. The blended rate for April is sitting right at 4%, you get the sequential build and pricing trend at 3.25%, which basically positions us right where we thought we would be heading into this peak leasing season.

Yes. Just to supplement that, Eric, it's Mark. It's the difference between guidance when we gave our guidance, we talked about the year being kind of like a normal year 2023, but maybe a little bit less of intra-period growth and what's going on so far this year. And so far this year, absolutely consistent with that expectation. So those two terms are being used to describe different things, guidance versus so far so good this year.

Bob, the first question is on real estate taxes. I know this year is faring well. Just be curious, as you stare out the next few years, are you seeing any early examples or hearing any chatter that cities need to tax apartments a little bit harder to fill the hole left by office and other commercial real estate sectors that are seeing impaired valuations?

Yes, I would say there hasn't been much discussion yet because we're really focused on 2023. To your point, John, 2023 is actually turning out better than we expected. We have the support of Prop 13 in California, which is beneficial. Looking ahead, we always face issues with revenue and budget gaps and how municipalities will find the necessary funds. Overall, we feel very positive about our current position in 2023. It’s still too early to predict what municipalities will do in 2024, what those revenue gaps will look like, and how they will address them. So, at this moment, I’d say it’s too early to determine for 2024.

Okay. And then the last one for me. Michael, just curious if you could expand on the softness in pricing power you're seeing in Denver and your expansion markets. I know it's a small sample size of properties, but just curious how you're seeing fundamentals on the ground there relative to some softer West Coast markets.

Yes. I mean I think I would carve them out a little bit different. So Denver, you clearly have supply pressure sitting on top of us in the downtown submarket, but yet the suburban portfolios are actually doing pretty well. When we go into the Texas markets, we clearly are seeing just more concessions being used. You have demand, right? But when you look at across all of these expansion markets, any of the reported data, including our own portfolio, which again is a pretty small subset. It's less than 5% of the company's NOI. The occupancies tend to be running lower in these kind of expansion markets for us. The one exception I would say for us is Atlanta, seems to be doing a little bit better than even what we thought coming into the year. We just don't have quite as much supply pressure on us. So we see a little bit better pricing power than what we thought.

Okay. Would you expect Denver and Texas NOI growth to lag or outpace your legacy footprint over the next year or two?

I believe our coastal markets are well positioned not only for this year but for the long term, given the demand drivers and housing costs in those areas, which have enabled them to perform strongly. As we entered the Sunbelt markets, we had a clear understanding of what to anticipate for the initial years. The positive aspect for us is that most of our acquisitions are performing slightly better than expected and are aligned with our projections for this year.

Just a couple of follow-ups on the topline growth. Michael, I know you don't necessarily guide to leasing spreads, new renewals, or blend. But just any thoughts on kind of where our spreads might be for the year? And it certainly sounded like bad debt is trending better. I realize it might be a little too early, but how much of a tailwind could that be if things continue sort of on the path they're on today?

Yes. Well, maybe I'll start, and Bob, you can kind of build a little bit on the bad debt. So in terms of just the leasing spreads and kind of guide, a lot of that had to do with where we were with our embedded growth, where we were with loss to lease, capturing the loss to lease. And I think I said, right, as we were working through the call back in February, we expected roughly 2%, 2.25% on new lease change for the full year, renewals right around 5% and blended is right around 4% for the full year. When you look at where we sit today, we're set up going into our peak leasing season, where, again, we're going to do 60% of the transaction. We're set up right where we thought we would be relative to the guidance. We have a little bit of pressure that we're doing more concessions in those downtown submarkets in Seattle and San Francisco. But that's kind of being offset by some of the outperformance we're seeing in the East Coast markets.

Yes. And Steve, on the bad debt side, just to fill out the question, we certainly did better in the first quarter. We expected the first quarter to sequentially be equivalent, excluding governmental rental assistance to the fourth quarter, and we're a couple of million dollars better. And that equates to a little bit under 10 basis points on a full year basis for revenue. That trajectory is continuing into April, so it's still early. And so we would expect to perform better overall. But keep in mind, the 90 basis points assume that we're having improvement. So it's just how much that improvement is better relative to what we embedded in guidance, but we do think there's potential upside there. To the extent we continue to see that same pace as we play out through April into May and the rest of the year.

And Steve, it's Mark. Just to help you with your mod a little. The governmental payments are really key to the volatility because in the first quarter of '22, we got about $9.5 million of governmental rental relief. In the second quarter, we got almost $15 million in 2022. So we need to make up that difference in terms of improved delinquency performance in the second quarter. And then you drop all the way down to a little below $6 million in the third quarter and then only $2 million in the fourth quarter of 2022. So you can see that those rental relief payments are key to understanding. So the delinquency, we think, will improve the whole year, but there could be quarters where bad debt net because it's being compared to a number with so much governmental rental relief in it is just not as good as it appears to be, and then the next quarter, you'll see it even back out.

Okay. My second question is about capital deployment. You mentioned that acquisitions and dispositions will balance out to be net zero. I'm interested in any distress you're observing in the marketplace and the potential opportunities that may arise from it. Reflecting on the period after the financial crisis, you were proactive in purchasing distressed properties like broken condos. Are you beginning to notice similar situations emerging now? Additionally, are you experiencing a significant slowdown in new projects or planned starts among competitors and merchant builders?

Transaction volume has significantly decreased, with closings down by over 60 percent nationwide, and this decline is consistent across various markets. There's much less activity overall, but those sellers who are moving forward recognize that cap rates are currently between 5 percent and 5.25 percent, which motivates them to engage in transactions. The sellers include private REITs that need to fulfill redemption requests, which is driving some activity; merchant builders who are not financially positioned to hold property long-term; and floating rate borrowers facing expiring caps they cannot cover. While there are opportunities, the pace has been slow. However, I anticipate that these three groups will likely see increased activity in the next six months, and we are eager to invest more capital as these chances arise. As we've previously noted, we've capitalized on market dislocations, and we’re prepared to do so again. Meanwhile, we are actively buying and selling properties opportunistically. In terms of new starts, they are sharply reduced. We initially expected about 110,000 starts in our markets this year, but that number now appears to be closer to half, and I expect even more planned starts will fall off as the year progresses. It's challenging to make developments work with cap rates at 5 to 5.25 percent, as a yield of around 6 percent is necessary. Despite costs not rising as steeply as they did a year ago, they are still increasing, and financing costs remain high, making it difficult to underwrite new developments. Thus, we anticipate that even more development deals will be withdrawn.

Yes. And Steve, it's Mark. Just to supplement that. I mean all this supply in the Sunbelt markets, Denver, places we'd like more long-term exposure, but we recognize that it's going to be a tough couple of years, that's an opportunity for us. I mean we're going to sell low performing assets in the coastal markets are assets where we have an over concentration in the submarket and kind of trade in and accepting that there might be a little near-term decline and putting it in the pro forma. But as you said, I mean, I'm very hopeful. I think we're in a really good spot where our numbers are going to show well comparatively in the coastal markets, we'll exercise our usual good expense control, and then we'll turn around and deploy capital. And Alex got a big team, a very capable, experienced people out there ready to buy. So I think we'll be active as soon as those opportunities are more substantial.

This is Chandni Luthra, Goldman. Could you guys help us understand what the collections process will look like from here? And what the magnitude and timing of recovery from past accounts could shape up to be. Like do you have to go to courts to get rents from tenants who are perhaps no longer active with you or you're just evicting now? And what kind of experience are folks witnessing with the court processes these days?

Yes. Chandni, it's Michael. So we clearly have evictions filed right now with the courts. You are seeing a little bit of momentum pick up. I would tell you across the country right now, it feels like most of this stuff is set up at about a six-month timeframe from the time you file to the time you actually get to your proceeding with a court date. But really what's happening on the collections front is twofold. So one, you have individuals that you are filing on that have a lot of past balances with you. But if they start paying you current month's rent, those past balances are somewhat protected still to date and go out into like '24. I think maybe some of them even stretch into '25. So you have a little bit of a longer tail to go after the previous balances to collect. But we are starting to see this resident behavior where they're making decisions either to move out in front of any kind of eviction proceeding or actually just start paying us their current month's rent knowing that we're ultimately going to have to come to terms with what happens with this previous balance. In areas where those balances are not protected, we have sent much of that over to the collection agencies and let collection agencies start working. That's a slow process because typically, what you need to see is a lifestyle change. You need to see somebody needing to go buy a car or a home or some other thing that then causes them to come to terms that they got to clean up that balance. So I think what you should expect to see is the court system is going to continue to move at this pace of, call it, the six-month window. And you'll see us gradually just start chipping away at this delinquency and gradually start to improve the recovery of this past balance.

So then can there be a reversal to some write-offs or some reserves that you've taken in the past as we sort of think about the magnitude going forward?

Yes, certainly. Since all of those historical balances that Michael just described have been written off, any collections would appear as a current period gain, offsetting bad debt. These collections would be reflected in our financials. However, as Michael mentioned, we do not expect to have significantly incorporated that into our overall projections, and we anticipate that it will lag.

Got it. Very helpful. And a follow-up question is on L.A. mansion tax. So obviously, you guys sold a property ahead of that sort of tax change on April 1. But as we think about the composition of your current portfolio and what you've laid out in the past that you want basically 33% of your portfolio. It's sitting in sort of each of the coasts and then 33 in the Sunbelt. How do you think about the impact from this policy change to affect how you think about sort of selling properties in L.A. going forward and you're reaching towards that optimal mix of geography that you've laid out in the past?

It certainly has an impact. The rate increase from 1.5% to 5.5% in Los Angeles was meant to generate funding for cities to develop affordable housing, but it may have had the opposite effect, resulting in fewer transactions and lower revenue collection. This could lead to a reduction of the rate in the future, as it seems to lack a solid foundation as public policy. In the meantime, there are alternative properties in California that are not subject to this tax that we can consider for transactions. Additionally, forming joint ventures could help us reduce exposure in a market like Los Angeles, where selling a property might not be the best option.

Yes. Chandni, it's Mark. To add to Alex's response, this certainly affects how we strategically achieve our goal of reducing that exposure. However, we remain committed to that objective and will find various ways to accomplish it. For instance, we might consider selling properties in Ventura County or areas outside of San Francisco and Los Angeles, where we have plenty of options available. We have other strategies we can implement, and we will approach this carefully.

On the concessions, have they gotten better or worse as the year has progressed? And is the gap between markets? Is it getting lighter or narrower?

Yes, this is Michael. Currently, our concessions are primarily focused in urban areas like Seattle and San Francisco. When we entered January, I mentioned during our fourth quarter call that demand was improving, and we began to see concessions decreasing in most markets. This trend has largely continued, with most markets moving away from concessions. However, around mid-February into March, we did notice a rise in concession usage in the downtown areas of Seattle and San Francisco, and that has remained steady. In recent weeks, there are signs of hope as demand and application volume are increasing in those regions, which may allow us to start reducing concessions again. However, overall, they have remained stable for the last couple of months.

That's very helpful. My second question is about the transaction market. Does the 5.7% stabilized cap rate on the Atlanta deal indicate a motivated seller or reflect the actual market conditions? Is this the direction for future deals? Additionally, are you observing a reopening of the transaction market now that you're anticipating a modest level of activity this year?

Michael, this is Alex. The 5.7% really isn't a reflection of market. It's more a reflection of the property being in lease-up right now. So we're taking it over the middle of a lease-up and we're going to finish it off. So we're getting compensated for doing that. So I would say, as I said earlier on the call, the rates are somewhere between 5% and 5.25% for a typical deal. And so yes, we're getting a little bit of a boost there because we're taking on a little bit of a lease-up, but that's not an indication of market. And then in terms of other opportunities, I mean, we're obviously always looking for other opportunities, and it has been pretty slow though so far.

So I want to go back to the topic of job losses. And I know you said that you're really not seeing that much of an impact. But are there any indications yet of job losses of residents impacting expected turnover? I mean, is there anything you're learning now as you're sending renewal notices out for the spring? And I guess if there's any differentiation you're seeing on this topic between tech-heavy markets like San Francisco, Bay Area, Seattle, where there has been more high-profile job losses announced versus other markets of yours.

Yes, Nick, it's Mark. I'm going to start, and Michael is going to supplement with some market specifics. I mean, again, when we look at the general economics, professional and business services, for example, still has positive job growth. And that's an area where we do have a lot of our residents employed. Finance and insurance kind of flat, information service is certainly down but not down that dramatically, and the unemployment rate remains very low, especially for the college educated. So I guess, I just want to point out again on the macro. The macro picture is very good for our company and for the markets we sit in, not just in the long term, but in the near term in the here and now. So certainly, there can be another shoe that drops, but the current numbers we're all seeing are certainly declined from the COVID recovery numbers, but they're still pretty good, and people losing jobs are finding them. And that's been the experience that looks to me like in the general economy. And I'll let Michael comment on what he's seeing in the rest of our portfolio.

Yes. And I think, one, you got to put into context that the reported turnover for the first quarter was really low. I mean it's not quite record little, but it's really low number. So the absolute number of move-outs that we're having is clearly below any kind of historical norms. And when we start drilling in and we look at those reasons for move-out, we're really not seeing anything indicative of changes. You're not seeing kind of job loss or job change pick up anything different than what you would expect for the first quarter of any given year. Specific into like a Seattle or San Francisco where you saw kind of more of the headlines and we said on the last call, we thought a lot of those layoffs were being dispersed across the country, not just heavily concentrated in those markets. I think what you've seen, we have not seen anybody really give us keys telling us they're breaking the lease or they're not renewing because they were laid off. What we do notice in those two markets is the in-migration, meaning what percent of brand new residents are coming to us from outside of that MSA. The in-migration in those two areas is less than what you otherwise would have expected, which I think makes sense given not only the layoffs, but more importantly, like the hiring freezes that have been taking place. So you're just not seeing them draw into the market like they used to.

That's very helpful. My second question is about Los Angeles. It seems that there isn't much supply in the market, except for Downtown. You mentioned dealing with delinquent units moving forward, and it appears that this is currently affecting occupancy or will do so in the future. I'm curious about how you feel about this situation. It seems like a shadow supply scenario where you and other landlords in L.A. are finally getting tenants to leave, and I wonder if you are confident that there is enough demand to replace those departing tenants.

Yes, it's Mark, and Nick will start, with Michael possibly adding later. I'll begin by discussing the employment base of our residents in the market. We've analyzed the major tech companies and discovered that only about 3% of our residents are employed by these big firms in Los Angeles. This indicates we have very low exposure to the tech sector within the diverse L.A. economy. In fact, L.A. currently appears to be performing better than the San Francisco Bay Area and Seattle, where a larger percentage of our residents are employed by tech companies, which likely have a more significant local economic impact. We essentially have two vacant buildings in Los Angeles that we expect to fill as they enter the same-store market this year, indicating strong demand. Examining the local economy shows it aligns well with our portfolio, which includes businesses in content creation and other sectors, some of which may face challenges. However, the disproportionate tech layoffs are not specific to Los Angeles; they are a nationwide trend. If there is any concentration of such layoffs, it is more prominent in San Francisco and Seattle than in L.A.

Yes, No, I wasn't specifically really wondering about tech in L.A. I just meant the issue of delinquent units coming back to market for you and other landlords, right, as you're getting people out and rates almost a supply issue in the market.

Yes, but the supply is being fulfilled by individuals who are employed. That was the main point of my comment. Many of these people work in diverse industries, so it’s not as if everyone is losing their job in Los Angeles. The employment situation there is quite strong. There is a significant demand for housing, and Michael observes positive demand numbers regarding applications and similar metrics. This is the basis of our confidence—a diversified economy in which, as I mentioned, we and others are effectively bringing empty buildings to the market. I am confident that the demand will persist based on our observations and the employment composition in the area.

So back to the bad debt question. If you were to sort of magically flip a switch and you'd be back to 40 basis points bad debt like you'd see normally, would that recovery be less than the rent relief number that you gathered last year about $32 million. I'm wondering how much the rent relief overcompensated you or maybe undercompensated you for the bad debt that you took on? I'm just trying to understand that math.

Yes, you are correct that the governmental rental relief in 2022 was $32 million. To return to a normal bad debt level, you would need to reach about 40 to 50 basis points, which translates to roughly $1 million in bad debt per month. In reviewing the disclosure for Q1, we were averaging around that amount in January and February. So, if you consider a $3 million difference over 12 months, that would exceed the governmental rental relief figure. However, if we could immediately return to that $1 million per month level, we would be moving in the right direction. Unfortunately, that has not happened yet, but we remain optimistic that it will occur soon, as it would be beneficial for growth. Does that clarify things, Rich?

Yes, yes. That's great. And then my second question is, Michael, I think you mentioned you're running a 3.25% market rent growth at this point. If memory serves, I think you said your guidance presumed 3% market rent growth for 2023. And I know you guys are trying to be careful about overpromising having not updated guidance yet, and that's coming later. But it seems to me you're ahead of the schedule from a market rent growth, particularly at this point in the year, shouldn't 3.25% barring a major disruption from some sort of recession. Shouldn't that really be a maybe a significantly bigger number as you get into the heavy leasing season and maybe that will be another driving force to you upticking your guidance, just a better market rent growth trajectory than you expected? If you could comment on that, please.

Yes. I mean I think, Rich, you can look at that and say the 3.25% sequential build from January 1 is about where we peg where we should be of what a normal cycle is. The 3% for the full year, remember, you got to blend in what happens due in that first quarter and the fourth quarter. So when you put it all into the blender, could you be up at a 4%, 4.5% in the peak leasing season? Sure. And you still could average to the 3% for the full year. So I think I would just look at the trajectory that we see the sequential build of application volume and the sequential build of this net effective pricing trend is basically resulting in us being right on top of where we thought we would be from the blended rate growth, which is what manifests itself to the P&L.

Circling back on bad debt. So it was 1.7% of revenue in the first quarter, excluding the assistance payments. But you obviously mentioned that it improved in March and April. So I'm curious if you can just compare the whatever leading-edge figure you have to that 1.7%.

Yes. The 1.7% would likely be around 20 basis points better, possibly a little more, maybe 30.

Okay. Perfect. And then going back to the next question. You gave the 3% employed by Big Tech in LA figure. I'm curious if you have the figures handy for the Bay Area and for Seattle and if there are any other markets like, I don't know, New York that have a larger number too.

Yes. I've got some numbers for you. I don't have the East Coast, but the Bay Area is about 14%. And Seattle is about 30%.

A couple for me. I guess first question is can you provide the new and renewal numbers for March specifically? And where are you sending out renewal rates today for May? And what's the loss to lease in the portfolio today?

Yes. Okay. So let me just start with loss to lease. So we snapshot that on the 15th of every month. By April 15, we were at 3.4%, which basically compares to, I think we are 1.5% on January 15 again, trending in line with where you would have expected it to be. In terms of like the March, April, I will tell you both new lease and renewals are basically flat when you look at it sequentially. You look at the blended rate, and you can see that we're moving from a 3.8% in March to a 4.0% expected in April. So again, right in line with what we would think based on the sequential build heading into the peak leasing season. If I look forward to think about transactions that are on the books for May, we have renewals on the books, we've got some expected move-ins for leases that just haven't started yet. Those are also trending in line with what you would expect, which you're starting to see that improvement kick into gear on new lease change and you got that consistency on renewal. In terms of the forward view on renewals, we've got quotes sitting out there for the next 90 days. I think I said in the prepared remarks, we really do expect a lot of consistency here. We're renewing about 55% to 60%. We don't see any reason not to expect that in the next several months going forward. We're achieving somewhere in this 5.5% to 6% achieved renewal rate increase each month. We don't see a significant change there. We have a lot of confidence in this renewal process. My expectation is we turn to the corner to the second half of the year. We do expect to see a little bit of moderation on renewals, probably more like in that 4% to 5% range, which is just a function of the comp period and what we see as we return to more of a normal pricing trend.

Very helpful. Another question on, I guess, some of the charges in the quarter. It sounds like the property, legal and admin charges are tied to the eviction process, but can you comment on the other charges, the $5 million environment settlement and the $2 million data transformation project and if we should expect those in future quarters, too.

And I'll start. Bob will help here. The data transformation project is something we're working on. We mentioned this before in prior calls. It's a big data analytics project with an outside vendor. You can expect a couple of million dollars more there and then it should be at an end. All of our internal employee hires and all that, that's in our normal overhead load. So continuing costs are in the run rate of the business. The sort of discrete one-time sort of events are separately categorized, as we said on Page 24 of the release. And I don't know, Bob, if you want to comment on the risk.

Yes. The other components are adjustments to various kind of regular course litigation reserves that we made during the quarter as we got more information and adjusted our outlook. So those are all case-by-case dependent and depend on facts and circumstances at the moment.

Got it. Got it. And one more question on cost. Is there any part of the property damage from the cost in California at the rainstorms. Any part of that recoverable perhaps from insurance?

No, this all falls, it's Mark, below our deductible handouts. So this is all covered by us.

So two questions. First, on the insurance, you guys mentioned that and we've heard from others that insurance has become more challenging, expensive, especially in like Florida and Texas. So two parts to this. In your experience, do you expect that the insurance provider will rapidly adjust new capital come in and that this won't really be a problem? Or do you think that it's actually could give you some opportunities to buy deals where the existing owner can't get insurance on their property and therefore, provides you guys with some opportunity to buy some of those in some of the expansion markets.

It's Mark. That's a great question. The insurance market usually reacts when costs rise as much as capacity has increased. However, we're not seeing that yet. The difference now is that fixed income options are becoming more attractive. Reinsurers have various investment choices, and the fixed income market, along with current undervalued equities, may appeal more to them. This creates more competition for reinsurance investments. During this off-season, as we've just renewed our property program, we're actively seeking additional capacity elsewhere. Given the severity of this recent windstorm risk, I'm uncertain about the availability of extra capacity for that kind of risk. While EQR itself doesn't have Florida exposure and is not affected by that risk, it has had repercussions in other areas of the market, with many facing much larger price increases than our roughly 20% rise on our property program. Normally, I would expect the market to expand, but I'm curious about how quickly that will happen, considering the ongoing concerns about windstorms and the alternative investment options available to insurers and reinsurers. I hope that provides some clarity.

The second question pertains to the tax arrangement you made in Atlanta. You've mentioned before how the 421a tax incentives in New York affected your earnings when they phased out. Do you anticipate a similar situation in Atlanta, and are you planning to pursue more tax deals in general, or will you approach them on a case-by-case basis?

Yes, that's a great question. We certainly aim to avoid repeating situations like that. It's important to examine the internal rate of return (IRR) in the deal. Starting with elevated cash flows, we achieve a slightly better cap rate because in the future, we'll face higher taxes. So by years 8 or 9, taxes will increase, and we'll see some flattening effect. However, this won't be on the same scale as the 421a program. We keep track of these situations, ensuring no single year becomes overburdened, so we don't feel like we're compromising one area at the expense of another, as long as we're confident in our IRR. Our overall IRR allows for upfront payments in exchange for cash flow stability expected 8 to 10 years down the line. We believe this approach is viable, and we plan to engage in deals like this. Most of our new projects will include similar elements. Additionally, we'll consider some older properties. Alex and his team are evaluating those opportunities as well. However, keep in mind that with older properties, significant capital investments are often necessary, which can impact the IRR. Therefore, we'll assess the IRR and use it as a benchmark.

And in some cases, Alex, this is Alex. As the abatement burns off or when it burns off, some of the units might go to market. So you got to pick up there, too. So it's not all downside.

Looking at the broader picture regarding your comments on potential assets available for investment, your leverage decreased in the last quarter. It seems that this year you intend to balance funding for acquisitions with asset sales. If you're looking to allocate additional capital beyond asset sales due to the abundance of opportunities, can you discuss the sources of that capital? Are there discussions happening with potential joint venture partners? If so, what type of capital are they interested in? Additionally, what are your thoughts on leverage, and how do you view your current liquidity position for investments?

So first off, there isn't such a significant opportunity out there that it's worth using our precious leverage capacity or issuing a bunch of equity below what we think the intrinsic worth of the business is. So I haven't been presented yet with that issue. Talking to the Board, we're certainly willing to take leverage up. We have a stated leverage policy, Bob?

By 5 to 6x net debt to EBITDA.

Yes. And we're approaching 3x so into the 3x. So I would say to you that there are several billion dollars of capacity in the system to buy great assets at great prices using debt when and if we see those opportunities, and we're looking hard for those. We don't see them yet. But I'd start with debt. But certainly, the JV market is another source of capital. We're very aware of that. The private market continues to love the apartment industry, even if the public markets are being buffeted a little bit by some of these crosswinds. So we're out there looking for other sources of capital for sure.

And can you talk about the returns that private market is looking for. Are those sources of capital are looking for? How are they underwriting apartments today? And what kind of trends are they looking for?

Generally, they're looking for the same kind of return, a cap rate of around 5% to 5.25%, depending on the assets in the transactions market.

Yes. Regarding capital recycling and the updated guidance, I understand the strategy of acquiring assets at higher cap rates and selling them at lower rates to create value. However, with your implied cap rate around 6% right now, I noticed your earlier comments on the slowdown in development starts, which typically impacts future growth. How do you view the acquisition side in light of this? Do you still expect challenges in making acquisitions pencil out for a while? Unless asset sales match up with acquisitions, do you foresee limited activity on that front?

It's really about matching sales and acquisitions. We keep track of that, ensuring we don't get ahead of ourselves on either side, and just align them. It's a neutral approach, but we believe we are achieving our goal of diversifying our footprint.

And the focus from an acquisition perspective remains in your newer markets rather than some of the more established markets.

Quiet primarily, but also in the sub of our established markets. And as we've talked about, being opportunistic, there may be opportunities that come up. There's more dislocation that are appealing anywhere and we would chase those.

I'm going to divide this into two parts because there’s the challenge of converting large office buildings with expansive floor plates in urban areas. Properties on LaSalle Street in Chicago or in Midtown Manhattan, for instance, typically span an entire block and often have limited windows relative to their total space, along with few plumbing fixtures. Engineering firms in Boston have done some work on these types of buildings, but there are not many large buildings suitable for repositioning. They might be feasible if the original building is demolished, but repurposing them will be difficult. In suburban areas, such as the Bay Area or suburban Washington, it’s common to tear down an office park and construct apartments instead. We’ve participated in those types of projects, but they differ entirely since no building is being reused. Reusing an office building in an urban setting is challenging due to the necessity for plumbing fixtures in the units and the need for windows, which larger office buildings generally lack. However, as urban property owners, we desire to see central business districts thrive. These areas contribute taxes that support public transit and safety, and we aim to reposition them. This process will be more time-consuming and likely more expensive than some may anticipate. I believe it’s unrealistic to expect that a relatively new office building can be effortlessly transformed into an attractive apartment complex in major urban centers like Manhattan or Los Angeles. Therefore, we will take a cautious approach, as urban repositioning is unlikely for us at this time.

In New York, particularly downtown, there was significant activity driven by a now-expired tax abatement aimed at facilitating conversions. The 421g program was specifically designed to encourage these conversions. However, this process is not straightforward and generally requires support from public policy.

I just wanted to touch base on the new lease change in April relative to 1Q. It looks like it kind of stepped up 30 basis points. How does that compare to kind of the typical acceleration in April versus 1Q?

I don't know if I looked historically back, I will tell you it's sitting right on top of what we modeled at the beginning of the year, which is what we would say more like a 2019, 2018 kind of curve and expectation. Some of this just has to do with the timing of who moved out? What was their previous lease? So when I look at the 30 basis points growth, I would just tell you any time you look at these statistics or these metrics on such a short time period of time, it does create some volatility with it. So we tend to look at this over the longer stretch. And right now, I've said this a couple of that, we're sitting right where we kind of modeled for the year and write what we would expect based on just the normal sequential build.

Okay. It sounds like concessions use picked up in March and April in Yale in San Francisco. If you stripped out those two markets, how is kind of new lease rate trending?

I think the impact on the overall portfolio was like 20 or 30 basis points on the net effective, like new lease change. So if you just pulled out those two markets with the heavy concession use, I think that was what the impact was.

All right. Well, thank you all for your time on the call today and for your interest in Equity Residential. Good day.