UDR Inc (UDR) — Q4 2017 Earnings Call Transcript

Greetings, and welcome to the UDR fourth quarter 2017 earnings call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Vice President, Chris Van Ens. Thank you, Mr. Van Ens, you may begin.

Thank you, Chris, and good afternoon, everyone, and welcome to UDR’s Fourth Quarter 2017 Conference Call. On the call with me today are Jerry Davis, Chief Operating Officer; and Joe Fisher, Chief Financial Officer, who will discuss our results; as well as senior officers, Warren Troupe and Harry Alcock, who will be available during the Q&A portion of the call. I will address three topics today, first a macro outlook for 2018 and beyond, how do UDR strategies’ differentiating characteristics fit into this outlook and finally a quick review of 2017. First, our high-level demand assumptions for 2018 include a general economic outlook as measured by consensus GDP growth of 2.6%, the second highest level over the past decade, creating a growing tailwind. The continuation of solid job growth and accelerating wage growth as full employment is upon us. Regarding tax reform, the general view is it creates a bias towards vendor ship as well as a positive impact on corporate earnings and our residence take home pay will increase. We’re taking a wait-and-see approach, therefore is not explicitly factored into our guidance. And slowly improving single-family housing market but with minimal changes to the overall home ownership. Potential headwinds include elevated new supply and higher interest rates both into the curve. Taken together, these macro drivers should result in a relatively stable 2018 apartment environment with our pricing power and occupancy expected to be similar to that of 2017. Beyond 2018, we’re more optimistic on a macro outlook for our business as global and U.S. economies are enjoying broad-based growth after years of monetary easing and now tax reform. As multifamily demand typically echoes the broader economy, we should continue to see healthy demand coupled with 2019 apartment deliveries that are expected to decline. All in all, a positive set of facts but too early to call 2019, although UDR will benefit from an improving NOI contribution from our recent development completions which totaled approximately $500 million in capital invested. Moving on, we just continued publishing our two-year outlook, given our stable outlook. A consistent strategic direction that we’ve executed well upon over the last five years, our ongoing best-in-class disclosure and both solicited and unsolicited feedback from our shareholder base. Moving forward, we will continue to openly discuss our strategic direction with market participants. Next, the strategies we intend to employ throughout UDR's primary business areas in the year ahead look fairly similar to those employed since 2013, because they work and include first our best-in-class operations, which will continue to be driven by strong blocking and tackling and our innovative technology-driven initiatives that consistently boost our run rate results. We were the top same-store growth performer in 2017 and expect to again be that in 2018. Second, we prudently allocated capital throughout 2017 and will continue to do so in 2018. Our developer capital program is accretive to our bottom line and we will continue to look for opportunities while remaining disciplined in our underwriting. Our development pipeline will likely shrink in 2018 due to the difficulty of hitting return requirements on new projects. But we will continue to look for accretive opportunities to backfill our pipeline. While our third-party forecast called for interest rates to increase in 2018, we had minimal refinancing exposure due to the significant balance sheet activities we completed throughout 2017. And last, our diversified portfolio, by both geography and price point, should continue to serve us well in 2018 and beyond. Let me close by saying that as we look back on 2017, we executed our growth plan well, which resulted in two same-store and FFO guidance raises, and we have performed well for our shareholders. A special thanks to all our UDR associates for your strong blocking and tackling in operations, disciplined capital allocation, and continued willingness to actively innovate across all aspects of our business. With that, I’ll turn the call over to Jerry to address operations.

Thanks, Tom, and good afternoon, everyone. I’m pleased to announce another quarter of strong operating results. Year-over-year, fourth quarter same-store revenue and NOI growth were 3.1%. After including pro rata same-store JV communities, which were urban A+ products, revenue and NOI growth were 2.8%. Accordingly, results were driven by solid blended lease rate growth of 1.9%, a robust top-line contribution from our long-life operational initiatives, stable occupancy of 96.8%, annualized turnover that was 40 basis points lower year-over-year, and a continued objective to drive down expense growth wherever possible. Full-year 2017 same-store revenue and NOI growth were 3.7% and 3.8%, respectively, and driven by factors similar to those that contributed to our strong quarterly results. A special thank you to all of our associates in the field and the corporate office for continuing to maximize our top line growth while also limiting controllable expense growth to under 2% in 2017. Moving on. We saw minimal pressure from move-outs to home purchases or rent increase, at 14% and 5% of reasons for move-out during the fourth quarter. Likewise, net bad debt remains low, consistent with previous quarters. Next, the primary 2018 macroeconomic assumptions underpinning our same-store guidance include national job growth of approximately 150,000 per month, with wage growth averaging 3% to 3.5%. These are set against elevated multifamily completions in many of our markets due to supply slipping from 2017 to 2018. I would note further delivery slippage throughout 2018 due to construction labor shortages remains a wild card. 2018 UDR-specific assumptions are as follows. Overall, pricing power in the form of blended lease rate growth is expected to be relatively comparable to what we saw in 2017. Occupancy is forecasted to remain in the high 96% range. Other income should continue to grow at an outsized rate versus rental rate growth, perhaps not as strongly as we saw in 2017. Controllable expense growth will remain in check due to efficiency initiatives but real estate taxes will continue to provide pressure, given our 421 burn-offs in New York and higher valuations across various markets. B quality and suburban properties should generally continue to outperform A quality and urban assets, and same-store community addition for the full year will positively impact our revenue growth by 10 to 15 basis points, expenses by 15 to 20 basis points, and NOI by 20 to 25 basis points. Taken together, we are expecting same-store revenue, expense, and NOI growth to each be 2.5% to 3.5% in 2018. Holistically, we anticipate that our 2018 operating strategy will continue to favor occupancy over rate growth as apartment fundamentals are expected to bump along the trough. These are improving, nor meaningfully worsening throughout the year. Importantly, we anticipate blended year-over-year lease rate growth to crossover versus last year sometime in the first quarter. Regarding our markets, those expected to grow same-store revenue and rate above the high end of our 2.5% to 3.5% portfolio growth include Seattle, Los Angeles, the Florida markets, and Monterey. These markets represent 26% of forecast 2018 NOI. Washington DC, Orange County, San Francisco, Boston, Nashville, Dallas, and other small markets that represent approximately 63% of forecast NOI are expected to be in line with the range. And New York and Austin, which represent approximately 11% of forecast NOI, are expected to generate growth below the low end of the range. Moving on, our development pipeline in aggregate continues to generate lease rates and leasing velocities in line with original expectations. In our $350 million Pacific City development in Huntington Beach, what we have delivered and leased is achieving strong rental rates, but past construction delays continue to negatively impact our velocity given the project's high-end clientele. Pacific City will be a game-changing asset in Orange County once complete but will be a drag on our 2018 results versus previous expectations. The 345 Harrison project, our $367 million project in Boston, we recently opened our leasing office and are around 6% preleased. 345 and our JV developments remain largely on budget and on schedule with a notable positive exception of our west property. This community is leased up at a much quicker pace than underwritten and has raised rents three times to date. Community-specific quarter-end lease-up statistics are available in attachment 9 on our supplement. Last, I would again like to thank all of our associates in the field and at corporate for making 2017 another successful year for the company. Here’s to a successful 2018. With that, I’ll turn it over to Joe.

Thanks, Jerry. The topics I will cover today include our fourth quarter results and forward guidance, a transactions update, and a balance sheet and capital markets update. Our fourth quarter and full-year earnings results came in at the midpoints of our previously provided guidance ranges. FFO adjusted and AFFO per share were $0.48 and $0.42 for the quarter, and $1.87 and $1.72 for the full year. 2017 AFFO was up $0.09 or 5.5% versus 2016, driven by our strong operating platform which produced robust NOI growth as well as our disciplined capital deployment decisions. Next, I’ll provide several high-level comments related to our 2018 guidance, the details of which can be found on attachment 15 of our supplement. Full-year 2018 FFO as adjusted per share guidance is $1.91 to $1.95 and AFFO is $1.76 to $1.80 respectively. Primary drivers of the $0.06 of growth between our 2017 FFO as adjusted of $1.87 and our 2018 $1.93 midpoint include a positive impact of approximately $0.07 from same-store, JV, and commercial operations, flat G&A year-over-year, a neutral impact from development and developer capital program investments after accounting for funding costs and the negative impact of approximately $0.01 from higher LIBOR and other non-core items. Additionally, the difference between our 2018 FFO as adjusted midpoint of $1.93 and $1.95 we provided in last year’s three-year strategic outlook is driven by the following: a positive impact of approximately $0.02 from developer capital program investments, high prepayment activity, and lower G&A, offset by a negative impact of approximately $0.02 from lower forecasted 2018 same-store and JV growth and a negative impact of approximately $0.02 from developmental delays. Moving on as Jerry indicated in his prepared remarks, our full-year 2018 same-store revenue, expense, and NOI growth guidance ranges are each 2.5% to 3.5%, with forecasted occupancy of 96.7 to 96.9. Regarding sources and uses, we have de minimis amounts of pre-financing that needs to be completed in 2018 and continue to focus on dispositions to fund our development and developer capital program. For the first quarter, our guidance ranges are $0.46 to $0.48 for FFO as adjusted and $0.44 to $0.46 for AFFO. Next, regarding transactions, during the quarter, we sold two fully owned communities, Vista Del Ray and Villas at Carlsbad located in Orange County and suburban San Diego for $69 million at a weighted average nominal cap rate of 5.4%. The communities were 50 years old on average. Subsequent to quarter-end, we entered into a contract to sell Pacific Shores, a 264-home community in Orange County for $90.5 million, subject to customary closing conditions. As we look into 2018 and beyond, we continue to favor investment in our fully owned development pipeline and developer capital program which had a quarter-end investment balance of $159 million and an effective yield in the mid-7% range. However, given the difficulty of finding economical land in many of our markets, it is likely the size of our development pipeline will continue to shrink for the foreseeable future. While it is our desire to add more land to the balance sheet, to restock our pipeline over time, we will remain disciplined as we underwrite prospective deals. Next, moving onto balance sheet and capital markets, during the quarter we issued $300 million of 10-year unsecured debt at a coupon of 3.5%. In conjunction with the issuance, we redeemed $300 million or 4.25% debt originally due June 1, 2018. At quarter-end, our liquidity as measured by cash and credit facility capital, net of the commercial paper balance, was $855 million; our financial leverage was 33.2% on un-depreciated book value, 24.3% on enterprise value, and 28.9% inclusive of joint ventures. Our net debt to EBITDA was 5.3 times, and inclusive of joint ventures was 6.4 times. Looking ahead, we remain comfortable with our credit metrics and don’t plan to actively lever up or down, although you will likely see our revolver balance drift lower throughout the year. With regard to the profile of our balance sheet, similar to our 2017 activity, we will continue to look for MPV-positive opportunities to improve our duration and increase the size of our unencumbered NOI pool. Finally, we declared a quarterly common dividend of $0.31 in the fourth quarter or $1.24 per share when annualized, and in conjunction with our release, we raised our 2018 annualized dividend to $1.29 per share, representing a 4% year-over-year increase and a yield of approximately 3.7%. With that I will open it up for Q&A.

Hi, good morning Jerry, you mentioned that you expect blended lease rates to turn a little bit positive early in the year, just curious what markets are predominantly driving that re-acceleration.

When we compare January of this year to January of last year, we see a slight improvement. We were at a negative 0.3% in January 2018, compared to a negative 0.7% in January 2017. About half of the markets are performing better with the new lease rates compared to last year, including Boston, DC, Seattle, San Francisco, the two Florida markets, and Salinas. Some markets are close, while others, like New York, are down year over year. In terms of renewal growth, January saw an increase of 4.9% on an effective basis, which is a slight decrease of 20 basis points from January of last year when it was 5.1%. Overall, we believe we have reached a turning point in January and February, and we do not expect a rapid increase in blended rate growth beyond last year's levels. Last year, the growth was consistently below the previous year, so we expect that blended rate growth for 2018 will be similar to 2017, which was in the mid twos. Additionally, the embedded rent earnings coming into this year were about 1.1%, approximately 30 to 40 basis points lower than what we had at the start of 2017.

That’s helpful and then you mentioned turnover was done, I think you said 40 basis points in 2017, I’m just curious how that stacks up historically with turnover and what are you assuming going forward from a turnover perspective?

We thought last year we had a lot of success in turnover again it was down 40 basis points in the fourth quarter at 41%. Full year was just under 50%, was 110 basis points, where in the last year I would remind you that we started this short-term furnished rental last year, which had a negative effect on turnover, so the numbers would have been even better if we had those 200 or so move outs related to those short-term rentals but as we look into 2018, we continue to listen to our customers, we continue to not be excessively aggressive on renewal rate increases and today we would be forecasting turnover to be roughly flat with what it was in 2017.

Just thinking about supply, what’s the level of conviction in any sense of what the decline may be from ‘18 into ‘19 that you guys are expecting at this point.

Juan, as we forecast out to ‘19, we had a couple of different data points to help triangulate as we think about it, but when we look at starts and permit activity that took place in 2017, obviously those were down around 10%. So, I think that gives you a good lead time when you think about typical construction timelines that we would expect 2019 to come about that launch. Also, obviously talked to our groups on the ground, trying to get a sense for what they see taking place and what they see as competitive supply going forward. And its conversations with the brighter market participants and the merchant builders and they continue to have difficulty, given the construction financing environment out there, to really get new starts going and get their capital lined up. So, I think we have a decent amount of conviction that it is going to trend down from ‘18 level, what will remain to the question is how much of ‘18 into ‘19, but we feel pretty good they will be coming down.

Great and then just on the same store revenues, what’s the main driver between the variance from bottom end to high end and what do you guys factoring with regards to concessions and if you could just give us an update on what you seen on a concessionary front.

Sure, Juan, this is Jerry. I guess to start with concessions on more of a historical basis. Our fourth quarter concessions were down 35% year-over-year and if you factor in gift card, which show up down our marketing cost those were down 71%. So, we’ve been utilizing concessions as well gift cards less than we did a year prior. We see concessions levels continuing to come down a bit in 2018 as we modeled out the year. You asked how do you get to the high end and low end of our guidance and our guidance runs from 2.5% to 3.5% with a mid-point of 3%. I guess first I’m going to walk you from our 3.7 reported in 2017 and we get down to 3. First, we don’t expect any addition to revenue growth from occupancy, we forecasted occupancy will be stable at high 96 range. So, you don’t have 20 basis points of growth like we did in 2017. Second, as I stated earlier, those embedded risks that we entered the year with were about 40 basis lower and what they were last year, so you don’t have that, that takes you down another 40 basis points and then other income, which was a major contributing factor to our outperformance of 2017, we’re not counting on it being quite as much of a benefit in 2018 as it was in 2017, so that’s probably 10 basis points less. So again, you go from the 3.7, you don’t get the 20 basis points of occupancy, you don’t have the 40 basis points of embedded rents and you lose 10 basis points compared to the prior year of other income growth, and it gets you to 3. Another way of looking at it to get to that midpoint is our blended rate growth both last year and this year we expect to be in that mid two range and then when you look at the contribution that we expect is outsized from other income we think it’s going to be somewhere in that 40 basis points to 70 basis points and that gets you to the 3%. So depending on how you like to come from it, that’s why this is a midpoint what gets us to the top end would really be outsized job growth that helps us push rents, but outsized wage growth which right now looks like it’s going to be about 3% for this year and if we have more success on other income items such as the short-term furnished rentals, as well as parking above what we have in our plan, that would get us to the high end; will get us to the low end 2.5 would be lower job growth in the expected, or rational pricing from some of this new supply that we are going to be competing with and if we are less successful on our other income initiatives.

Question on community larger markets D.C. and Orange County, obviously last year I think demand growth may be disappointed in Southern California overall coupled with some new supplies. It just seems like the new supplies may be kind of burning off to some degree at least in Orange County by the end of ‘18. Something you talk about demand growth in Orange County what you are seeing there and then I guess while you are on it, let’s talk about D.C. and what you are seeing in terms of private sector employment.

Orange County last year we felt some effects from supplies especially in locations like Huntington Beach and job growth that was probably the biggest culprit to our disappointment. We only had 13,000 jobs in 2017 down in OC compared to about 25,000 in 2016. Current projections that we’re getting from Moody’s as job growth in '18 should be back up to about 28,000. You are seeing a reduction in manufacturing jobs but an increase in white-collar jobs in Orange County, so again we’re expecting job growth to be about double what it was last year in Orange County. Supply is currently expected to be a hair higher than it was last year, this year, or in 2017 it was about 5,000 to 6,000 units and '18 is projected to be closer to 7,000. So, Orange County if the jobs comp should do comparable to what it did this year we are currently forecasting revenue as you look at Orange County to be in the below 3s. When you get over to D.C. the year started out with a sluggish job growth and it picked up measurably as the year progressed. What we feel like hurt us more in D.C. this past year was due supply down in the ballpark areas as well as on the southwest waterfront, a little bit of supply also in Noma, and even though we don’t have properties directly in those submarkets, we felt that most acutely in our Logan circle U Street area where during the fourth quarter we actually had revenue growth, it was negative 1.5%. So, within a district when you have a different neighborhood it is drawing down some of our resident base.

And then just quickly on the dispositions you made in the fourth quarter and under contract in 1Q '18 in Southern California can you talk about the sale cap rates on those? I suppose like some of these weren’t ROI CapEx opportunities management 50 years old kind of limits to what you can do that, would you shed some color there?

Drew, this is Harry. The sale cap rates were around 5, there is a top 13 effects for the buyers who have much lower cap rates, you are right these are 50 year old assets in sort of our analysis included the theory that capital flows into value-added product or extraordinary which from our perspective resulted in very good pricing more in the fact we thought we were being paid for any potential value add that we could have put into the property. I mean if you just look at price per unit which I think are sort of a more enduring and consistent metric that cap rates of these assets all traded for well over 300,000 per unit. I mean just by way of comparison we just built a brand-new property in urban at $335 a unit which is very comparable to the price per unit that we received on these old 50-year-old assets.

I guess one follow up on that. Looking for private equity and other investors are obviously very interested in suburban value add play, are there any kind of just warning shots or transaction that you are seeing that are evidence of maybe more interesting CBD core type product or is supply kind of needed there, need to work its way through before you think that.

We are starting to hear and see some evidence that capital is flowing back to core CBD as you mentioned. Again, there is just an abundance of capital that’s chasing multifamily today. At some point, that capital needs to find a home. So, where value-added continues to be oversubscribed from the capital demand standpoint you are going to see capital reallocate in trying to find that home and in core we are starting see that a little bit.

Jerry going back to your prepared comments on the different markets and where they stack up relative to the same-store range can you give us a sense of which market might potentially diverge most widely from your current forecast and what the drivers might in those specific markets?

Sure, I’ve been gone this and everybody always seems concerned about Seattle. Right now, we have Seattle just one of our top four or five markets with our revenue growth north of four. Currently Seattle has come out of the gates a bit sluggish similar to what it did last year and then it turned over. I will tell you this even though it feels a little bit sluggish versus our original plan when I look at new lease rate growth in the month of January in Seattle it was positive 0.5%, last January it was negative 1.5%. So, while it doesn’t feel great versus our original plan, it feels stronger than it did last year and accelerated. We are cognizant in Seattle that you have got new supply that’s going to hit predominantly in the CBD as well as up in the EU district. We only have two same-store properties in those markets, two small deals up in the EU. A lot of the new supply that hit Bellevue last year has been absorbed and job growth is occurring out there whether it’s from Salesforce or Amazon or REI consolidating their campus. So, Bellevue where we have a large concentration, we still are doing well, fourth quarter we have revenue growth north of 6%, we also have some B assets which are down in the southern suburbs and the Northern suburbs that continue to perform well above our average, though. While we recognize that Amazon has come out since they are going to take their future hiring level from the 70,000 that they talked about 50,000, there other tech companies that are starting up facilities whether it’s a Southlake Union or Bellevue or whether it’s Facebook, Google, Salesforce that are operating in more of a diversified workforce beyond Amazon. So, Seattle is one that I think can go either way, it can surprisingly upside the last two years, as everybody had concern or supply really couldn’t hit it so that’s one that we are watching quite a bit right now. And then the starting out the year a bit better than original expectations in San Francisco, you’ve had good job growth especially down in that area, the financial district where Salesforce has just started occupying their building as well as the new offices that are opening up down in Mission Bank, but right now San Francisco is continuing to do pretty well. And then the last one it’s really taken off has been Orlando, very strong early results there, it’s not a major market for us but I think the influx of people from Puerto Rico has driven the population up and they are getting jobs and they are renting apartments, so those would be more of the positives.

And then anything on the negative side?

Right now, I think Boston has started out a bit sluggish, again that can happen in the winter months there, we obviously had a disappointing fourth quarter in Boston where revenue growth was under 2% after being north of 5% and that was really related predominantly to pricing pressure within the CBD, mainly in our back-bay property, as well as there’s a lease-up that’s competing against us in our seaport area property. But Boston is one that I think most people feel even the supply is there, the job growth is going to be very strong but it’s one that starting off on our stabilized deals, it’s been a bit weak, but when we look at the success we’ve had at our 345 Harrison deal, we’ve leased over 40 units there in the last month, and we don’t even open for occupancy for a couple more months. So, kind of we’re watching down but historically seeing in Boston that once March comes around you tend to see a significant acceleration in traffic patterns.

Secondly, it’s more of a I guess a housekeeping question, as you mentioned the contribution to the same-store revenue and NOI from properties being newly included in same-store, could you give us a sense of which properties are being included in that number, at least among the major ones just to know the changes that are proposed up?

Actually, if you guys out there want to look at on page 11 of our supplement we do detail out in the middle of that page what properties come into same store so you’ll see the additions to the first quarter of ‘18 and the full-year same stores. And it’s predominantly I think it’s four properties, three properties, four properties excuse me in the Seattle market, 880 Newport Beach which is the property down in Newport Beach and then Edgewater which is in the Mission Bay area of San Francisco, and it’s about 2,200 doors.

Hey good morning guys, thanks for taking the phone call. We spent a little bit of time on some of your bigger markets but also want to spend maybe a little bit of time, start talking about some of your smaller markets and how much that diversity is helping your revenue growth in the year ahead and maybe as you answer that question I’d love to maybe get a little bit more color on what you’re seeing in job growth outside of some of the major markets and how that relates to supply. It’s a big question but I’ll leave it up to you.

I guess I would start with you know probably three of the strongest markets we’ve had over the last two years have been our two Florida properties, Orlando and Tampa where not only have those markets done well but we’ve done exceptionally well within those markets versus our peers. When you look at Orlando and Tampa our expectation in 2018 will be a slight deceleration from this year but still revenue growth in the 4 to 5%, Harry spoke to the influx from Puerto Rico that’s affecting Orlando but even prior to that Orlando was enjoying very strong job growth and in 2018 job growth in Orlando is expected to be about 2.8% compared to about 1.3% nationally. Tampa is coming in at about 2.7% so it’s also coming in very strong, and other than certain submarkets, there’s not a ton of new supply. Our properties in those two markets also tend to be in the B, maybe in B- range, but we don’t compete nearly as much against the new supply. Another market that has probably been our leader the last couple of years, it’s not really significant but it’s our Monterey portfolio which has had double-digit growth and then high single-digit last year in revenue growth. This next year it should once again be our top market at right around 6% revenue growth. Employment growth is going to be stagnant at about 1.1% so slightly below the national average; it’s predominantly an agricultural community. What really benefits that market is there’s been no new supply probably in the last four to five years as job growth has continued to do well. And then the two markets that have been a little sluggish for us and we think will be in that middling range for us this year would be Baltimore and Richmond. Baltimore is this next year’s going to have job growth fairly close to national average at 1.3%, Richmond’s going to be at about 1.5%. So, they’ll kind of be in the middle not big contributors or detractors.

Got it, and just one follow up question. Are you seeing any sort of population migration trends away from San Francisco, Seattle, D.C., Boston to some of these, I don’t know, secondary markets that you can identify at this point or is it maybe too early to put a finger on that?

It’s probably a bit too early to determine if you're referring to tax reform or something else.

No, just generally speaking. We’re hearing that population migration is down over the past 5, 10, or 20 years but starting to see some population migration trends to cities that are maybe a little bit more affordable and still dynamic as well. So, you obviously have a diversified portfolio, and I was wondering if you’re seeing any evidence of that.

Yes. You’re seeing a bit. I mean, we’re seeing population growth come to places like Denver, Portland. I think Seattle has got some influx that of Northern California, within the state of California you’re seeing people move, especially protect jobs from the Bay Area down into Playa Vista down in Southern California. But I wouldn’t say anything of significance other than those.

We are monitoring migration trends and population growth closely. Our diversified portfolio means that while some markets may experience outmigration, we are likely to see benefits in other areas. Traditionally, the Sunbelt regions tend to have higher population and employment growth, though income growth may be slightly lower. In contrast, coastal areas typically show more significant changes in income and wage growth. Over the past year, our strongest wage growth has been in Northern California and Seattle. We consider both immigration and income growth when assessing the potential to enhance rental income ratios over time.

I just wanted to follow up on Richard’s question on your Sunbelt exposure. It’s been going down steadily over the last few years, it’s down 17% of your NOI and four years ago it was 27%. Will you potentially be allocating to the Sunbelt based on your findings of tax reform?

Hey, John. It’s Joe. First, before tax reform, we've consistently mentioned our desire to increase exposure in certain markets, particularly Sunbelt areas like Austin, Nashville, Denver, and Portland. We've been able to enhance our presence in all of these markets except for Austin at this point. We're focusing on these areas compared to our bicoastal holdings. In 4Q and continuing into 1Q, we've also seen some disposition activity, such as the sales in Orange County and Southern California, which resulted from our significant holdings in Orange County and the upcoming Pacific City development this year that will boost our NOI exposure. Regarding tax reform, it's still early to gauge its effects; I don't anticipate a significant impact in the first couple of years, but it's a relevant long-term consideration. Our analysis of the IRS data showed that overall, our consumer base experiences a $1,700 after-tax increase, which is about 3%. In the bicoastal areas, the increases are around 1% in New York, 2% in California, and 2.5% in Boston, while other markets see increases of 3% to 3.5%. Therefore, the situation is not as severe as some headlines suggest regarding potential migration trends, but it's something we are continuously assessing.

And do you think the peak leasing season will give you an indication of this or will it take a couple of years potentially to realize the full impact?

In terms of migration trends within MSAs, it’s going to take longer than a couple of months of bottom-line impact on the consumer pockets before we see an impact. The hope is, of course, that as everyone has more dollars in their pockets that as you go through leasing season, maybe you see some additional strength.

First question regarding expenses. The guidance over the last couple of years has generally been close to the upper limit, possibly even slightly exceeding it. As you formulate the outlook for this year, how much should this be considered, and what factors do you think would contribute to the fluctuations between the higher range and the mid or lower range?

Yes. Again, our guidance this year’s 2.5% to 3.5%, pressure point is going to be on real estate taxes which once again are going to come in high single digits. We have some impact from 421s which will drive total expenses up almost 40 basis points to 50 basis points. The other pressure points we’re feeling are personnel. And while we see wage pressures probably pushing us up about 2.5% to 3%, we’ve come up over the last year with some efficiencies within our workforce whether it’s on the sales side, the administrative side, or maintenance side that I think will be able to compress the impact of that down. Probably we want to push us to the high end of guidance, if we get some unforeseen tax bad guys or don’t have as many appeal wins as we’ve typically had, we really don’t budget for those significantly but that could affect us on the tax side. On the personnel side, it really just depends on labor markets. Last year, we were surprised up in San Francisco as well as Seattle when wage pressures took our personnel cost up between 5% and 7%. We feel like, in certain markets, we’ve addressed wage scale issues. But that’s something that could kick in this year. Joe was talking about both the benefit from tax reform but also we are seeing wage increases on a national basis go up 3%. Now if we see wage pressures, we would hope with some outsized rent growth that would accompany that. So if it pushes us to the high end there, we would think there will be a corresponding push to the high end ideally on the revenue side. But our other expense categories, primarily it’s repairs and maintenance or marketing costs, we have continued to work to create a more efficient way for our residents to deal with this. And we think we can get both of those categories very close to flat to negative. In fact, currently, we’ve got about 33% of our onsite tours are booked through appointments online. So, we’ve been able to cut out some of the personnel burden there as well as over the last year, year and a half, we’ve installed package lockers into over 100 of our properties, which has made our people much more efficient.

If you look at last year, was the increase towards the midpoint or higher mostly driven by property taxes or personnel compared to your initial midpoint guideline?

It was more personnel.

I have a separate question about the land market. It seems to be quite resistant to change, which makes it challenging to underwrite new development deals. What do you think could trigger a change? What has led to changes in the past?

We have been discussing this for the past six to twelve months, which is why our pipeline has significantly decreased with new net additions to the land pipeline being nearly non-existent at this point. We have consistently indicated that while rents have stabilized at long-term levels and cost inflations are rising above that, the main issue remains land pricing. Therefore, the only significant change we need to see is either an acceleration of rents that outpaces inflation or a revaluation of land pricing. Although we have observed at least one example of such a revaluation in a deal we are focusing on, I wouldn't say it's widespread at this time.

One of the reasons your stock is underperforming is the issue of supply. Joe, you mentioned that land is difficult to manage. I see that as a positive aspect. Sure, we might not be able to pursue as much development, but one reason the multifamily sector has struggled this year is due to supply constraints. Do you consider that a generally positive indicator? I suppose that question is open to everyone.

Clearly it goes to a positive on the ground fundamentals if supply comes down. For 90 plus percent of our business, that’s a positive if development is more difficult to pencil. For the other side of the business, on the transaction side, you may see the pipeline ramp down a little bit, which results in less earnings contribution near-term but in theory you make it up on the same-store NOI side over time.

Yes, that seems like a favorable ratio; I would gladly give up 10% from my 90%. In terms of your perspective on land and the overall market, do you still observe ongoing deals? Are there still irrational land transactions taking place, not just with UDR but from others as well that could lead to questionable new development projects? Or do you feel like the activity is beginning to slow down, even beyond your company?

I hope that most deals are rational rather than foolish, especially the ones we pursue. However, it's becoming increasingly challenging to finance these deals, and fewer of them will be viable. That said, it doesn't imply that no deals will be feasible or that capital won't be available for new development projects. UDR, while maintaining our disciplined underwriting approach, should still be able to replenish our pipeline. We anticipate this will occur over time, but it does mean we need to examine more deals to find viable options, and it is likely that construction starts will remain below the levels seen in the past three to four years.

Right. Hopefully, you and the REITs will lead by example and we will see how it plays out. The last question I have is, Joe, you mentioned that the development pipeline is likely to remain at the lower end due to various factors. Concerning the DCP effort, do you think the same six projects will persist for a while, or do you anticipate some changes, with the total number staying about the same throughout the year?

I think there is potential to net out to the same number over time. We’re sitting at, call it, $160 million or so today of exposure there. Over the first quarter, you’ll see DTLA which is coming up through its option period, so we will work through the kind of buy, hold, sell analysis on that one. But we do have another $60 million of funding left on some of the other deals. So, will be at a $180 million or so of exposure. And we’ve talked in the past about kind of our earnings and cap on the program that we impose on ourselves. But we think we still have another $100 million of capacity. The difficulty is going to be if we see development overall coming down, you can expect that there is fewer developers therefore looking for that type of capital. So, there may be fewer opportunities. But we think we’ve probably got a shot at maybe a couple of them throughout the year that could continue to backfill the pipeline.

I’d add to that a little bit. I think you’ve been around long enough, and look towards the future, and you’ve got to realize if we’re in a rising interest rate environment, absent the NOI impact, the question is going to be loan proceeds and availability of lending in that environment and will that bring more assets to the market as construction loans start maturing. And we’re down two to three years down the road. But past experience always points to people wanting to get out ahead of that and start selling assets. And so, I think you are going to see a lot more transactional volume over the next couple of years. And inside of that, there’s always the opportunity to recap deals, buy deals. So, I think we’re just entering what I would call the natural progression of this cycle. And it will start with decreasing supply aspect, improving NOI trend, but at a higher interest rate environment creates a more transaction-driven market. And I think we are ready for that.

A couple of questions. First on the multifamily transaction market. With debt costs having gone up over the last six months, are you seeing signs of cap rates going higher? And even if not yet, do you think it’s reasonable to assume cap rates go up by a certain level, given the rise in interest rates?

I think, there’s sort of three factors that go into cap rates, one is interest rates, one is NOI growth and the other and perhaps most important is capital flows. Today, at least in the near term, capital flows are extraordinarily high. And therefore, there’s no reason to expect that the cap rates are going to move. And we have not seen any evidence that cap rates are going to move. If in the future, depending on what happens with the interest rates, clearly, if interest rates continue to climb, over time, there tends to be some loose correlation between cap rates and interest rates. But again, it depends on how those other two factors move. So, I wouldn’t be surprised to see cap rates move a little bit over the next year or so, but we have not seen any evidence of that today.

So, I guess, if pricing is still strong in the transaction market, Tom, I am wondering how you and the Board are thinking about share buybacks or special dividends, your stock, like most of the multifamily REITs, showing a meaningful discount to NAV. So, at what point do you stop investing in the developer capital program, stop doing acquisitions and instead focus on buying back your stock and selling more assets, if the transaction market pricing is still so strong and there’s risk of maybe cap rates going higher?

Hey, Nick. It’s Joe. Maybe I’ll set it up and just give you a couple of parameters around how we’re thinking about it, and then if anyone wants to come over the top. It’s a relatively new phenomenon, obviously with the selloff that’s taken place in the last 30 to 45 days. But the way we kind of think about it is where do you trade versus NAV, what’s the leverage profile, what are your committed uses, what are the alternative uses they compete for and then call it corporate factors? So, as you kind of take through those you have clearly a discount to NAV in place today. So, we’d agree on that front. From a leverage profile standpoint, we like where we are at from a maturity profile, a line utilization standpoint, and solid BBB plus credit. But, we’ve no intent to lever up, especially for share buybacks. So, you can kind of take that source off the table, which reduces your sources back to just dispositions, cash flow. And so, then, you come over to kind of committed uses. And when you look to our sub between development in DCP, we still have $200 plus million of committed uses at this point in time. In addition, we continue to take a look at DCP and development loans, not necessarily on balance sheet yet. We do have potential land parcels that we’ve been working on for a quite long period of time that could hit. So, when we’re thinking about shadow uses, that’s going to factor in the math. But ultimately, you get to a point where you do have available capital and similar to how our DCP and development program compete against each other for that amount of capital, you are going to have one more competitor in the ring which is share buybacks. So, compete those three against each other when we have the capacity. The other piece of it be in corporate factors which I think everyone is aware of is a REIT from a tax gain capacity standpoint, we can only sell a certain amount of assets each and every year. And right now, our dispositions are really allocated towards those preexisting uses at this point in time. But I think as the year moves on, we will take a look at where the discount is and what the alternative uses are and make the best decision at that point.

I appreciate the detailed response. However, at what point do you begin to reconsider your investments in development given the current market conditions? Many REITs are grappling with similar challenges. Considering that your FFO growth this year is 3%, which matches your same-store growth, when do you evaluate the merits of continuing to invest in development versus potentially buying back stock?

That's a valid question. We will continue to evaluate our internal rates of return on development, which are generally in the low to mid-teens range. While DCP is focused on acquisitions and development, you would see a stock buyback on an unlevered basis. If your unlevered assets are seven and you call it a 10% unlevered asset value buyback, you achieve an internal rate of return of around 7.5% to 8%. So, the internal rates of return remain arguably more attractive, although there is additional risk involved. That will be part of our discussion as we assess each development and whether we can earn the targeted extra 150 to 200 basis points, compensating for the increased risk. Ultimately, we do not rely on equity issuance and are primarily looking at cash flow and asset sales to fund development. The potential for value creation and internal rates of return still exists. However, we are mindful that there are alternative uses of capital we might consider. Regarding your second point about same store growth and funds from operations growth being equivalent this year, which we touched on in our earnings release and my remarks, I think it’s important to clarify this as it ties into our development pipeline. We noted that developments in DCP are overall neutral for earnings this year, which raised a few follow-up questions. The reality is there is a net positive impact from our developer capital program and a net negative impact from ongoing developments. To put it plainly, we are facing a timing issue with Pacific City and 345 Harrison. We have over $700 million invested in these two projects, and this year, we expect an FFO yield of about 2.5% from that investment. As you may realize, this reflects a 4% cap rate that disappears on these developments, which drives negative cash flow initially but should improve as leases are signed. Over a few years, we anticipate that the FFO yield will stabilize in the high 5% range. Essentially, we have already paid for about $600 million of that $700 million project, which will start generating net operating income in the coming years with some remaining funding available from asset sales. So, while you're correct that this year there is no contribution, we expect this to increase as we move into 2019.

Let me have a brief closing, given the time element. First, I thank you for your time and interest in UDR. And second, if it doesn't come across, I want to make sure we state it. We feel very good about our strategies, about our continued execution and how this year is already starting out very strong for us. So, with that, we look forward to talking to you more in the future.