AVALONBAY COMMUNITIES INC Q3 FY2024 earnings call

Strategic Priorities

• Focused on four strategic priorities from Investor Day, including transforming operating model to achieve $80M annual incremental NOI, optimizing portfolio growth by increasing suburban and expansion region allocation, leveraging unique development growth engine, and ensuring access to cost-effective capital.

Q3 Results

• Exceeded core FFO guidance for the quarter by $0.03 per share. Started $450M of new developments. Increased full-year core FFO guidance for 2024 to $11.04 per share, implying 3.9% core FFO growth. Same-store revenue growth expected at 3.5%, same-store operating expense estimate midpoint lowered by 30 basis points to 4.5%, leading to same-store NOI guidance increase to 3% for 2024.

Portfolio Trends

• Third quarter performance strong, same-store portfolio well-positioned for slower leasing season. Turnover below historical norms, economic occupancy increased. Asking rent growth outperforming. Supply outlook for 2025 with established regions having lower deliveries than Sunbelt.

Building Blocks for 2025

• Embedded revenue growth ~1.1%, underlying bad debt improvement ~60 basis points, strong other rental revenue growth expected.

Operating Expense Outlook

• Moderation expected in 2025, with tax abatement expiration impact easing and AvalonConnect deployment reducing utility expense impact.

No specific detailed breakdown of product segments by revenue contribution provided in the transcript.

Growth Guidance

• Increased full-year core FFO guidance for 2024 to $11.04 per share. Same-store revenue growth expected at 3.5%, same-store NOI guidance raised to 3% for 2024. Expectations for 2025 include healthy job and wage growth, steady demand for apartment homes, lower new supply in established regions, and moderation in operating expense growth.

Risks

• Uncertainties in forward-looking statements, including risks from economic conditions, supply and demand dynamics in different markets, insurance costs, and potential impacts of natural disasters on site selection.

Q: You mentioned that deliveries as a percentage of stock should be around 1.4% next year, which I think is down a little bit from this year. Just based on what you're seeing on the ground, your pro formas, like where do you think that percentage could go over the next couple of years?

A: Yes, Eric, this is Sean. I can comment then Matt or others can certainly speak to it as well. But as it relates to our established coastal regions, first for 2025, we're expecting a reduction in delivery across those regions with the one exception being New York City, which actually is forecast to have a slight uptick. It's not material, but a slight uptick in deliveries in 2025. As it relates to where they settle beyond that, what I'd say is -- and Matt can speak this further is the development climate certainly has been challenging for a number of reasons, given what we've seen in-construction costs, what's been happening with capital costs and the impact, particularly on merchant builders across our regions. So given the fact that starts have come down and the fact that the gestation period for construction in our coastal markets is fairly lengthy given the product type, it wouldn't be a surprise to see deliveries for our -- again, coastal established regions to continue to trend down over the next couple of years, given what we've seen in terms of starts activity and the underwriting associated with new projects in those same regions. So hopefully that answers your question.

Q: For the four Sunbelt apartment projects you started this quarter, could you just talk about the underwritten yields on those and how you're looking at the value creation or margin on those projects? And I guess for Austin specifically, it's certainly been a market that I think people expect supply to weigh on it for a little while. So just curious if there's something specific about that project that lets you get to a higher yield than maybe the overall market would achieve?

A: Hi, sure. Hi, Eric, this is Matt. I can speak to that one. So we did start four deals this quarter, all of which were in expansion regions, two in North Carolina, two in Texas, and those deals are underwriting on today's rents to around a 6%, which would be on the tighter end of our range of development yields. I think our development starts for the year across the whole book is more like low to mid 6%, 6.3%. So it'd be at the lower end of that range, but still well in excess of our cost-of-capital and well in excess of where we think cap rates our assets would be trading. Every deal is different. So there are unique characteristics. The deal that we started in Austin, that's a parcel of land that we've owned for a couple of years and it's the first phase of what could be eventually a 1,300 or 1,400 unit garden deal. So it's -- there are some unusual costs loaded into the first phase because we're front-loading a lot of the infrastructure and amenities of what's really going to be kind of a signature community for us in that market. And that's our first start -- our first investment in Austin. We've identified Austin as one of our expansion regions really for four or five years, but have been pretty cautious about it up until now. But we're pretty bullish about the timing of that start in particular, because we think it's a nice match between hitting the low point on hard costs, which have come down. On that deal, hard costs are down double-digits compared to where they would have been 18 months ago when we could have started the deal when it was first ready to start. And when you think about that asset won't be in lease-up until '26 and we feel by that point, we should be facing very little new competition and with a basis that we like quite a bit.

Q: I guess, sticking with development, can you talk about your thoughts, your early thoughts on what's in the pipeline that you could possibly start in '25? And I guess just kind of continuing with a similar discussion with the starts you've done all-in the Sunbelt, I mean, clearly, Sunbelt is recovering from a supply glut, but who's to say it can't happen again? The Austin project certainly sounds unique, but can you just talk through how you think you can navigate development in the Sunbelt better differently than people who are facing a lot of supply here as we just think about the longer term based on the projects you're starting?

A: Yes, I guess I can speak to that one, this is Matt. When we look at our '25 starts book and we do think that we have an opportunity to increase our start volume further in '25, could be a range and we're not providing guidance at this moment, but we could certainly see increasing our start activity next year to something on either side of a range of about $1.5 billion -- from $1.050 billion this year. So we are ramping it up partially in response to what Ben was talking about where we think we can get a greater share of a lesser number of starts given our balance sheet and our capital position and the capabilities we bring to it. And it's really a mix, so I think this year our start activity will be about 40% to 45% in the expansion regions, probably be similar to that, maybe a little less as a percentage next year. So we do have a couple of starts on the West Coast where development economics have been under pressure for quite a few years. We're starting to see green shoots there, both on the operating side and on the hard cost side, some pretty significant savings. So we have a large deal we could start next year in San Diego. We might wind up starting a deal in the East Bay. We have a garden deal in Denver that would be an expansion region. We have more kind of higher yield business to start in New Jersey, a deal here in the Mid-Atlantic, opportunities in Boston, a deal in Palm Beach County in Florida. So it's a mix. I would say the product tends to be lower density garden, kind of simpler construction. That's where it tends to be working better right now. And if more likely, it will be in more in the expansion regions or some of our -- I'm sorry, in the established regions some of our expansion regions, Denver and Florida, in particular, Southeast Florida, assets are trading more generally above replacement costs there. There's probably a little more pressure in North Carolina and Texas, and that's where it really does depend on the product and the submarket and specific -- the specific dynamics of the site you're looking at.

Q: I guess just switching gears to expenses. We appreciate the detailed line-by-line view for next year. I guess two ways to ask the question. One is just focusing on insurance specifically, I mean, clearly a lot is happening in Florida, happened in Florida. What gives you confidence that insurance can go lower in '25? And then also just if you were to boil down this third column on the right, do you think your expense growth rate is higher or lower in '25 than '24, if you're even able to answer that question?

A: So Jamie, this is Kevin. I'll start on insurance and Sean will probably follow on the broader look on OpEx for next year. So in terms of insurance, this year's expected insurance expense increase of about 10%, just to kind of give you some context, it's being driven primarily by increases in property insurance premiums and losses where the premium increases from property relate to our May 2023 renewal that continued to affect us earlier this year. But we had a roughly flat property renewal in May of this year, very successful in that regard, partly due to the kind of the abatement of decline in insurance premium pressures in that property insurance market relative to prior years. And that flat property renewal this past May provided some relief from the impact of higher premiums in this year's numbers and into next year. As we move into 2025, we just see based on what's going on in the various insurance markets that we have, a continued movement towards stabilization in program costs, as we look to renew property and other types of insurance next year such that we expect to generally renew those at more typical growth rates. Our property renewal is in May, and as you know, we have very little exposure to the high risk areas, where there have been problems such as in Florida, where we have limited exposure to Southeast Florida where there's concrete construction and generally have more of a coastal footprint. So we've been insulated from a lot of those pressures as well. The only exception we see with respect to insurance is liability insurance, which is seeing some above average premium increases, but fortunately, liability insurance comprises less than a quarter of our overall total insurance spend. So as a result, when you put it together and look at insurance costs for next year, while it's still early, we currently expect our overall insurance costs to be more in the mid to high single-digit range for next year, which is closer to more normal levels for us.

Q: I just wanted to look at the kind of projection for improvement in lease growth in November and December. I guess just maybe kind of whether it's just easy comps or kind of what are the other maybe indications or things you're seeing in the portfolio today that kind of give you the confidence that, okay, things could reaccelerate here in the last two months of the year relative to October?

A: Yes, Adam, this is Sean. I can take that one. So first, in terms of high-level strategy for us, as I mentioned on the mid-year call, we had a nice run-up in occupancy at the beginning of the year kind of throughout the first quarter. And so we started pushing harder as it related to rate growth and we were able to do that through Q2 and most of Q3, which is the time when you want to do that given the heavy lease expiration volume, roughly 60% of our leases expire during those two quarters. So that's when you want to get it. But in terms of overall strategy then as you get into September and October, you do want to sort of stabilize occupancy as you head into slower leasing season. So as we move through September into October, you saw that in terms of the deceleration, particularly on the new move-in side. So that was part of the broader strategy. As it relates to where we are today, occupancy is relatively stable, and as I mentioned in my prepared remarks, given the softer comp in terms of where asking rents were in Q4 of 2023 relative to where they are as of now, asking rents are about 3% higher than where they were last year. So where we are signing leases currently is presenting a nice spread on the move-in side. So as we look forward, you know, October blended rent change was 1.2%. We see it ticking up into the high 1% range for November and then the mid-2%s in December, our expectation is that all of that is really on the backs of new move-ins, which were down about 180 basis points in October, but we expect that to flip to be modestly positive in November and a little over 100 basis points in December. Renewal offers were already out. We negotiate with residents, so for the most part, what you're going to see is the improvement coming on new move-ins as we move through November and December, given where asking rents are today.

Q: I wanted to ask about your apartment renter base. Have you seen any demographic shifts recently as millennials continue to age and move-out to buy remains low? How are the younger age cohorts showing up in your portfolio?

A: Yes. So this is Sean. I wouldn't say there's been any meaningful shifts recently. Obviously, as we went through COVID and then initially started coming out of COVID, there was a lot of movement initially in COVID, not as much doubling up, more single-person households. All those things have sort of transitioned through COVID, I'd say have stabilized at more normal levels, the percentage of roommates, et cetera. So I don't think there have been any significant shifts. I think as you look forward, just given the nature of demographics and some of the development Matt was talking about, I think, being more heavily suburban, some of the townhome products certainly fits the aging millennial profile where they want to be a little more infill in our established regions. It's very expensive to buy a home. So if they get a nice quality townhome product with a small yard or a nice deck and be in a good school district, that's highly attractive. So we are making sure our portfolio is well-positioned for the demand that's to come, which may represent slightly larger households when you include kids in some of these markets than what we've seen in the past. But looking at it over a short period of time, you get a lot of false signals in terms of just some noise in there that I wouldn't necessarily say has really resulted in anything significant in terms of shifts in the last few quarters.