AvalonBay Communities, Inc. Q2 FY2025 earnings call

Key Takeaways

• Second quarter and first half results exceeded initial guidance, driven by higher occupancy and rental revenue growth, and tight operating expense management.
• Updated OpEx growth forecast at 3.1%, 100 basis points better than original, translating to higher NOI growth in 2025 at 2.7%.
• Healthy demand across most portfolios, with low new supply in established regions at levels not seen in over a decade.
• $3B development projects expected to generate differentiated external growth, with development underway trending above pro forma stabilized yields.
• Progress on portfolio allocation, aiming to acquire $900M of assets this year, funded by dispositions.
• Strong balance sheet, having raised $1.3B of capital year-to-date at 5.0%.
• Core FFO growth of 3.3% year-to-date, continuing to position towards top of sector.
• Started $610M of new development projects in first half, raised target to $1.7B for full year.

Operations

• Updated same-store revenue growth outlook slightly below original due to change in same-store pool and bad debt.
• Asking rent peaked earlier than original outlook, contributing to lower effective lease rates.
• Bad debt improvement pace below initial outlook, with challenges in Mid-Atlantic and New York regions due to regulatory actions and court systems.
• Regional performance: New York, New Jersey, Seattle outperform; Mid-Atlantic, Northern and Southern California, expansion regions underperform; Boston in line. Southern California's revenue growth moderated due to labor market weakness in L.A.
• Development and investment activity: Lease-up NOI lower than budget due to delays in deliveries and slower leasing velocity, but development activities remain profitable; pending transactions expected to close in third quarter, advancing portfolio allocation goals.

No detailed breakdown of product segments by revenue contribution. Focus on regional performance: New York, New Jersey, and Seattle regions expected to outperform original budget; Mid-Atlantic, Northern and Southern California, and expansion regions projected to underperform; Sunbelt region market occupancy at 89.5% vs established regions' 94.8%. Development projects: $3B of development underway trending above pro forma stabilized yields.

Full Year Guidance

• Maintained full year core FFO per share guidance at $11.39, reflecting year-over-year earnings growth expectation of 3.5%.
• Projected same-store NOI growth at 2.7%, 30 basis points above initial outlook.
• Development starts increased to $1.7B for full year, up from $1.6B.

Sequential Guidance

• Anticipated sequential increase in core FFO per share in third quarter: $0.03 increase in same-store revenue, $0.02 increase in NOI from new development, $0.01 benefit from capital markets and transaction activity, offset by $0.08 increase in same-store operating expenses.
• Anticipated sequential increase in core FFO per share in fourth quarter: $0.03 increase in same-store revenue, $0.06 decrease in same-store operating expenses, $0.04 increase in NOI from new development, $0.01 benefit from capital markets and transaction activity.

• Weaker job growth than expected, impacting demand and pricing in certain regions.
• Market softness in Mid-Atlantic and Southern California, with challenges in selling assets in D.C. due to TOPA law.
• Impact of CEQA in California, potentially slowing development process.
• Uncertainty in New York political and rent stabilized unit actions, affecting rent stabilized portfolio.

Q: Just on the delayed occupancies and development. You mentioned the Denver communities. So I was just hoping to get a little more color on what's impacting the pace there and kind of what's the normal leasing pace versus what you're seeing?

A: Sure, Eric, it's Matt. The -- so the pace has been fine. The deals that we had in lease-up in the second quarter, we're averaging about 30 homes per month in leasing, which is more or less what we would expect for this time of year. And again, the shortfall is really a little bit of it is based on just some deliveries moving around to later in the year at some communities. And then there is one lease-up in particular we have in urban Denver Governor's Park, where we've had to offer elevated concessions and the pace is not what we had originally anticipated. That's a very, very competitive submarket within urban Denver. We have a second lease up in suburban Denver, up in Westminster. That one's going fine, but it's also just a little bit behind pace but maybe not as far behind as Gov Park. And that -- I guess the other one that I didn't mention is we do have a lease-up in suburban Maryland, which is also seeing a little bit of elevated concession activity. So it really is contained to those 2 markets. But as we look to a lot of the lease-ups we're opening now, they're in pretty strong markets. So we are seeing pretty good traction in the rest of the book.

Q: I guess I wanted to talk about the chart on, I guess, Page 13, the asking rent trend. And obviously, there was a clearer noticeable kind of leveling off in sort of the maybe mid-May time frame. And I guess I'm just curious, from your perspective, what do you think happened there? And why do you think things sort of softened up or didn't continue that normal seasonal upturn?

A: Yes. Steve, it's Sean. Happy to talk about that. What you can tell from looking at the chart, things were ahead of our expectation for a good portion of the first half of the year. But I think you -- what we observed is demand has been a little bit softer, primarily our expectation is tied to slightly weaker job growth in the first half of the year than originally anticipated. So when you start to look across the footprint at that across the first half of the year, we ended up with about 100,000 fewer jobs than originally projected. So that's probably the primary driver.

Q: I guess just following up on the chart on Page 13. So can you talk about what this means for your 3Q and 4Q blends in your outlook? And then also, as we think about earning into '26 and your view on year-end rents, how much do you think this change in your outlook affects your '26 earning?

A: Yes, Jamie, it's Sean. I mean, given we're sitting here in July, I don't think we're really prepared to talk about the earning for 2026 yet. But what I would say in terms of blends is that we're essentially expecting what we saw in the first half to continue through the second half of the year in terms of overall rent change performance.

Q: Just going back to the asking rent growth curve this year, which markets really dragged on that specifically? And I guess what do you think really you need to see? Is it just a pickup in job growth to kind of get back to that same steepening in the curve that you saw last year and sort of in the pre-COVID period you outlined?

A: Yes, Austin, good question. I mean I'd say, as I mentioned earlier, first, fundamentally, in our mind, it is a job growth issue. When you look at it across the various regions, it's pretty apparent that the job growth being slower than anticipated, it's pretty broad-based. Obviously, it impacts different regions to varying degrees. I'd say at this point in time, the regions where we're expecting underperformance to be most material relative to our original outlook. When you start thinking about rent change and revenue performance are really the Mid-Atlantic and Southern California.

Q: I think you guys referenced maybe a little bit softness in D.C. in recent months. Wondering if you could maybe just double-click on that. What exactly are you seeing in the market, right? I think it's sort of surprised to the upside earlier in the year, maybe surprised with it stability early in the year. What sort of changed there? Is it resident uncertainty? Is it sort of more concrete job loss? And I guess just maybe also unpack what's happening in D.C.

A: Yes, Adam, I'm happy to talk about that. I think it's a combination of different things in terms of what we're actually seeing on the ground. As I mentioned previously, at Nareit, I think the -- we're having a lot of conversations with existing residents at renewal time about their lease options moving forward, both what term of the lease they can sign, what happens if I happen to lose my job, what are the lease termination options, what does that cost me, what if I need to transfer to another apartment, kind of speculating a little bit on the downside from residents, which is just pushing out the commitments that they're making, just trying to preserve optionality. So we're hearing that from our centralized renewals team in terms of closing on those renewals. We've also seen an uptick in concessions, again, mainly in suburban Maryland submarkets, in the District of Columbia as I think the market has sort of prepared for what's anticipated to be maybe weaker demand. And then obviously, job growth just hasn't been there as well.

Q: Looking at Slide 16, and I appreciate your comments earlier about sort of the way you quote development yields prior to stabilization a little bit more conservatively. But if I look at that bucket that is kind of not as seasoned at the moment and you simply mark that to market today. I mean what does that yield uplift look like relative to the sort of low 6 number we see in front of us?

A: Yes. We really don't mark them to market until the time comes when we're getting ready to start leasing internally and then we don't externally until that's validated, as I mentioned, through the 20% leasing. So if you're talking about the 11 deals that don't start lease-up until '26 or beyond. We really haven't looked at that, but I would -- when you look at the market mix, you look at where they are. The one thing I can tell you that we do know is that costs are probably going to come in under at least from what we can tell today. And you're still 1.5 years to 2 years out from opening for lease-up. So who knows what happens to market rents between now and then. I wouldn't say that their market rents in that basket is below where they were when we underwrote them.

Q: On the pending D.C. asset sales, I think, Matt, you mentioned that you started marketing that last year. I'm wondering how...

A: I don't know. D.C. specifically is a very difficult market to sell assets in, maybe the most difficult in the country with the way their TOPA law works there. So there's not a lot that does trade there. There were a couple of recent trades that closed in D.C., I think one that closed a month or so ago that may be JBG sold. So there have been a few, but I would tell you, in general, cap rates today in most of our markets relative to where they were when we struck that deal kind of October, November of last year, probably about the same. Some markets might be up a little bit, some might be down a little bit. But generally speaking, if you look at where the tenure is, it's kind of gone all over the place, but it's not far off of where it was then. And I would say the same about cap rates.

Q: On the development homes occupied the expectation for '26 and tying that to your more muted job growth forecast. I guess, can you talk about that a little bit, the 3,000 development homes occupied for '26, has that changed?

A: Jeff, it's Matt. No, that hasn't changed. That's really a function of deliveries. And so when you look at -- we are in a down year for us for deliveries, which goes back to 2, 3 years ago. We have started less development. So we're ramping up development starts. Last year, we started a $1 billion and this year, we're starting $1.7 billion. That's going to translate into more deliveries in '26, '27, '28 than we had in '24 and '25. So we'll generally price the homes to absorb them. So it's not really a function of a macroeconomic view of what '26 is going to look like.

Q: I thought that there was a really interesting chart in the presentation on market occupancy across the Sunbelt. So my question is, do you think that we need to see occupancy trend back towards essentially the pre-COVID level in the Sunbelt in order to really see pricing power in that region?

A: Yes, Ami, this is Sean. I mean it certainly needs to move that direction. You will gain some incremental pricing power as it moves up, but you won't realize sort of full pricing power until you get back to a more normal stabilized level of occupancy. In the case of that big spread there, there's a ton of standing inventory, as Ben mentioned in his prepared remarks. And so that stuff, whether it's 1 month free, 2 months free, look and lease specials, et cetera, concessions in those communities will be pretty heavy, getting them leased up, which will certainly impact the existing stock, just not to quite the same degree. But you need those communities to lease-up and then the whole market come back to a stabilized level before you have really, I'd say, firm or strong pricing power.

Q: So 2 questions here. First, just big picture, there's the debate over return to office, how that's impacting apartments. Certainly, for urban apartments would make sense as that would be a clear benefit. As you look at your suburban portfolio, just given predominantly that's what you have, have you seen any nuance where return to office has actually been a negative in any of the locations?

A: Yes, Alex, it's Sean. What I would tell you is it's not often that we see that. I'd say the one place where -- maybe 2 places we have seen that over the last year. It's not really recent, I would say, is during Q2, Q3 of last year, we definitely saw more people moving from parts of Central New Jersey up into Northern New Jersey to be closer to the city as an example. And that we did see some migration out of Florida back to some of the major employment markets in the Northeast. Those would be the 2 places where I'd say we've seen that really occur. But I mean, the other thing to think about is, given our footprint, some of the suburban markets are job centers, right? So if you think about Microsoft and where they're located outside of Seattle, Google and Facebook and others around Mountain View and parts of San Jose. So it's not just an urban situation that's creating that demand. You do have these core sort of suburban job center locations that definitely have benefited from return to office.

Q: In your 1Q investor presentation, I noticed you had a construction hard cost pie chart that broke down input costs. I didn't see that in your 2Q investor deck. My question is, what inputs are you seeing higher costs now and/or lower cost than when you forecast this 6 months ago?

A: Yes, this is Matt. I don't think it's necessarily changed. That Q1 presentation was really kind of illustrative, and it was really put out there to kind of orient investors to the fact that the hard -- the materials component of the hard cost is a relatively small percentage of the overall deal capitalization of a deal. So I don't -- we haven't seen that, that's necessarily changed. And again, right now, what we're seeing is that headwind of potentially higher material cost is being more than offset by the tailwind from subcontractors getting hungry for work. And if anything, over the last quarter, that's just accelerated with -- you're starting to now see a reduction in for sale starts activity. And again, we're continuing to see great bid coverage and buyout savings relative to our budgets. So the trend continues to be favorable in that regard.