AvalonBay Communities, Inc. — 2024 Q1

It's Nick here with Eric. Maybe just on the capital allocation and then rotation into the Sunbelt. You made a comment in the prepared remarks about seeing opportunities below replacement costs. And so I was just curious if you can quantify kind of that. Obviously, it's probably range, but kind of how far below replacement costs you're seeing on average then also the size of the opportunity you're seeing in terms of product, I mean, on the market in those expansion markets.

Yes. Sure. Nick, it's Matt. I would say the discount replacement cost is obviously going to vary to some extent based on the age of the asset. I mean, in theory, assets that are 10, 20 years old should be trading below replacement cost because there is some depreciation there.

Would you expect some of that product to start to come to market? Or do you think it's more -- owners right now will be more of a wait and hold? I'm just trying to understand how kind of the current supply and the rate uncertainty may impact kind of your acquisition strategy and maybe urgency into moving into these, if we fast forward a year or 2, and the supply picture has started to improve.

Yes. I mean, who knows? I would say that there is more volume coming. And if you talk to the brokers, they'll say they're pretty busy with [ BOVs ]. This is the seasonal time of the year when you start to see an uptick in transaction volume.

Nick, I'll add a couple of comments, guess it's well put by Matt. I generally see as our window of opportunity being open for a decent period of time and 2 primary reasons: one, the supply dynamics that exist in the Sunbelt. Per my prepared remarks, we expect to be with us for a period of time. So that softness on rate and occupancy and a weight on asset values is we think, we'll be here.

Yes, Jamie, I'll start with a couple of comments. So one is just the sort of the facts and the known dynamics that exist. Supply in the Sunbelt, yes, it is going to be peaking later this year, but it is going to remain elevated into 2025.

Yes. Austin would also be at the top of that list. Just look at percentage of stock coming online. That would be high up on the list. Generally, in the Sunbelt markets, the more urban-oriented submarkets are generally seeing the highest levels of supply coming online. And that's one of the reasons we've been conscious as we've been growing our expansion market portfolio to really push ourselves out further into those marketplaces out of a submarket or 2 with lower density product, lower price point. That is competing less directly with new supply.

It is. Yes, that's been a very conscious choice of ours. And we also think about it as complementing what we're buying with what we're going to be building. And so even to make the point further, what we've been buying tends to be slightly older product, lower price point, lower density products. Recognizing that our development, while it still will be suburban, will tend to be mid-rise and a little bit higher price point, once it comes to market. So we think about that as just our overall -- we talk about at a portfolio level optimization, but we also very much focus on it in terms of a market and a submarket perspective.

Sure. Well, the first thing I'd say is none of them have closed yet. So be able to provide more detail at the end -- on the second quarter call. But it's a pretty good mix. Three of the 4 assets are AVAs, so a little bit more urban than what we've been selling in the past, one in Jersey, one in Seattle, one in Boston, one in Southern California. So a good mix of geographies. And it continues to be a little bit of a bifurcated market.

Yes, so it's Sean. Good question and the question, I think, on a lot of people's minds. I think the way I describe it is, first, supply should not be an issue for an extended period of time. There are 1 or 2 assets in San Francisco as an example that are finishing lease-up.

Yes. I mean as it relates to this trend at asking rents, that's primarily driven by the East Coast markets. And if you look at it on a year-over-year basis, the East Coast markets are up 2% to 3% versus the West Coast markets are up about 1% roughly. That's being supported by markets like San Diego, Orange County, parts of L.A. Certainly, Seattle has had a nice recovery.

Yes, Steve, it's Sean. It's really 2 factors. One is what you described. We've seen sort of a faster improvement in occupancy. We experienced that in Q1. That is quickly translating to rate acceleration, which actually puts a little bit of pressure on occupancy.

Yes. You're correct. I did not state renewal offers. But renewal offers for May and June are around the high 5% range. So expecting them to settle sort of in the low to mid 4s is reasonable based on historical norms.

Yes, Steve, I guess, we -- there's actually -- it's not one number. There are different target yields for different markets and even down to different submarkets and also based on the risk profile of the deal. But we're generally looking for that 100 to 150 basis point spread to cap rates. What that's translating into kind of on average is probably a mid- to high 6s target yield. And then it's going to be lower in markets where deals that are less risky or markets where we expect stronger growth because ultimately, it's about the full investment return, the IRR. And it's going to be higher in markets that have the inverse of that.

Yes, Adam, it's Sean. Good question. And one of the factors to keep in mind is what's changing in underlying bad debt across the markets. If you think about it, it was like rent change is one component, but changes in occupancy, bad debt, et cetera. And particularly for the Southern California market, I would say that is a meaningful contributor to total revenue growth in 2024.

Yes. What I mentioned in my prepared remarks is that we expect like-term effective rent change kind of in the mid-2% range, which is about 50 basis points above our original outlook. What I indicated is that the second quarter should trend up probably in the low 3% range before decelerating in the back half of the year.

Yes, John, this is Kevin. Really, the $0.02 from better-than-expected capital markets activity was primarily driven by a combination of favorable interest expense and interest income as well as slightly higher budgeted -- higher-than-budgeted capital interest expense. So it's really in those categories where most of the favorability was realized.

Well, I was referring to Q1. We didn't have any transactions that closed in Q1. So transaction activity cap rates did not really have an impact. As you look at the full year guidance, we expect basically due to adjustments in a range of things that fall with the capital markets activity such as buying and selling assets and then movement of interest rates on existing debt and additional debt activity that we have anticipated.

John, it's Matt. So the only deal that we have that matures next year '25 is a very small $13 million loan in Northern New Jersey, very stable, strong market. So all the other ones don't mature until '26 or later. So it wasn't necessarily kind of first in, first out, so to speak.

I mean the rent versus own economics that we're seeing today are really unique, not something that we've seen. We've obviously, over time, seen small variations in that. But the combination of home price appreciation, particularly in our markets and the rise in mortgage rates has led to all-time levels, right?

Yes. I mean the forecast for this year reflected being a relatively stable level. Obviously, interest rates bounce around, prices bounce around. But in terms of the current year outlook sort of reflects generally where we are at this point in time have remained relatively stable.

Anne, this is Sean. I mean it's early in the calendar year for some of the assessment cycles that really are more heavily weighted towards kind of midyear and the back half of the year. What we have seen thus far is a little bit of an uptick in Washington State and Virginia.

Yes. Anne, it's Matt. So our asset preservation CapEx has been pretty consistent over the last -- well, between '23 and '24, around $1,600, $1,700 a unit, which is, I guess, roughly 6% or 7% of NOI, 7%. The NOI-enhancing CapEx, that's where we really increased our investment or we're looking to increase our investment volume quite a bit. I think we invested about $75 million, $80 million last year across the whole portfolio, most of which I guess was same store. We're looking to double that this year.

No, not really, Brad. I mean low 3%, 3.2%, 3.3%, somewhere in that ballpark. I mean we've seen asking rent growth kind of 5.5% or so through yesterday. That's played through just renewal offers that have already been made in terms of what our expectation is for rate growth. So it seems like somewhere in that range for the second quarter is reasonable. And then you will have to see how asking rent growth continues as we move through the second quarter.

Yes. What I would say, first, in terms of the expansion regions is we have relatively small portfolios in our same-store basket in those regions. So as you think of the expansion markets in Texas, for example, we don't have anything in Austin. There's only 2 assets in Dallas. We have seen -- at least in Q1, we saw a year-over-year increase in concession volume in Dallas. In the previous year, it was about 1/3 of all leases. It was roughly about half in Q1.

Yes. Amy, it's Matt. It is certainly true that there's less barriers. There's less regulatory barriers to entry in the Southern markets. And so supply is able to respond to demand much more quickly. And some of the supply kind of excesses you're seeing now are -- were a relatively quick market response to tremendous demand a couple of years ago that really started with COVID in some of those Southern or Sunbelt markets. So it is, I'd say, a shorter cycle, a more attenuated cycle. Demand comes, supply can respond quickly. But having said that, there is a lot of demand there. And the interplay between those 2 factors into our view on kind of our long-term portfolio allocation and trying to get to 25% there.

Yes. I'll add to that. And as we're thinking about the opportunity set in the Sunbelt, we've got in the near term, the ability to buy below replacement cost and be at a good basis and find that attractive from a long-term hold perspective. We are increasingly also focused on bringing our strategic capabilities and particularly our operating model initiatives.

Land costs?

Yes. So it varies, obviously, a lot by region. In some regions, we have seen, particularly in some of our [indiscernible] regions, we have seen land prices come down significantly for motivated sellers. There's plenty of sellers kind of like the assets we're talking about, who are not particularly -- there's no time sensitivity, and they're holding out.

Alex, it's Matt. I would say no. Our developer funding program is really focused on expanding our growth in our expansion regions. So we're not looking to grow our capital investment in New York.

Yes, Alex, this is Sean. I think the broad brush is relatively consistent of what you stated. But certainly, real estate is a local business here. And there are submarkets that are challenged for either demand or supply reasons or both.

Alex, I'll just add briefly. We've highlighted the improved job picture, right, given the change in expectations from the beginning of the year. But there are crosswinds, Sean touched on a couple. And I would highlight the inflationary impacts on our consumer and their wallet. I mean those are very much there and true when you think about car loans, I'm coming up for renewal, when you think about the beginning of student loan repayment. So the outlook has improved, but I would still describe it generally as sort of our consumer facing a series of crosswinds.

Anthony Powell here. Just a question on the bad debt improvement you saw in the quarter. What drove that improvement? Was it the core kind of improving their process, getting quicker, resi coming back in current? Maybe more detail would be great there.

Sure, Anthony, it's Sean. Sort of a combination of all those factors that you just laid out. And what I'd point to geographically, which might be a little bit of a surprise for people is most of the improvement was actually not in places like L.A., which have been sort of the poster child for this.

Maybe going back to the New York law that was just passed. I guess you don't want to increase more capital to New York. Was that a comment on the office ready or just a broader comment? I wanted to see if you can maybe just close your views on both the rental provisions and also the development provisions in the [ wall ]?

Yes. I mean -- this is Matt. It was really just a broader comment. When you look at our portfolio allocation, our portfolio allocation to the New York Metro area, I think, is roughly 20% today. It has been -- and we've been on a journey to reduce that over time. That's one of the regions we're rotating capital out of as we redeploy capital into our expansion regions.

Yes. Linda, it's Sean. I wouldn't say anything terribly significant. The only thing that I could point to a little bit is as you might imagine, as winter, COVID, the [ roommates ], the volume of [ room rates ] across the portfolio has certainly declined. It has kind of come back up to some more normal levels, roughly, I would say. That would be the only data point that I really could point to for you.

Yes, Sean, again. Not at this point that we've seen, other than certainly our lower price point assets in some of the markets, particularly on the West Coast, where we have a greater share of those assets are performing quite well. I think to Ben's point, there certainly are consumers that are feeling a little bit of pinch from what's happened with inflation, student loans, car leases expire, et cetera, et cetera.

Yes. Sure, Jamie. This is Kevin. Maybe just to kind of provide some context, I'll just start with our capital plan for the year. It's not changed significantly from our initial outlook. And as you recall, what we identified then and it's still true today is that for 2024, we have $1.4 billion in uses, which consists of $1.1 billion of investment spend and then a $300 million debt maturity later this year in November, which has a 3.7% interest rate.

Yes. Jamie, it's sort of -- one of the -- hedging is something we do. We evaluate continually over the course of the year. We don't have rigid fixed plans to hedge X percent of debt maturity, in advance of its maturity. It's really a function of what do we anticipate doing in the current year and the following year? And how do we think about our evolving sense of the capital plan that we'll have for each of those years and what the opportunity set looks like in the treasury market for hedging.

Yes, Michael, I'll make a couple of comments. So starts in the Sunbelt expected to peak at some point kind of mid this year, stay elevated as you get through kind of the middle of next year. And then given the reduction in start volume, starts to come down back towards more historical levels as you get towards the end of 2025. So I think that was sort of part of your comment there.

I think they start to approach closer to historical norms for a period of time. Matt made the comment earlier about now the barriers to starting deals in the Sunbelt and the shortness of those market cycles. So it does factor into how do we think about our overall portfolio optimization.

And Mike, one thing, I think, to keep in mind here is I'd be a little careful about isolating years as being very unique in terms of the delivery cycle and the impact on fundamentals. As Ben was alluding to earlier, what you see on that chart in terms of deliveries for 2024, where it does peak in the back half of this year, people will be leasing up. Putting those units into the market 12 to 13 months beyond sort of the initial delivery dates in terms of how they're leasing them up.

All right. And thank you all for joining us today. We appreciate your engagement and support, and we'll talk with you soon.