艾芙隆海灣社區公司 (AVB) 2004 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the AvalonBay Communities third quarter 2004 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session, and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touch-tone telephone. As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Alaine Walsh, Director of Investor Relations. Ms. Walsh, you may begin your conference.

Thank you, Angela. Good afternoon and welcome to the AvalonBay Communities third quarter 2004 earnings conference call. On the call today are Bryce Blair, Chief Executive Officer and President; Tim Naughton, Chief Operating Officer; and Tom Sargeant, Chief Financial Officer. If you didn't receive the press release in yesterday's Fax or E-mail distribution, please call us at 703-317-4636 and we'll be happy to send you a copy. As always, I'd like to remind you that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements and actual results may differ materially. There is a discussion of these risks and uncertainties in yesterday's press release as well as in our form 10 K filed with the SEC. Also, I'd lake to mention in both the wire release and the full release, we've included, as we always do, an attachment with definitions and reconciliations of nonGAAP financial measures and other terms that are used throughout the release and also which may be used in today's discussions. This attachment is also available on our Web site at www.avalonbay.com/earnings. We encourage you to refer to this information during your review of our operating results and our performance. With that, I'd like to turn the call over to Bryce Blair for his opening remarks. Bryce?

Thank you, Alaine. Last evening we reported EPS and FFO that exceeded expectations and allowed us to raise our full year guidance for the second time this year. On our call today we'll be discussing the strong execution in the key areas of our business which was largely responsible for that outperformance. Specifically there's four key topics that we'll be addressing. First in the area of execution, the strong execution in our core business has led to the first year-over-year NOI increases in over two and a half years. And in fact, this quarter we saw positive FFO growth, positive same-store sales revenue growth, positive NOI increase, the first time in three years that all of these three metrics have turned positive. This is a result of both strengthening fundamentals and excellent on-site execution. It's not one or the other, it is both happening together. Secondly, we're going to talk a bit about valuation. Our opportunistic disposition activity allows us to capitalize on a very strong disposition environment capturing value and further demonstrating the embedded value of our portfolio. So far this year we've closed on about 100 million and have about another 150 million that's likely to close over the next few months at an average cap rate of below 5%.

Now while we don't quote our own internal NAV estimate, we do try to provide all of the relevant data so that you may arrive at your own estimate. And often we're asked for our opinion as to an appropriate portfolio-wide cap rate for our assets. Without providing a specific number, the data from our recent sales and the cap rates at other private and aren't public Company portfolios have traded would suggest an appropriate cap rate for Avalonbay's assets would certainly be in the fives. Third topic we'll touch on is that of value creation. We'll be discussing our creative and growing development activity. With development yields 2 to 300 basis points above acquisition cap rates, our development activity provides a significant contribution to both current and long term earnings and NAV growth. Finally, we'll be addressing capital markets activity and our revised outlook. Tim will be focusing his comments on the first three in the areas of execution, valuation and value creation when he touches on our operations, investment, and development activity while Tom will be addressing the capital markets activity as well as expanding on our quarterly results and a full-year revised outlook. With that, I'll pass it to Tim.

Thanks, Bryce. As Bryce mentioned, I'll discuss property accusations and investment activity where I'll touch on new development as well as dispositions and acquisitions. Starting with property operations, property performance continue to improve in the third quarter. During the quarter as Bryce mentioned, we experienced our first year-over-year increase in same-store revenue in three years. Occupancy increase is up 300 basis points from the beginning of the year. By the end of the quarter, occupancy stabilized at healthy levels with every market over 95% as we shifted our focus to pricing. First in the form of reducing concessions and more recently to increasing market rents. Improving market conditions are playing out in our portfolio as expected. First in increased occupancy, which started in Q1, then in reduced concessions which began in Q2. And now in higher market rents, which occurred this quarter.

More specifically, year-over-year same-store revenue was up by .5% from Q3 of last year. Continuing a trend over the last several quarters of progressively better year-over-year results. All regions posted increases with the exception of northern California. The midwest, Southern California, and the Mid-Atlantic were the strongest performing regions on a year-over-year basis. Same-store expenses were up modestly at .3% driven in part by lower insurance, bad debt, and utility expenses in California. For the full year, same-store expenses are up just over 1% from 2003. Sequentially from Q2, same-store revenue increased by .6% with all six regions posting sequential increases. This is the second consecutive quarter sequential same-store revenue increased. This during our peak leasing quarters of the year. Economic occupancy was over 95% for each region for the quarter, and averaged just over 96% for the entire same-store portfolio. With occupancy stabilizing in the 95 to 97% range for most markets during the quarter, our focus shifted to pricing, as I mentioned earlier. Initially, this was occurred in the form of reduced concessions. As concessions per move-in have fallen steadily since their peak in April down over $400 per move-in or from roughly $1100 in April to $700 by September. And more recently in August and September, we have seen an increase in market rents of over 1%.

Renewal rents are up as well with same unit renewals up about 3% in September. While it is still early, we are seeing some traction in pricing. The biggest improvements of sequential same-store revenue across regions occurred in Southern California, the midwest and Seattle all increasing on the order of 1.5 to 2% since Q2. This is the second consecutive quarter of healthy improvement in Seattle and the midwest as these markets continue to recover from significant downturns. Southern California, on the other hand, improved again after its performance flattened somewhat in the first half of the year. The other three regions, northeast, Mid-Atlantic and northern California posted modest increases in same store revenue of .5% or less. The northeast experienced significant improvement last quarter Q2 due to occupancy gains and is just now seeing effective rental rate increases. This region along with northern California appear to have bottomed. Performance should accelerate with modest job growth in both of these regions over the next few quarters. Particularly given the depth of their downturns and the limited levels of new supply coming in these markets. These two regions account for almost two-thirds of same-store NOI, so any improvement in either of these regions will positively impact overall portfolio performance.

So in summary, we've come out of the peak leasing season a bit better than expected and with some positive momentum. We'll continue to see acceleration in same-store revenue on a year-over-year basis as we move through the fourth quarter. Although year end seasonal issues will result in same-store revenues flattening on a sequential basis. I want to shift now to investment activity where I'll start with acquisitions and dispositions where there was more activity this past quart. As we previously discussed, we've become more active on the acquisition front with a focus on value-added opportunities. In addition, we are continuing to sell assets with the focus on opportunistic transactions, focusing on unique opportunities to harvest value. During the third quarter, we purchased two assets. One in Chicago and one in Boston. Both of these acquisitions are planned for redevelopment. In addition, we have one other asset under contract in Baltimore. Last quarter, we discussed the Chicago acquisition, Avalon Briar Cliff, so I won't go into detail there. But I would like to spend a minute describing the Boston acquisition because I think it is both interesting and illustrative of what makes us different.

Essex place was purchased in September subject to a long-term purchase option secured in 1998 at the time our local development team bought adjacent land from the same owner for a new development community. The community known as Avalon Essex which we've since built and stabilized. We intend to redevelop Essex place, position it as a B community and manage it in concert with Avalon Essex, thereby providing a broader offering of products to the market. This is an attractive opportunity in that the price was negotiated at the time of the original purchase option and subject to modest escalation. This transaction is a good example of what makes AvalonBay different. Because of the fully integrated apartment Company in our markets, a s a developer, a builder, an acquirer, a seller, and an operator, we can create and harvest value in unique and often unpredictable ways where a single point of negotiation on a transaction that occurred six years ago can translate into an opportunity to create value today. The projected stabilized yield on this asset is in the mid-sevens on a prerenovation basis and around 8% post renovation or about 150 basis points better than cit an be obtained in the market today. On the disposition side, we sold one asset at the end of the quarter. Avalon Fox Mill were sold for over 38 million to a condo converter and represents another example of how we uniquely create and harvest value. Avalon Fox Mill was built and completed by Avalonbay in early 2000, and was sold at a sub 5% cap rate at twice our cost resulting in an over 20% unlevered IRR. This was clearly an opportunistic sale and one we pursued in response to a unique market condition.

We continue to search for other opportunities on the disposition side, where we believe we can earn an outsized return relative to the risks. In fact, we are currently working on a few other sales to condo converters that may close over the next two to four months. To the extent that these transactions occur in this calendar year they'll have a negligible impact on FFO. Finally, I'll turn briefly to development activity. Our development pipeline declined modestly this past quarter as we completed one community and had no starts. Total development volume stands at just over 700 million and we expect volume will remain fairly stable in the 700 to 800 million range over the next couple of quarters as we complete and start communities at about the same rate before it starts to grow again in mid 2005. During the quarter, we completed at Krogener Station, a 497-apartment community in north Bethesda, Maryland. This is the second community we've completed in this sub market over the last year. It was completed at a cost of 79 million or about 3 million below our original budget. So overall on Q3, operating results continue to improve extending many of the trends from Q2, occupancy stabilized at healthy levels and our focus shifted to pricing. Where we are seeing some traction for the first time since the economic downturn. We are more active on the transaction front looking for value-added opportunities on the acquisition side and unique opportunities on harvest value on the disposition side. Finally, we remain active on the development front. Where we continue to exercise a mix of business judgment and discipline and making new commitments. With that, I'd lake to turn it to over to Tom, who'll discuss financial highlights for the quarter.

Thanks, Tim. This afternoon, I'd lake to address three areas. First would be to recap or drill down how we outperformed our earlier estimates provided in July and highlight what elements are recurring as well as one-time events. Next I'd like to focus on the balance sheet, recent capital market activities, and the progress we've made to date on our investment management fund. Finally, I'll conclude with some comments on the fourth quarter outlook. In terms of recapping the quarter compared to the outlook we provided to you in July, we provided an FFO range of 80 to 84 cents in July, and using the 82-cent midpoint, we exceeded our forecast by 4 cents. There are four principal areas that contributed to the outperform -- outperformance each about a penny. The first was NOI communities exceeded our forecast. Second, we had lower net interest costs. Third, we had lower than expected other operating costs including abandoned pursuits. Finally, we recorded a gain on a land parcel that was sold in the Washington, D.C. market.

Just a quick note on two of these items, abandoned pursuit costs have been trending lower lately. But, it's important to note that any one abandoned development right could lead to a large write-off in any quarter. We're not aware of any potential write-offs right now, but we want to point out and remind everyone how volatile this category can be and especially in our markets. And as for land sales we do have some land inventory. It's about 100 million at cost, but we generally hold options on development rights not land. Future gains or losses on the sale of land are too unpredictable and volatile to predict. We generally will not forecast or budget land sales. Turning to our balance sheet and capital markets activity, the key metrics we use to measure financial strength remain solid. Our debt to total market caps 36% and our fixed charge coverage is about 2.8 times. 81% of our assets are unencumbered with either secured debt or commitments for tax protection. These attributes make our assets highly marketable and attractive to buyers which we again demonstrated this quarter with the sale of Fox Mill. Capital activity this quarter included a tax exempt debt refinancing of about $9 million, it lowered our rate by about 200 basis points. We worked on acquisitions that required either debt assumptions or debt placements. We also worked on the redemption of a participating mortgage note that we held on an asset in the Boston area. This note was prepaid in October.

And in addition to a full repayment of the note, we received a prepayment premium of 1.2 million that will be recognized in the fourth quarter. Just to clarify this is the payment that we will receive and not pay because it is unusual actually to be holding a note and receiving a prepayment premium for it. We made good progress on the investment management fund this quarter. We have a lead investor. We have soft commitments that will allow us to have a first closing sometime in the next several months followed by a second closing early next year. The planned equity raises 250 million and will allow us once levered to purchase approximately $700 million of existing product in our current markets. Turning to outlook, the midpoint of our FFO per share outlook for the fourth quarter is 87 cents. And the mid point for the full year outlook was lifted to $3.34. Fourth quarter outlook reflects operating trends at current levels and includes the 1.2 million prepayment premium noted above. There will be some short term dilution from the Fox Mill sale. The lost incomes are from the redemption of the participating mortgage note which did have a 10.2% yield on that note. Consistent with prior years, we plan to provide our 2005 financial outlook in mid-December and we'll wait until December to provide details but our macro view on 2005 is positive. Fundamentals in our markets are expected to outpace the U.S. leading to positive revenue, NOI, and FFO growth for 2005. We have noted in the past that many of you post your estimates for next year based on a third quarter run rate. If you plan to post 2005 estimates prior to our financial outlook release, we'd like to point out that the third quarter earning's run rate should be adjusted for the non recurring items I've noted in my comments as well as the expected NOI growth that should emerge in 2005 as the recovery in job growth progresses. With those comments, I'll turn the presentation back to Bryce.

Thank you, Tom. In late last year, we stated that 2004 would be a year of transition. One where sustained job growth would lead to a transition to more stable apartment fundamentals. We also stated that this would be a year where we be focused on strong execution across the core aspects of our business. We were committed to finding ways to outperform as the market stabilized. The external data and our own operating results confirm that this transition is occurring as well as speaks to the strength of our execution. I'd like to emphasize that -- emphasize a few data points to confirm that. Fist on the economy and apartment fundamentals, job growth for the year turned positive this year for the first time in three years. Next year, AvalonBay's markets are projected to generate over 600,000 new jobs, which will reflect an increase of about over 2% in job growth. Managed fundamentals returned to a balanced level in '04. This is the first time in four years. The ratio for next year of Avalon based markets is expected to exceed 2 to 1, which supports our view of accelerating growth in 2005.

In terms of our own performance, year-over-year NOI turned positive this quarter for the first time in two and a half years as I mentioned, reflecting the improving fundamentals and our focus on our operations. Our occupancy of 96.1 is now at the highest level since the first quarter of '01. Our year-over-year FFO growth rate turned positive this quarter for the first time in two and a half years, boasting at 7.5% increase over the same period last year. This increase is in part the result of the value created through our capital recycling efforts. During '03 and '04, we have or expect to sell about 700 million of properties at an average cap rate in the fives. This capital is reinvested into our development activity it yields 2 to 300 basis points higher. Our development pipeline now totals over 3 billion of communities under way or in the planning stages. Development has and will become an even greater source of value creation. What I hope you take away from our comments this afternoon are first that the expected transition in apartment fundamentals is indeed happening. Secondly, as a result of the strengthening fundamentals, and our strong execution, our results are exceeding earlier expectations and we indicated that with the raising of our guidance for the second time this year. And finally, given the nature of our markets, being supply constrained and having the strongest projected fundamentals next year, the quality of our products and our development pipeline which now totals over $3 billion we are well positioned for our performance in '05 and beyond. With that, operator, we'd be glad to open it up for any questions.

Thank you. Ladies and gentlemen, if you have a question at this time, please press star and the number one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press star, 2 on your touch-tone telephone. If you are using a speaker phone, please lift the hand set before asking your question. Again, if you have a question at this time, please press star, one on your touch-tone telephone. One moment, please, for the first question . The first question comes from Andrew Rosivach with CSFB.

Good afternoon. I'm wondering Bryce, you kind of touched on this. If you go back to your way back when December guidance that you'd been blowing away so early it's going to tap into the range. How much of that do you think might have been attributable to a larger spread between dispositions and development yields than maybe you thought of at the beginning of the year?

Andrew, that's clearly part of it. It is certainly tough to parse it if there is a great degree of specificity. I think Tom in his comments, commented on some of the reasons for outperformance this past quarter and they relate really to the general year in the sense of some of it is clearly from greater spreads in terms of the disposition activity being at very attractive pricing and ability to reinvest that, although clearly there is a lag time between the sale of an asset and the accretion from the reinvestment and development. But that is one factor. The second factor that Tom touched on was lower interest rates, really, throughout the year than we or many expected. We expected a rising rate environment this year that really hasn't materialized. The third reason is clearly the operating performance of the portfolio which we have -- which Tim spoke on, in his comments. So it's a mix of at least those three primary activities and I don't know if Tim or Tom, you want to add to that?

I'll just keep going. Tom, a quick one, it sounds like you guys are going to be selling some assets but nothing's in hold for sale right now. I'm wondering if that might be related that you're kind of warehousing assets a bit for a joint venture fund?

No it really relates to what triggers something to be on the balance sheet for held for sale, until you have a contract or an agreement to sell it, it's not separately classified as held for sale. We do expect that, you know, 150 million or so of assets could be sold in the fourth quarter, might carry over into early next year. Those are getting under agreement as we speak but they didn't meet the cutoff in terms of third quarter earnings state.

Okay. If you did have a closing in the fund this year, would you contribute any assets from your existing portfolio or would those all be kind of third party assets?

No, we have warehoused so far two assets that we purchased. A third we purchased by the end of the year. So we expect that three assets that we've acquired would be transferred over into the fund. It's important to note though that the assets we bought today were in our forecast so the fact that we outperformed isn't related to the fact that we bought those assets. Those were included in our plan. Got it.

Okay. Then Tim, a quick markets question for you. What is great about your portfolio is most of the markets seem to be seeing very little new supply. If there's one that the supply data keeps popping up it's D.C. I'm wondering if there are any particular submarkets that you might have concern about in your fort polio.

Within D.C. specifically, Andrew?

Yeah.

Stepping back a bit, 2004 is going to be the peak year for deliveries in D.C. and we're actually expecting that to moderate fairly substantially next year. I think we were on the order of just under 3% of inventory 2004 we'll be somewhere in the 1.5% of inventory in 2005. One of the markets we were concerned about was downtown D.C. the east end where there's been a fair bit of new supply that's been delivered there and it's still going to be delivered there in 2005, some of that is converting to condominiums which is helpful. But, frankly that was one of the reasons behind the sale of the Gallery Place, Phase !! end.

Thanks guys.

Your next question comes from David Ronco of RBC Capital Markets.

Hi good morning, here with Jay Leupp. Just a question on development yields, it looks like you ratcheted back your pro forma to 8.1 from 8.2 last quarter. It's down about 50 basis points year-over-year. Wondering just why you reduced it whether it was on the cost end or on the revenue end? And I wondered if you could just comment on how firm you think this latest projection is?

Well, David, this is Tim Naughton. I'll answer that. The last quarter reported the projected yields, average projected yields of 8.2 this quarter 8.1. In reality, it's down just a few basis points on the order of 5 or 6 basis points, and primarily on the revenue side of U.S. that's where average rents come down 10 or $15 and I think Avalon Pines was the only one that sounded a little bit more significant, on the order of $75. Just a little color on that. We just opened for leasing at Avalon Pines and we were trying to get leasing simulated which has been absorption's been pretty brisk there. But it rates about $75 under original pro forma. In terms of how firm it is, it's frankly a function of the market and we basically, you know, those are just a function of what the existing leases are and what we believe existing market rates would be for those that are unleased.

Tim, just kind of a strategic question to follow up on that one. You guys obviously have got to 96.1% occupancy here. Wondering how high you guys plan on going before you being more aggressive with rents? Do you see that happening?

We're pushing it now, David. We've gotten in September I think we -- economic obviously is 96.2 for September. We're probably going to run in the 96, 96.1 range for October. It is at about 96% which translates into about 5, 5.5% availability. Where you start seeing some traction in pricing. So that's, really as we started moving towards that 96 range is when we really started being more aggressive in terms of reducing concessions and in the last couple of months actually increasing market rents as well as renewal rents..

Thank you.

Sure.

Your next question comes from Rob Stevenson of Morgan Stanley.

Good afternoon, guys. Tim, can you talk about the cap rate on the Chicago acquisition? You talked about the Boston but not that one.

Sure, Rob. This is Tim again. I didn't mention it because we talked about it last quarter but it was in the mid 6son a pre-renovation basis, and a 7 low 7s on a post renovation basis. That was an off market transaction, was not a big deal. And you know, something we pursued through relationships.

And are either of these two assets that you are acquiring this quarter going into the JV or is this stuff that's got to be redeveloped on your own balance sheet?

Rob this is Tom Sargeant. The assets that we acquired to date that are going into the fund would be Briar Cliff which is the Chicago asset and Esplinot which is the Southern California asset. The Boston asset, because it was subject to a pre-existing purchase option wouldn't qualify as a fund asset.

Okay. And then Tim, what was unit turnover during the quarter and where was it a year ago. Then what's the move out to home purchases during the quarter?

Sure,Rob. This quarter, third quarter 71% annualized turnover. That compares to 74% a year ago in Q3. Q2's 62% but Q3's always the peak turnover. And your last question, was percentage related to home purchase? That stays stable at 28% from the last quarter which is actually still the high mark for us over the last few years. It's typically been in the 20 to 25% range.

Okay Tom, was there any significant lease termination fees during the quarter, significant level of termination fees in the numbers?

No, in fact, they are down year-over-year. If you were to carve that out, we could have actually reported a higher revenue growth year-over-year than we did.

Okay. And then, Tim, bad debt expense. I mean, what are you seeing there in terms of the trend?

It's gone down. It's running about .7% of market rent Rob, and I think we peaked right around 1% .9, .1%. So year-over-year is probably down in the order of 25, 30%.

Last question, Tim, the two assets that you guys completed development of in the first quarter, Steven's Pond and Derrion, what are the returns and the prospect looking forward for those properties these days?

What are the returns?

Yeah, I mean, how are they doing? The stuff that you basically completed during the first quarter now that they've had a little bit more than six months of lead stop and et cetera?

I can't speak specifically in terms of how the rents are doing there but they are both stabilized at this point, Rob and just to each of those markets. Boston's firmed a bit. It's a run a little bit flatter this past quarter. Had firmed a little bit more in the second quarter. Then Connecticut, generally Fairfield county has improved pretty dramatically from last quarter. You can see by the change in same-store occupancy. So we're starting to see the greater New York area which includes the Fairfield just giving job growth trends that we're seeing there. We're really starting to see that firm pretty nicely.

One other question that just came to me, in terms of acquisition, you talked about the one in Baltimore. Is this another sort of big asset to be repositioned or is this something more along the lines of your core product?

B asset to be repositioned kind of '80s genre.

Thanks, guys.

Your next question comes from Jordan Sadler of Smith Barney.

Hi, guys. Just on revenue, sequential revenue as you mentioned was up for the second consecutive quarter. What are your expectations? I know you said economic occupancies are sort of flattish in October, '96, but given that it's sort of the slower leasing season, do you expect it to be up again in the fourth quarter?

Jordan, this is Tim. We actually expect it to be relatively flat relative to the third quarter. That's largely due to seasonal issues so as this relates to same-store occupancy tends to trend down a little bit in the fourth quarter as well as just transactional revenue which trends down as well as you get it outside of the peak leasing season. So year-over-year, we expect it to continue to accelerate as we've seen over the last several-quarters but on a sequential basis due to seasonal issues we expect to flatten in Q4.

Then just on the northeast in general you started talking about Connecticut, Fairfield sort of firming up a little bit. What are your expectations, I guess, over the next sort of year or so 12 months, I think you have about 10 developments in the northeast coming online. Do you think that those are going to do better than originally anticipated or sort of slowing based on what you're seeing today.

Well, it depends when they were started honestly. The northeast has been improving here for the last, you know, 3 to 6 months. Particularly the New York area, so to the extent the asset started, you know, a year ago it's gone through a period where it's dipped a bit, you know, and so it's just going to be a function of when it actually started. In general, northern New Jersey probably will be the last to recover particularly along the waterfront. In general we are seeing firmness across the portfolio in the New York area.

Okay. And then maybe one for Tom on the fund. Have you disclosed anything yet on the fee structure? I sort of missed the timing on that, the closing.

Jordan, we haven't disclosed anything on the fee structure but I'm glad you brought the fund up because I think someone else referred to it as a joint venture. And this is very different from a joint venture. It does have a different fee structure. It does have -- it's a discretionary fund so we're not having to identify the assets ahead of time. But there generally are fees that are in the following categories. There's an asset management fee that's generally in the 1 to 1.5%, maybe .75 to 1.5% range. There is a property management fee that depends on market conditions. And those are the two principal fees that are recurring. Then there are promoted structures after you receive certain hurdle rates. You get generally 20% of the profit above that hurdle rate.

What's the hurdle?

The hurdle's 10.

Okay. Leveraged, right?

Leveraged, correct. So these are the general parameters that you see in terms like this. I'd say that our terms are clearly market. That's what we were trying to accomplish is a transaction that would clear the market. These are the range of the terms that you might see.

Okay. Did you say timing on a closing?

You know, I think that we got a really good shot at getting it done by the end of the year. It could creep over into January depending on holidays but we do have a lead investor. We do have committed 25% of the fund. We're committing to 20% of the fund. We have another 30% soft circle so 75% of the initial 250 million is largely committed. We're confident that that's enough for first closing followed by second closing maybe in the first quarter of next year.

Okay. I remember one stipulation about it. This was exclusively where the stipulations would be completed for the next three years or so.

Correct.

Upon the launch of the fund not include this Essex acquisition?

Well, what we've said is that anything that we commit to in terms of acquisitions this year beginning with this year would go into the fund because Essex place was a commitment that originated in 1998, it doesn't qualify for the fund. There are some carve outs like if the assets over 100 million, we would carve that asset out because of diversification, but this is meant to be the exclusive acquisition vehicle during the investment period, which is three years. We're looking to put every acquisition that is committed to after January 1, into the fund.

And two quick housekeeping issues. The amount of land on the balance sheet at quarter end?

About a hundred million.

Okay. That's the development in the development pipeline, right?

Yeah, there's a hundred million that we own. Land that we're carrying on our balance sheet is a hundred million.

Okay. And just the timing on the Fox Mill sale?

That was end of the quarter, Jordan.

Thanks, guys.

Your next question comes from Stephen Swett of Wachovia securities.

Tim, on northern California, your occupancy rates are in that 95% plus range. Could you just comment on where you think that market is relative to your others? Are you starting to reduce your concessions in that market or is it still a quarter or two away?

Steve, this is Tim. You know, I guess what's changed in northern California is rents appeared to have bottomed. We actually over the last several quarters occupancies have stabilized in the 95% range. I think the market was a little bit lower than that. But for our portfolio it was in the 95, 95.5% range. And more recently I think what's happened is the market's come up a little bit and rents have started to go flat where they had been negative. So it's not what I would say in early stages of recovery yet.

Okay.

Bryce, do you want to add anything to that?

Steve, just a couple of other data points on that, we've been talking for sometime about this year being a year of transition where the department of fundamentals basically came back in the balance. By that, we mean basically demand and supply roughly at a one ratio. Within our overall markets, the northern California property -- the northern California markets, San Francisco, Oakland, and San Jose are three of only four markets that are still negative in demand/supply fundamentals as we track them. San Jose being the most negative and that's clearly where we have a large concentration of our portfolio. It's a market that has not yet started to generate any positive job growth in San Jose. As differentiated from San Francisco and Oakland. That's continued to see a fairly robust level of supply. You know, as Tim mentioned in his comments, that's a market that is not yet on its feet but it does have a potential positive source of opportunity for us when it does because of our concentration there.

Okay. And Tim, I think you mentioned that -- or Tom did that you expect to push your development, you're under construction up in say mid year 2005. How much do you think, you know, you would look to push that total under construction volume? Next year?

Well, we're currently 700 millionish probably because of the 800 million here over the next quarter or two. That could easily -- that could go to a billion kind of mid next year. Based upon what we've got in the pipeline right now in terms of what are likely start dates for the things in the pipeline. Obviously, that's assuming that the market's ready at the time that we're ready.

And then on the disposition front, is there any particular market you guys would look to to concentrate some of your near term dispositions in or do you feel you are pretty well balanced at this point?

Well, as we mentioned before, it's really less about strategic sales, Steve. It's less about portfolio allocation and really where our focus has been on the opportunistic sales. Which continued to be Southern California, D.C. to some extent particularly where you see the condo activity and we're seeing cap rates that, you know, you know, equate into 15 to 35% asset premiums over the underlying apartment fundamentals.

Okay, last question, Tom on the mortgage note that you said was paying off, could you just give the number on the size of that note and the rate and the payment penalty again?

Yeah. The note was about 25 million. It also had some accrued interest -- accretive and unpaid interest that was included in the payoff. The amount of the prepayment premium was about 1.2 million. And it's interesting to note that that was paid off in October and had they had the leisure to wait until early next year, there would have been no prepayment penalty so we were encouraging a payoff, and, you know, a couple of other notes. That note was in default if you remember we disclosed that in our SEC filing, so we're pleased to get full recovery of the note, full recovery of accrued interest including the interest that was in default and a prepayment premium of 1.2 million. We came out fine on that transition.

Okay. Thank you very much.

Your next question comes from Richard Aoling with ABP Investment.

Hey, guys. Just have a couple of follow-up questions on Steve's question regarding the note and Tom, just a little housekeeping, where did that show up, the interest income on that, the current pay portion? Is that in like other income line item?

Well, it's a little more complicated than that, Rich, because that note under 1046 had to be consolidated so you ended up seeing part of it NOI based on the performance of the asset and the difference would go to minority interest. It's just a weird a duck.

Okay. I thought it would be easier just to plug a line item.

No.

Okay. All right. On some of my more interesting questions now. Tom, I noticed that you're interest, excuse me, your debt went up about 94 million rounding up, but it looks like you only invested about 54 million in new development/redevelopment spending. And I'm just curious where the other amount came from because it looks like you sort of netted out your acquisitions and your dispositions for the quarter. Maybe I might be missing a part.

Well, I might be missing a part. You threw out a lot of numbers. Why don't I call you back after the call and I'll reconcile those cash flows but it's certainly fundable and not that 50 million isn't a lot of money, Butt I would have to follow up with you after the call.

Okay. Sort of on the same vain, your variable rate, excuse me, your line of credit debt has gone up to 200 million. Where are you guys comfortable taking that?

Well, that's one element of variable rate debt. There are other components of variable rate debt that if you were to add it all together we're at about 17.7% of our debt's floating at the end of the quarter.

Right.

We're comfortable at up to 25%.

Right. In the mix, because I know you've got the tax exempt as a considerable portion of that. That's why I kind of excluded that from the question. I know that's less sensitive. I don't know if you have a target for, you know, breaking down tax exempt versus other line debt.

Not really. We don't really have a target between the two. I think if we stay below 25%, we feel like that that gives us some hedge on economic activity and the impact that it would have on interest rates without, you know, betting the farm. So there's a level of floating rate debt that you have that can actually increase your risk adjusted returns and we want to be, you know, slightly higher than history but not go overboard especially on a rising rate environment. The 25% floating rate debt is easily manageable especially within an apartment portfolio that responds to interest rates and changes in economics pretty quickly.

Right. My other question is regarding your G&A. It ticked down a little bit this quarter, which I think if I'm eyeballing your previous years, it's sort of seasonal. Where do you think the fourth quarter run rate comes in at and then also if you can just comment on capitalized overhead that's been going up. I guess it's related to obviously development projects picking up steam here if you could just give me an idea of where you expect those to be heading?

Let me answer the last question first. The increase in capitalized overhead relates to the pickup in our development activity. We staffed up our team to respond to the opportunities in the market. And that, you know, in terms of where that will trend out for the year, it'll roughly -- and then G&A in general will roughly be in line with what we provided in our initial outlook in January. I think the ranges we gave there, if I am correct, G&A is expected to go up 10 to 15% for the year, and we think that that will trend in that area.

Okay. Okay. And then so you said also the capitalized overhead. Because what I'm hearing seems like for the next couple quarters, your amount of development activity should be in like a stasis mode. So you don't think you're going to be doing a lot more hiring there?

I'd refer you back to the outlook we gave at the beginning of the year for that category which was 6 to 9% total change in capitalized G&A for the year. We think it will be within that range.

Okay.

Tim, do you have something you'd like to add?

Yeah. If I could just add to that Rich. Total development activity just isn't what's under construction. It's also what's in the pipeline. In fact when you look at actual development overhead, those folks are spending more of their time on stuff that's in the planning and entitlement stage.. I think it's on attachment 11 you see that the pipeline's gone up to over 2.5 billion which is an increase of 250 million over last quarter's and an all-time high. So there's more deals out there that folks are working on. What's under construction has been relatively stable over the last quarter to what's in the pipeline coming is actually going up.

So the backlog is building, huh?

Well, the backlog is building the team is gearing up to support that, and one comment I think I made a few quarters ago is what you should be worried about is if you see a pipeline growing and you don't see any G&A growing because that can spell trouble.

Right.

You've done a good job of keeping the infrastructure in place and making sure we're matching the organization to the opportunity and not getting them out of sync.

One last question, I don't mean to monopolize, but do you have just I guess for us to have a benchmark against what you are looking for in that same-store sequential NOI for the fourth quarter?

We said that it would probably be flat.

I just want to make sure we got it right.

Let me correct myself. You said NOI and we actually expect NOI will increase slightly third to fourth quarter sequentially as it does seasonally each year.

Is that from the down tick in expenses, I guess?

Exactly. Revenues would be flat, expenses would be down and NOI would be up third to fourth quarter.

Care to quantify it? Or just up?

You know, no, I think we'll just let it come out the way it comes out.

Your next question comes from David Harris from Lehman Brothers.

Good afternoon. I have a couple of small points. Tim, I'm going to turn to you first. On the concessions reference that you make in your press release, you are saying on a sequential basis, overall concessions were up in the third quarter over the second quarter. The concessions to establish communities were down quite significantly. Are we to suppose that the concessions related to developments were up quite sharply?

I may have missed the second part of your question there, David. Concessions are -- total concessions are up second quarter to third quarter because there's more move-ins in the third quarter over the second quarter. When you look at it on a concession per move-in basis across the stabilized portfolio, it was down 18% on a concession per move-in. In terms of the development portfolio, I think concessions were flat to modestly up this past quarter on a sequential basis.

Okay. Then Tom, if I could just turn to you, in terms of the promote related to the fund that you've got moving along there, is there any way you're going to be able to book the promote on a year by year basis or is it something that you would -- we might have to wait for you to harvest to the end of the-- the life of the fund?

David, the way the fund is structured is that it's not likely that you would be in a -- it's a hybrid. There's two ways to do the promote. There's the portfolio test or there's a deal by deal promote. We've actually found a new way to do it, and that's called the hybrid which looks a lot more like the portfolio test. So I think you wouldn't expect. We wouldn't expect to see a promote earned until toward the end of the fund. So it's not going to be early in the fund it'll be kind of asymmetrical towards the end of the fund life.

So you're going to have a standard clawback feature in there presumably?

There is a clawback, but if you're paying the promote out at the end of the fund life chances of the clawback becoming operative are pretty small.

In terms of thinking about the impact that it might have on your FFO for next year we're likely to see some uptick related to the management fees and asset management fees that you referenced earlier?

I think so. I think it would be modest. We're not really doing it for current recurring fees. We're doing it as part of our overall sources of making sure that we're sourcing all of the capital sources that are appropriate given where we are in the business cycle. So I wouldn't count on it from a see standpoint. More so that I think over time you'll -- I think we'll be proven to be pretty smart in terms of how we sourced and allocated that capital.

Okay, thank you.

Your next question comes from David Shulman of Lehman Brothers.

Hi. Do you have any energy price hedges in place for the winter?

David, this is Tim, in terms of energy, it depends on the market. Maybe about 30, 35% of our energy costs are actually hedgeable across our markets so the majority, more than 50% would actually float with the market. We've actually seen. I mentioned in my remarks more of the energy costs are in electricity. We've actually seen reductions in the third quarter as a result of California where the public utility rates came down by about 15% starting in March. We do think there's some risks there in the fourth quarter obviously with where oil prices are, and heating oil, natural gas prices are going. We think we could see natural gas prices up 10, 15% potentially on a year-over-year basis in the fourth quarter.

And obviously David, while we remain vigilant on that as you know from our portfolio, the vast majority of the utility costs are borne directly by the resident given the age of our property and separate metering of utilities.

Just -- I'm just concerned more about just common area.

Yes, well, we certainly are concerned about that. It's a relatively small component of our cost structure relative to an older portfolio.

Okay, thank you.

Your next question comes from Ross Nesbaum of Bank of America Securities.

Hi it's Karen Ford here with Ross. One of your competitors noted a small pause in the Southern California markets. You guys, I think, said that you had good performance there this quarter. What are you seeing for later this year?

Karen, this is Tim Naughton. As I mentioned in the first half of the year, if we had a pause it really occurred more in the first half of the year for us. And actually saw kind of a continuation of previous trends or a reacceleration in the third quarter and that's what we're still seeing here in October.

Okay. Thanks very much.

Your next question comes from Rich Anderson of Maxcor Financial.

Thank you. How was your appetite changed for future development joint venture activity?

Rich this is Tom. You know, joint ventures are, well, nothing's really come about that would make us want to change our thoughts. But let me just recap why we do joint ventures. We do them to mitigate overall market risks, to mitigate concentration risks in any one location and also economic risks. Too much capital allocated in any one market early in the recovery so there are some assets on the development side that might fit those screens. If it doesn't those screens, I've been some could say internally obnoxious about reminding people what the screens are. We generally prefer to do development on our own balance sheet. We think in terms of allocating capital that's the best place to allocate capital. We're seeking other sources of capital when it comes to acquisitions and redevelopment activity on those acquisitions. So just to point out, we are working on a joint venture permission based Phase II that we expect to close sometime this year, which would enable us to start that asset sometime next year. We also completed the financing of Del Ray, which is in Southern California and also an asset in Seattle this year in Kirkland. So those are the major joint venture activities we've had on the development side this year.

Okay. Are there any other purchase actions available to you like what you did in Boston?

No, Rich, there are not.

Okay, thank you.

Your next question comes from William Aikerson of Merrill Lynch.

Yes, thank you. Good afternoon. On the development pipeline, it looks like the fourth quarter projected capital costs invested went from 64 million in the third quarter up to about 113 million today. Expected completions are about the same. I was wondering what that was driven by and was it related to the amount of money in redevelopment that you intend to spend on the recent acquisitions?

William, are you referring to the tax intends?

That's correct.

I think what that is is for deals that are actually projected to start in 2004 in new developments that we're actually projecting will have three deals start in 2000 of -- in the fourth quarter 2004. I think it's capturing some element of those costs.

Okay. It was just a big number that kind of jumped off the page. More qualitatively, on the last call, Avalon was expecting the peak season to put pressure on occupancy and put pressure on concessions. Really, what happened was just the opposite. I was wondering if there was something about the current cycle that makes it more difficult to look ahead even over so short a time horizon?

William, this is Bryce. I think what we spoke to and reflecting back on our comments and your observation of those, what we said was that the recovery that we were seeing was very weak. Still is very weak. It was very weak in the second quarter. And as you move into peak leasing season, you just have more volume of transactions, you have more people moving out, you have more people moving in. It is a period to be concerned. That's a large part of our job is to worry about things. And so as we moved into the peak leasing season, we were not ready to declare victory on the health of the markets. We were extraordinarily focused and I'm personally very proud of how we operated our portfolio during that third quarter. We had really three goals this year on the operating side, each of which we've achieve. The first was to get full and we were asked on the first quarter call what we meant by that. And we said to get to a 96% occupancy level. We achieved that. We were then asked what happens then? And we said our next focus is on reducing concessions. And we've achieved that. Concessions are reducing. And the third element is increasing market rents. We're starting to see some positive movement there. So at the portfolio level we worked real hard on the basics which this business is not complicated but it is very hard. And we're pleased with how we performed during the third quarter. But it is difficult to forecast when conditions are relatively fragile. They do remain fragile. I hope our comments have not been taken out of context. When we talk about positive revenue growth and positive NOI growth. As you all can see from the data it is positive but meagerly positive and certainly not levels with which, you know, we experienced in the mid '90s when we saw very, very strong revenue and NOI growth.

I'm certainly not faulting you for being conservative.

We'd rather please on the upside than the other way around.

It's just, you know, this economic recovery is different than most historical ones in that there's been a consistent or at least a recent lack of job growth, and that's certainly had to complicate matters for you guys.

It does. I would say while we have not been -- we have not been pleasantly surprised in the level of job growth, in other words, it has been anemic and actually backed off a bit of late, we have been pleasantly surprised at -- even with a modest level of job growth, we are seeing improving fundamentals more quickly in our markets and we spoke about that in the second quarter than our experience would have shown. We think there's lots of reasons for that, not the least of which is some of the very strong home ownership surges we've seen over the past really 24 months. You know, we said last year and continued this year that we think that has, in essence sucked forward some of that forward supply for home purchases. We're still seeing move outs high. But, the relationship between changes in demand for apartments as driven by modest job growth has come about more quickly in many of our markets than we would have expected. But it is still very fragile and very modest. We're still hard at task and not letting the foot off the accelerator.

Very quickly on the markets. I think I heard you say that something of an inflection point might have been reached in the Pacific northwest, in the midwest, I mean, the Pacific northwest I can certainly understand that. That's been verified by earlier earnings reports. But the midwest as well?

This is Tim Naughton. Yes, the midwest. In fact this is the second consecutive quarter of pretty decent same store sequential revenue growth and in the midwest and Chicago, I think we saw about 15,000 job growth at least by our numbers in the third quarter. So we do think the worst is behind us in the midwest. At least in Chicago where our portfolio's located.

Okay. Also earlier, you sounded optimistic about the northeast even though the revenue gains were -- the rental rates were actually down in four of the six markets. And the revenue, total revenue gains were well off the second quarter basically still sounded as if so far this quarter you feel it's going all right.

Yeah. Actually what's happening, William, is during the quarter by September we actually started to see some effective rental rate gains in the northeast. So while it was down quarter to quarter on a sequential basis as you went through the quarter, it appeared to have bottomed in August.

Okay. Thank you very much.

Your next question comes from Dave Rodgers of Key/McDonald.

One quick verification for Bryce. On the $700 million of asset sales, that you were talking about, over what time do you anticipate doing that, and I wasn't sure because of Tim's comment on being opportunistic, so I wasn't sure whether to match that up with development spending or completions or again just kind of a time frame?

Okay. Well, I'm glad you asked the question because I want to make sure I'm clear on this. 700 million is '03 and '04. It's historical. We sold 450 million last year. This year we have or expect to sell 250 million. Put those two together it's 700. What I was trying to do is indicate or the -- what will be a 24-month period, '03 and '04 that we are a seller of about 700 million and cap rates of about 5% so it wasn't prediction of '05. I will say interestingly, to comment on your question about matching up to development, there in that same time period we invested about 700 million in development. If you look at the development schedule about 350 million this year into new development activity, so it is not coincidental. I mean it is part of what we're about. Is recycling of capital from assets that either strategically we wanted to dispose of as we did in 2003 when we exited certain markets like Minneapolis or opportunistically through sales of condominium converters to generate capital through our disposition activities, capturing the value that's embedded in that portfolio and recycling it into our development activity at higher yields.

Thanks. Sorry, I misunderstood that. For Tom, two questions, the first is in terms of G&A. What are you looking for in 404 costs. Can you give us an update on any of the Sarbanes-Oxley compliance?

The answer is too much.

Can you get a sense that our CEO is not happy about the investment in Sarbanes-Oxley? None of us are. I think to some extent there are some good things that came out of it. But, I think all of us are feeling a little bit of frustration in terms of having to go through that process and incur those costs. But to answer your question, about 750 to 800,000 of third party costs when you add on top of that increased staff, an internal audit, and the diversion of time that going through that documentation process has caused us in terms of our folks administrative staff that could be, you know, making improvements in other areas. You know, it's probably close to a million dollars, so it's a big number and it's hard to assign a lot of value to that investment today. So that would be what we're seeing on Sarbanes-Oxley.

Thanks. And the last question, in terms of real estate tax, accruals seem to be up a little bit higher than our expectations in the third quarter, do you think there's some upside in the fourth quarter to with respect to what you've accrued year to date?

It's interesting. I read your piece. I think you quoted increasing 12%. That's for everything including new developments that have come online. As you bring new developments online, you stop capitalizing taxes and insurance and you start expensing it. If you carve out the development, our property taxes year-over-year actually slightly declined on a same-store portfolio.

Would you expect that to continue?

I think it'll be flat from the sequential, you know sequentially. But I think you have to then revert back, what are all the pressures on municipalities and states? I still think there's a lot of pressure for property taxes to go up.

Thanks for the input.

Your next question comes from Hassad Kasim with Reed Funds.

Hey, guys. I'm just wondering how, Tom, do you guys account for the acquisitions that are supposed to go in the fund? I thought those were being warehoused, and if they are, how does that run through the P&L?

It runs through the P&L just like any wholly owned asset today because the fund hasn't closed and therefore we're holding those assets. We say warehoused that's really just a term of ours. They are on our balance sheet and we are getting the yield from those until we close the assets into the fund. But those assets were included in our forecast. So the outperformance you saw in the third quarter is not because we bought assets. That was planned.

Gotcha. I guess more of a philosophical question going back to your capitalization policies. It seems like at least to me that most folks kind of discount that and don't really give you the credit you deserve for having the cleanest capitalization policy. Have you folks internally given any thought to perhaps reverting to how your com stat capitalizes expenses just so you guys are on a level playing field?

Well, one, I want the audience to know that I didn't plant that question, first and foremost. It is interesting. We do have a capitalization policy that is an outlier from the industry. I think most of the industry capitalizes carpets and appliance replacements, et cetera. I do believe this is an industry that focuses on FFO in terms of metrics and reporting what is our multiple on an FFO basis. If you revert to an a AFFO multiple, AvalonBay, you know, doesn't enjoy as a high multiple as we think we should given our growth prospects and our balance sheet, which are the two drivers behind multiple. So we understand we're an outlier.. We have been an outlier for ten years now. We're hopeful that the industry will give us more credit over time for our conservative capitalization policies. But we do believe that largely this is an industry that prices off of FFO.

Great. Thank you.

At this time, there are no further questions. Are there any closing remarks?

Operator, I just want to thank everyone for participating today. I know we'll see many of you at NAREITs the middle of next month. Thank you for your participation.

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect.