艾芙隆海灣社區公司 (AVB) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen and welcome to the AvalonBay Communities second quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] 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. Good afternoon and welcome to the AvalonBay Communities second quarter 2005 2005 earnings conference call. Please note 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 and Form 10-Qs filed with the SEC. As usual the release includes an attachment with definition and reconciliations of non-GAAP financial measures and other terms. The attachment is available on our website at www.avalonbay.com/earnings. We encourage you to refer to this information during your review of our operating results and financial performance. With that I'll turn the call over the Bryce Blair for his remarks. Bryce.

Thank you, Alaine, and welcome and thank you for joining our second quarter call. With me on the call today are Tom Sargeant, our CFO; Tim Naughton, our President; and Leo Horey, Executive Vice President of Operations. On last quarter's call we modified the format a bit in order to shorten our prepared comments allowing for more time for Q&A and an overall efficient call. We received positive feedback from many of you and thus will continue with this revised format.

On the call today we'll be addressing three topics, an overview of our quarterly results, an update in our investment activity, comments on our updated financial outlook. First I'd like to touch on a few macro issues, specifically the economy, apartment fundamentals, and the effects of condo-mania on our business. In terms of the economy as you know it continues to show strength growing jobs at an annual rate of about 1.5% nationally. While overall job growth in AvalonBay's markets is running at a slightly lesser rate of just over 1%, all six of our regions are experiencing positive job growth. This ranges from a low of about 0.5 of 1% for northern California to a high of about 2.5% for the Seattle market. The positive job growth over the past year has resulted in strengthening apartment fundamentals in our markets resulting in meaningfully positive revenue growth for the first time since 2001.

Given the strengthening apartment fundamentals one might expect this to be the big topic in our industry, yet it's being overshadowed by the impact of the strong condominium market and how it impacts our business. Discussions with investors, analysts, and our own management team have increasingly been more and more focused on the strength of the condominium market, its impact on our business and most importantly what actions do we take as a result. The strength of the condominium market is affecting our business in a number of ways, some negatively and some positively. And I just want to touch on them starting first with the negative impacts.

It's negatively impacting us in competition for land and subcontractors ultimately driving up costs. It's negatively impacting us in competition for people, experienced multifamily development and construction professionals, particularly in our markets, are in very short supply. It's negatively impacting us in competition for our customers, this past quarter 25% of our move-outs were due to home ownership.

Now on the positive side condo conversions do reduce rental stock and while surely some will come back as rental the overall effect is positive to apartment demand supply fundamentals. Finally it's certainly a positive for asset values as condo converters have helped drive down cap rates to unprecedented levels. We've worked hard to find the right balance in our response to the super heated condo market. It's important that we look for ways to capitalize on this without over reacting which could divert us disproportionately from other value creation opportunities. One clear response by us has been to dramatically increase our disposition volume which we'll comment on later.

Given this as background let me turn to a review of our quarterly results. Last evening we reported EPS for the quarter of $0.74, and FFO per share of $0.97. The FFO per share represents a year-over-year increase of 17% which can be largely attributable to three items. I'll touch on each briefly. First, from growth in same-store sales revenue, we reported growth in same-store sales revenue of 2.7% versus the second quarter of last year. This is is the highest year-over-year growth rate in three-and-a-half years. And quarterly sequential rental revenue growth of 1.5%, which is the highest in four and a half years. Now while we're pleased with the absolute level of revenue growth, what's particularly encouraging are the components of that growth. As you know changes in revenue are driven by both changes in occupancy and changes in rate. Over the past few quarters our growth in rental revenue has been driven primarily by occupancy gains as opposed to changes in rate. This shifted and during the second quarter the majority of our revenue gain, 2.2 of the 2.7%, came from rental rate growth. This is is an important transition or inflection point and it's a positive sign of the strengthening fundamentals in our market.

Second source of year-over-year growth in FFO was from the continuing contribution from our recently completed development communities. During the quarter we completed two communities and we have an additional three -- we completed two during the quarter and have an additional three in lease-up. So our development activities continue to be a meaningful contributor to earnings growth. Third, from gain on land sales which contributed $0.06 per share for the quarter.

Turning to investment activity I wanted to briefly update you on our development and acquisition activity, then Tim will comment on our expanded disposition plans. We remain very active on the development front completing two communities during the quarter while beginning construction on two others. Two new communities total almost $90 million in costs and bring our total volume of communities under construction to approximately 670 million. We expect the dollar volume communities under construction to grow throughout the balance of the year reaching approximately 950 million under construction by year end.

We were pretty quiet on the acquisition front with no acquisitions during the quarter and one $25 million acquisition so far in the third quarter. The acquisition market is extremely competitive. There's abundant capital and competition from condo converters that bid up prices, driving down cap rates to unprecedented levels. While we have a couple of additional acquisitions that we're pursuing we will continue to be very selective in our acquisition activities. Now while it's a challenging time to be a buyer we think it's a very attractive time to be a seller, particularly for those who own quality assets in strong markets, assets that are attractive to condo converters. As a result of the excellent pricing we have experienced so far this year and the continued strength of the market we have substantially increased our disposition plans. Tim will update you on our sales to date and expectations for the balance of the year.

Thanks, Bryce. As good as it's been to be a seller over the last couple of years 2005 is proving to be an even better year. We began the year with modest sales expectations but have consistently stated that we are prepared to act opportunistically based upon market conditions. Our original outlook for dispositions this year was on the order of 125 million. Now we are projecting asset sales of approximately 500 million, or four times our original guidance. So far this year we've closed on four assets totaling 161 million, representing an economic gain of 95 million, or more than two times our investment. These assets were sold at a sub 4% cap rate and an unleveraged IRR of over 20%. The average hold was eight years and three of the four assets were sold to condo converters.

The most recent disposition was the sale of Avalon Crossing in Rockville, Maryland which closed on July 1. Avalon Crossing was developed by AvalonBay and completed in early 1997 at a cost of under 14 million. After owning and operating this community for the last eight and a half years, we sold it to a condo converter at over 44 million, more than triple our investment, or at an economic gain of more than 200%. The unleveraged IRR was over 22%. As an asset, Avalon Crossing has provided two unique value propositions. First, through the initial development where the community was delivered at a yield well above then prevailing cap rates, and second, through the sale itself where the community was sold to a converter at a premium of 35 to 40% greater than an income buyer could justify. Both of these elements of value contributed significantly to obtaining this outsized return.

Sitting here in mid-2005 the level of condo conversion activity remains strong as Bryce mentioned and has actually expanded in many markets. In our markets over the last couple of years most of the activity has been concentrated in D.C. and Southern California. However, more recently conversion activity has picked up momentum in many other markets. Such that we are now seeing aggressive pricing across virtually every market at cap rates ranging from 3 to 4% from condo converters. In fact, our targeted assets for expanded dispositions are in five different markets, all outside the D.C. and Southern California regions. We are currently in the contract stage for six assets totaling roughly 350 million that we expect to close before year end. All these communities are being sold to condo converters.

These additional transactions will bring our total volume for 2005 to approximately the 500 million level mentioned earlier, at an average cap rate of under 4% these are obviously attractive transactions but they are also a cost-effective form of capital that we intend to ultimately redeploy into our growing development pipeline at yields of 7% plus. This accretive reinvestment of proceeds will provide additional earnings growth over the next couple of years. With that I'll turn it back to Bryce.

Thanks, Tim. Overall with regard to our investment activity as we've said on the past two calls, our plans for 2005 were to be first aggressive in our development activity. Secondly, selective in our acquisitions and finally, opportunistic in our dispositions, and our actions have been consistent with this. As I mentioned, our development activity will approach 950 million by year end. We've shown very limited acquisition activity. We've been very opportunistic in our dispositions, quadrupling our volume for the year.

I'd now like to shift to a discussion of our updated financial outlook for the year. Despite absorbing the modestly dilutive effects of a substantial increase in our disposition volume we're able to lift the range of our financial outlook that we provided in December of last year. In our release last evening we provided an updated range for our expected FFO per share of $3.65 to $3.75, which reflects an increase of $0.08 from the midpoint of the range provided last December. Tom will provide some additional color in the components of that updated guidance.

Thanks, Bryce. Let me first start with expectations for NOI growth. For the year we expect NOI growth of 3.5 to 4%. This is up slightly from our initial financial outlook in December when we projected growth of 3.5% at the midpoint.

Turning to the impact of expanded dispositions on our revised outlook we expect $0.01 to $0.02 per share of dilution for the $350 million of increase in our dispositions, and as Tim mentioned this is a very cost effective source of capital and that dilution has remarkably little dilution which speaks to the current strong market conditions and demand for high quality assets. Interest savings to date will continue due to the expanded sales and lower than planned debt issuances. We'll likely have some cash on the balance sheet at the end of the quarter and at the end of the year which is somewhat dilutive. We don't anticipate additional non routine events for the remainder of the year. The combined effect of these items resulted in a net increase of our original -- to our original outlook which was -- which was a revised range of 3.65 to 3.73 for the year, or an increase of $0.08 per share at the midpoint of the range. Adjusting for the benefits of reduced interest from expanded asset sales and non routine items that are difficult to anticipate our overall performance for the year is pretty much consistent with our December FFO outlook.

Looking at quarterly projections it's important to note that quarterly FFO for the first two quarters has averaged about $0.96 which does contain these nonroutine items. As we don't foresee further non routing items, the quarterly run rate will fall for the rest of the year to about $0.88 per share to reach a midpoint of 3.69 for the year. NOI will decline in the third quarter from the second quarter due to seasonally higher expenses, before rising in the fourth quarter over the third quarter, again due to the seasonal expense patterns. Bryce, I'll turn it back to you.

Thanks, Tom. In summary we are encouraged by our results for the quarter. The performance of the same store portfolio confirms the strengthening fundamentals in our markets that we expected. The strength of our sales activity confirms the attractiveness of our markets and the quality of our assets and provides further evidence of the embedded value in our portfolio, a value that we believe is not fully reflected in consensus NAV estimates. The volume and quality of our development activity demonstrates our ability to continue to create substantial value to both earnings and NAV growth. We're pleased with our results to date, we're encouraged with regard to the implications for the balance of the year, and we're taking actions now which will continue to position the Company well for future outperformance. With that, operator, we'd be pleased to address any questions from the audience.

[OPERATOR INSTRUCTIONS] The first question is is from Jordan Sadler of Smith Barney.

Good afternoon, everybody. I'm here with John Litt. I just had a question regarding Tom's color on the guidance. On NOI for the third and fourth quarters what are your expectations in terms of revenue growth sequentially?

Jordan, we don't want to parse the components of NOI. You can look at what we've done in the first half of the year and compare what our overall guidance for the year is and you'll see that our NOI growth in the second half of the year is going to be pretty robust, about 4.5% on average.

Okay. Do you know what sort of growth sequentially is embedded in your overall full-year expectations in terms of revenue, though?

We do but we don't want to parse the revenue and we'd like to avoid discussing sequential changes with year-over-year changes because it can just become confusing on the call.

Maybe another way. Were the trends that you were seeing operationally in the second quarter -- do you expect that they will continue into the third quarter?

They being NOI?

Revenues. It seems like you guys continued to drive rents as Bryce discussed, 2.2 of the 2.7% increases on revenues year-over-year was from rental rate growth. Do you think you'll continue to be able to push rents in the third quarter?

Let me turn it over to Leo for that question.

Jordan, yes, we do expect that we're going to continue to see increases in the rate. Obviously last year at this time we got to a much higher occupancy platform, and as we've been discussing we have got to continue to push rate in order to continue to see revenue growth, and we believe that's possible.

Okay. Then maybe just on the disposition guidance what are the planned uses of proceeds right now?

Jordan, again, this is Tom. Uses of proceeds at this point are to pay down a credit facility immediately. Obviously there's only so far you can go in paying down the credit facility before you have cash on the balance sheet. We do expect to have cash on the balance sheet at the end of the third and fourth quarter, and that is going to be somewhat dilutive, but that cash ultimately will be used to redeploy into our development communities as we progress with our development pipeline.

What sort of magnitude is development spending likely to be in the second half? Funding.

Hold on just a sec. I'll give you that.

Okay.

Jordan, if you have another question?

Sure. The other question would just be the gains generated from these proposed sales are going to be significant, I would imagine. Are you guys planning to redeploy or exchange into acquisitions, or how you -- how will the gains be traded? Will they be dividended?

Jordan, Tom again. There's a couple of tools we have at our disposal to deal with the excess gains. First, we will use the provisions of Section 858 of the Internal Revenue Code which allows you to use future distributions to cover prior year taxable income. That's a tool we've used in the past and that's available to us again. Secondly, we are going to be using 1031 exchanges for development where we can match up new developments with some of the gains on assets sold. At this point, we believe those two tools would allow us to meet our distribution requirements and avoid having taxable income that's not distributed.

Okay. My last question would just be on the land sale gains. Can you just remind us, I guess, the nature of those properties? I notice that the overall gains relative to original costs seem relatively small, given that there's sort of demand for land these days. What were the issues associated with those parcels, or why were the gains so relatively small?

Jordan, this is Tim. Unlike the dispositions on the existing apartment communities I wouldn't characterize these land sales as opportunistic. The two deals that were sold were in Seattle, northern California. The deal on Seattle I'd actually characterize as a little bit defensive. That was a deal that we had actually started construction on shortly before 9/11 and actually stopped after 9/11. It was a high-rise community. And just given the economics of high-rise, we are focusing our efforts in the Seattle market on wood frame podium product, principally in the east side markets of Kirkland and Bellevue. So we just thought it was an opportunity to go ahead and exit a deal that we thought the costs were fairly prohibitive relative to high-rise economics.

In the case of the northern California transaction that was really part of the original acquisition strategy of that piece of land. It's part of a larger deal that's about 1,000 units. It was a multiphase take-down, with the first take-down was the largest piece of it. We basically, went in with a builder, but we were the contract purchaser and were able essentially to flip it, a portion of that to build at a modest profit. But that was really part of the original acquisition strategy where the values were set at the time of the original contract so that's why the profit there is modest.

Okay. Great. Thank you.

Jordan this is Tom. Just to follow up, if you've got a schedule, attachment 10, you can see the development activity detailed on that schedule.

Okay, but does this include the starts that are expected for 3Q?

It includes the starts for 3Q but not for 4Q. So it would not necessarily accurately show the full second half of the year, but it is, Jordan, the data we disclosed and we've disclosed consistently.

Perfect. Thanks.

Your next question is from Karen Ford with Banc of America Securities. Please proceed with your question.

I saw that there was an uptick in your development yields, albeit small one, but it's the first one we've seen in awhile. Was that a product of construction costs coming down, just the basket of products or fundamentals or all three, and do you expect that trend to continue?

Karen, this is Tim Naughton, for the most part, the basket change marginally, as Bryce mentioned, we completed two and started two new communities. The rents are relatively stable with the exception of a couple of communities. You'll notice there's a pretty big adjustment up in the case of Christy Place, an adjustment down in the case of Juanita Village. But for the most part the other communities were within 25, $50 of the average rents left last quarter. In terms of construction costs, they're basically unchanged. One or two communities had a couple hundred thousand dollars up and down which more or less cancels one another out. So I think it's more a reflection of the markets are stabilizing for the most part, even with respect to higher end product, Seattle is is probably a little bit of exception to that. We are starting to see a little bit more pricing traction on some of the development communities. We're actually seeing concessions start to moderate there on the high end.

That segues well into my next question, which is I saw concessions had ticked up year-over-year and sequentially, can you just talk a little bit more color about that? Is a product that you're pushing rents?

Karen, this is Leo. As you know, concessions is one element of getting base rental revenue growth, along with occupancy, along with market rents, and in truth market rents increased at a rate that was greater than REIT increase in concessions. So concessions did pick up a little bit from quarter to quarter, but market rents grew at a faster pace. As you saw we did accomplish significantly more revenue growth and revenue growth based on rate. So it really was just part of a business decision and approach to get the rate growth that we're looking for.

Okay. Finally, just the $0.02 of legal expenses. Can you just talk about what the litigation matters that pertains to and whether or not that will be ongoing?

Well, Karen, legal is ongoing. It's what you incur during the normal course of business. What I would refer you to is our 10-K where we detail all the legal activity. There's not a lot but it's material that we disclose in our 10-K and 10-Q each quarter.

Okay, thanks.

Your next question is from William Atchison with Merrill Lynch. Please proceed with your question.

Thank you. Good afternoon. On the sale of the two land parcels, could you give us an idea of the price per square foot?

William, this is Tim Naughton. In the case of northern California, I'm going -- not offhand, but my recollection is both those deals were in the -- on average, in the $65 a foot range, 60 to $70 a foot, Seattle deal being a little bit higher than the northern Cal deal.

How would that compare to the average price per square foot that you have under option locked up in the development land bank, the 2.8 billion?

The average on the development rights pipeline, first of all, we own about 40% of those development rights. We've got -- the total contract value of that property is around $360 million. $365 million. Which represents roughly about 15 or 16% of the estimated total capital cost. On average I would you, this is answering the question a little bit differently but on average I'd tell you those contracts have been out there a couple of years during a period of time in which land has obviously appreciated, in some cases doubled, in certain markets, in other cases appreciated more moderately. Bryce?

I think I'd just add to that, Tim, that, Bill, I think it would be inaccurate to try to extrapolate from the two land sales to try to calculate any embedded value in the land portfolio, given the nature of the two sales, as Tim mentioned, one was a defensive sale of some land in Seattle that frankly we didn't feel underwrote as a high-rise rental The second was a sale of land to a converter in San Francisco in the northern California market that we had contracted for at the time of our land purchase. So pretty specific transactions, as opposed to the overall land portfolio that we own.

That's good. Commentary on the D.C. market. It was a little bit weak in the first quarter. The rent rate turned around in the second quarter but the economic occupancy was down 80 basis points. I don't know, we all think of the D.C. market as being so strong. Could you give us a little bit more color on that?

It's Tim Naughton again. In terms of D.C. I think we've always kind of characterized it as a market we expect sort of a stable, mild recovery. And we'd expect it to be a little bumpy as we've absorbed peak supply coming through in 2005. But sitting here today, mid-2005, fundamentals are roughly in balance. We're starting to see some traction certainly in the area of renewal rents, where renewal rents are coming in at sort of 5% plus. The supply that is being delivered is being absorbed. There's still concessions more generally in the market as you often see in a market that has higher supplies. It's just more of a convention to the lease-up process to offer concessions. Lastly, I'd say the high level of conversions that we're seeing which continues in D.C. is combined with the solid job growth, is starting to shore up the market here locally. Leo, I don't know if you have anything else to add on that?

No.

if you'd just help me in my mind, a little reconciliation with the -- I mean the overall, concessions per move in up 17.8%. But if you look at the total concessions, they were actually down 800,000 or 16%. Could you help me -- is there a contradiction there?

Bill, this is Leo. I'm not quite following your figures. On a year-over-year basis, they were up about 17, 18%, on a year-over-year basis market rents were up about 3.1%. The absolute dollars clearly delivered more rent to the bottom line and on a sequential basis they were up about 7%, 7.5% and market rates again were up on a sequential basis about 1%, but overall that absolutely delivered more rental rate to the bottom line as is reflected in the results.

I guess to be more clear I'm looking at attachment 14, concessions granted. You've got 4,254,000 second quarter this year versus 5,042,000 last year. That's is the decline I was referring to.

Bill, what it's going to come down to is the number of move-ins is different, because when I quote you a concession number I'm quoting it to you on concessions per move in. While I've acknowledged that concessions per move-ins are up, the absolute number of move-ins would have changed and that's what causes the difference. understand.

Lastly, Hewlett-Packard announced a down-sizing, I think it's 15,000 employees, with a lot in San Francisco. Now, my limited understanding is that they're not going to be cannibalizing their R&D people. Do you see that as a -- now not posing as much of a threat to assets in the San Francisco market?

Bill, we feel pretty good about what's going on in San Francisco. The fundamentals that you read about are pretty positive, and the truth is there was some projected supply coming. That may actually be a negative number with all the condo conversions. So we're seeing strength. We aren't seeing the HP situation affect us, and we feel pretty comfortable about the direction that San Francisco is moving. In fact, of the three markets in northern California we feel the best about San Francisco.

Your next question is is from Christian Kim with Deutsche Bank. Please proceed with your question.

Hi, good afternoon. I also had a question about the disposition activity for the rest of the year. You said the 350 million should close by the end of the year. Is there any way you could maybe drill down a little further? Do you see most of that closing in the next three months or further out?

This is Tim Naughton. Probably about two-thirds will close toward the end of the third quarter, and the other third towards the middle of the fourth quarter.

The cap rates on that you said were in the 3 to 4% range?

Yes, it's averaging in the mid 3's.

Mid 3s. And my last question is given these low cap rates, why not sell more than the 500 million for the year? Why not go 2 billion? Why not go that far?

Christian this is is is Bryce. It's a good question. I can assure you we looked at a range of alternatives from not selling -- not increasing it at all to increasing it more than the 500 million. What we're trying to balance is trying to capitalize on what we think is a pretty attractive sales environment today while balancing that against our strategic and portfolio allocation goals as well as liquidity and tax issues that Tom talked a little bit about earlier. So it's a little bit of a jigsaw puzzle to work through those items. We feel the 500 million represents an aggressive disposition plan for '05 and we'll obviously reevaluate '06 at a later date.

Thank you.

Your next question is from Steve Swett with Wachovia Securities. Please proceed with your question.

Good afternoon. Regarding the opportunistic sales that you're talking about, have you thought as well about doing some of -- perhaps some more land sales more on an opportunistic basis as opposed to the two that you've done already?

Steve, Tim Naughton here. We have on occasion. We certainly try to break out any transaction that we're getting ready to start. How much of it is really -- how much of the accretion is really attributable to the land versus the building profit, but the dispositions that we're talking about, there's value there in kind of all parts of the ownership cycle, if you will, from the build to the own and operate to ultimately the sale where we're able to sell at a pretty big premium but it's something we're evaluating in terms of -- and will continue to evaluate in terms of selling potentially some of the land sales to condo builders, but there's still an opportunity to create a lot of value through the development and construction of those. To the extent we can do more -- create more value that way, obviously it's going to guide our actions. Bryce, I don't know if you have anything to add to that.

Yes, Steve, just to add one other thought, I think your question was, the way I interpreted it, was directed at our existing portfolio of land. I think Tim answered that appropriately. I'll tell you one thing that has impacted us, the strong condo market, is how we approach potential new land opportunities. It is very competitive out there to purchase land for rental when you're competing against a condominium developer. We have on occasion and the northern California land sale was an example of it where we look at a larger parcel, the one in northern California was in fact a parcel of 1,000 units, and we out of the box look at it as a mixture of rental and for sale, then parcel off some of that to a for sale developer in the area. I think you can expect that we'll be looking at things like -- more things like that in the future, larger parcels where we can use our knowledge, our relationship, and our approval expertise to manage through the approval process anticipating right from the beginning that some of it may go to condos.

Tim mentioned 15 to 16% of the construction cost is currently the land component on average. How has that trended over the past year? If you were to be looking at land today would it be 20 or 25% or is that just too pricey for you guys to pursue land at that percentage of the total cost?

Steve, Tim Naughton again. That percentage actually hasn't changed much actually in the last few years but I think it's somewhat reflective of the business that we've been pursuing. We've talked about this in the past. There's plenty of deals that we just do not bid on today, particularly if it's in a market that's just a very hot for sale market and it's close to being permitted. So a lot of the deals that we're doing today have longer entitlement periods or in many cases they're entitled for something else that we're intending to re-entitle but that actual percentage hasn't -- interestingly, hasn't changed all that much over time. Of course, construction costs have gone up during that period of time, so land values obviously are going up, but the percentage relative to total development costs actually hasn't gone up that much.

That's helpful. Last question, on the fee stream reported in the second quarter, is that fee stream largely recurring, or is there any one-time component of that?

Steve this is Tom. There was about 300,000. It was somewhat of a catch-up. But that fee stream I would consider largely recurring.

Thanks.

Your next question is from Rob Stevenson with Morgan Stanley. Please proceed with your question.

Good afternoon guys. Tom, you may have gone over it, but did you mention what the litigation costs were for in the quarter?

No, I didn't, Rob. I just referred everybody to the 10-K which details everything out.

It's just that there isn't anything incremental in addition to what was going on -- what went on in the 10-K?

There's nothing new.

Okay. And then question for you, Bryce. In terms of strategy, when I look at the development rights page and sort of tick down through it I come up with about a little bit less than 25% either by number or by total capital costs of the future development being on the West Coast, about 40% of your portfolio is there now. Does that make you feel comfortable, the sort of shifting, if this pipeline goes off as planned, and there's not a significant amount of West Coast stuff added over the next few quarters, that the portfolio shift is going to wind up being even more substantially East Coast weighted and more specifically the northeast?

Well, that's a good question and an astute observation, Rob. Our development opportunities are a function of opportunity. They're a function of what the strength of the markets that are there and our organizational capabilities in those markets. Clearly the West Coast over the last few years, particularly the Pacific Northwest and northern California, have not exactly been ripe for new development opportunities. In Southern California we've been focusing very strong on over the past few years and really been growing our development team there and Tim may want to give a brief update in terms of what we have in the pipeline in southern California. So we are intent on continuing to grow our pipeline in -- on the West Coast, but how we manage our portfolio overall isn't just a function of what we add. It's also heavily impacted by what we choose to sell, and that comes to how I answered an earlier question when we think about our dispositions it's really a way to affect our capital allocation goals, so we're more likely as an example to sell an asset in a Stanford, where we have six assets, than we would in southern California where we're trying to grow the portfolio, or Long Island or Chicago. So we can control our capital allocation by a number of means, what we develop but also what we choose to sell. Tim, why don't you just touch briefly on what we have in the pipeline underway or in the pipeline at southern California.

Sure, Bryce. We currently have three communities under construction in southern California that we started over the last 12 to 15 months and we've got three or four more in the pipeline. Pretty spread out from Ventura County to the north to Orange County to the south, with most of the activity occurring in L.A. County. The product tends to be more podium product, three, four-story over structured parking, but we're also doing three story walk-up in Camarillo which is in Ventura County. I'd also add that we've been adding development rights in northern California more recently as Bryce alluded to us staffing up there, where we've got three or four that we've added over the course of the last 18 months or so, 12 to 18 months that are pretty capital intensive-type deals. So that will add substantially to the development right pipeline there.

And I guess the only other thing I would add is, Rob, is that the yields have always been highest in the northeast, and as Bryce mentioned, it is -- development is opportunistic by its nature. We not only just have a mature organization there but we have -- it tends to be the most imperfect of the markets that we operate in where we think we're -- as a result we think we've got the greatest opportunity often to had add value to the development process.

But if the northeast specifically or the East Coast in general is is where you guys -- if you were to see the most opportunity there, do you have any problem in ratcheting up that allocation up to 75% of the portfolio?

No, because we could control it through dispositions.

Okay. All right. Thanks, guys.

Your next question is is is from Craig Kucera with FBR. Please go ahead with your question.

I was going to ask about your development rights. Can you give me a sense for the time frame between getting a development right and then potentially developing on it, is it driven by the entitlement process? Are you putting this on a development right as it's sort of midway through the entitlement process?

Craig, Tim Naughton again. Typically it appears under attachment 11 once it's gone through -- successfully gone through due diligence process, so that would typically be three, four months, perhaps, after initial contract, and then you'll often see the development rights stay on the schedule for three or four years. There's some deals that have stayed on there for nine or ten years. There's some deals that have only been on there for 18 to 24 months before we actually started construction. I would estimate that the development pipeline is about a four-year inventory of development rights such that if it's about 2.8 billion today that would support roughly about 700 million in new construction. If you just take it back about three or four years when it was running about 1.5 billion we'd have been starting about 400 million. So it takes about four years on average but it could range from two to ten.

Okay. That's helpful. And it seems like most of your starts recently have been in sort of the northeast and California. Is that where you're seeing the more compelling opportunities to take advantage of these development rights, at least for the next 18 months or so?

I think the starts are more of a function in some ways of how long they've been going through the entitlement process and how long they've been under control. We've been active from the very beginnings in the northeast going back to 1993, 1994, so we've never really slowed down dramatically any of the markets, because the markets didn't dictate that, whereas in northern California we did essentially stop pursuing new opportunities for some period of time. As Bryce had mentioned, Southern California, our efforts have really been made over the last three or four years to build a pipeline there. I would say that the -- all of our markets are -- we're pursuing opportunities in all of our markets. Again, the yields are probably the most attractive in the northeast in terms of looking across our regions. Yields in California actually tend to be on the lower end of the scale but where we think the NOI and rental growth is likely to be out-sized for the few years.

Your next question is is is from Rick Paole with ABP Investments. Please go ahead with your question.

I just have -- most of my questions have been answered. I have two questions. One, maybe I'll just direct this to Tom, because he answered the other two questions on it, and I hate to beat a dead horse, but on the litigation matter, if nothing has changed or there's nothing specific here, why was it pointed out that this is a special charge? Why isn't it just the normal course of business in G&A?

Rich, well--.

It's just got me confused why if there's -- . was something settled or?

No, nothing was settled. In the normal course of business you have litigation that arises. When you accrue for those litigation costs, legal and possible settlements, it's very lumpy, it's like abandoned pursuit cost, so we can't meter it in. It would be nice, but we can't meter it in, and we just have to respond to the probabilities of things occurring, and that's what we do with legal accruals. Similarly, if we were to have a legal settlement that goes in our favor, we can't accrue a gained contingency even if we think we're going to get something back, that's a gained contingency. We can't accrue it. So when you know you're going to have some -- or you think you're going to have some costs, you have to accrue it. When you think you're going to have a recovery, you can't accrue it. So it's a very lumpy line item. I would liken it to abandoned pursuits. In that it's one of those things we're going to all have to live with. It's just a little bit more lumpy than we like.

So the next leg of that question is, what does this imply for G&A going forward? Is the current quarter a good run rate, or is this lumpy and it's going to go back down? What do you expect for the back half of the year G&A?

Well, as I said, this legal element is lumpy. I don't think you could reasonably expect that you're going to see that again in the third or fourth quarter. In terms of if you wanted to carve that out and look at G&A going forward G&A actually will probably go up for the rest of the year because we do have some timing issues related to Sarbanes-Oxley costs in that a lot of that audit work, internal audit work, is done in the third and fourth quarter of the year, so you're likely going to have more G&A there depending on how we perform for the year you're likely to have more G&A for bonus accruals, et cetera. All of that considered in our outlook.

Are you comfortable with giving a specific guidance range on that or no?

Not specific to that category, no.

Next question is probably directed at Leo. I was just curious on the concessions if you could give some color on, you don't have to walk through every market, but are there any markets where concessions were different than the average, let's put it that way?

Rich, concessions, as Tim mentioned earlier, were more substantial in the Washington D.C. area, as was discussed last time, although they did ease somewhat in the D.C. market. We also saw some increased concessions in the San Jose market and a slightly higher use of concessions in the San Diego market.

Okay. Thank you.

Your next question is from Rich Anderson with Maxcor Financial. Please go ahead with your question.

Thank you. Just a couple of quick ones. I was looking at your EPS guidance from the beginning of the year. It was say in the $2 range, middle -- midpoint, and now it's something like 5.35, or 5.37. Is it fair to say that the gains from the incremental dispositions will be in the range of, say, $250 million?

Rich, this is is Tom. I think you can look at that gain number per share, multiply it by the number of shares that we have outstanding and get a pretty good read of the GAAP gains. As you know GAAP gains are different than economic gains and you have to adjust for the effect of depreciation, et cetera, but I think you're on the right track.

Just to maybe provide some support for that back of the envelope analysis, on your attachment three, other assets, 154 million, is a majority of that the book value of assets to be sold?

Attachment three.

Other assets.

No, no. These assets that are going to be sold were not under contract at the end of the second quarter. They're included in real estate. The other assets, if you note, hasn't changed very much at all from the number.

I see that. Well, I was close. On the dispositions, I count 16 sort of submarkets, I guess, in your attachment four, established communities. How many submarkets do you think you might have after you complete this $350 million of disposition?

There are no exits of any markets.

Okay. And last question, do you have an estimate for NAV?

No. Not -- well, we do, but we don't disclose it.

All right. Thanks.

Your next question is from Carey Callahan with Goldman Sachs. Please go ahead with your question.

Hi, just to follow-up on Richard's question, it's actually Dennis Maloney. Pardon me. Just wondering if you could elaborate a little bit more on the criteria you're using in terms of identifying what properties you're going to sell. Is it market, is it absolute level of growth prospects, or is it just purely opportunistic?

This is Tim Naughton. It's largely opportunistic. We look at -- we typically look at what we think we can get as a condominium sale -- to a condo converter relative to what we believe an income buyer would pay and where those premiums are greatest but that rise to the top of the list. Certainly the market that it's in is contextually important. As Bryce had mentioned over time we'd like to reduce exposure in San Jose and the Fairfield markets so that's certainly relevant, but it's largely opportunistic and not strategic in terms of -- in terms of the sales -- by strategic, I mean looking to exit a market, for instance.

Then just conversely I was wondering if you could comment on the acquisition criteria for the fund in terms of cap rates and in terms of post redevelopment yields, what you're looking for there.

Post renovation yields would typically be in the low to mid 6's that we look for. Going in cap rates are often 5ish to low 5s. Again, we're generally not competing on assets against condos that would be attractive to condominium converters. We're generally competing against income buyers and you're often seeing a 30 to 40% discrepancy on what an asset could get through condominium conversion than what an income buyer is willing to pay.

Then just lastly, I think I heard you mention that about 25% of your turnover -- 25% of your move-outs were to single-family homes. I'm just wondering how that varies by market and are you seeing less move-outs in the more expensive housing markets?

With respect to move-outs, yes, it's about 25 to 26%. It runs from a high of the high 30s, close to 40% in the Midwest and then it's in the mid teens in both of the California markets, so you're in the 15% range. That's where -- the second part of your question again was?

You answered it right there. It was just really given that the markets themselves, in terms of affordability of single-family homes, are you seeing the more expensive -- in the more expensive markets are you seeing less move-outs, and I presumably -- I presume the question -- the answer there is yes.

Absolutely.

Thank you.

The data doesn't lie in that case.

Your next question is from Steven Bloom with European Investors.

Why don't you give some more color on what's been going on with the operating margin. It's been down year to year in the second quarter and I believe it was down in the first quarter. I thought you had suggested that the drop in the first quarter was a little bit unusual, and might be, I don't know, timing of expenses and it might pop back up. Are we still looking for that in the second half of the year? Are there other factors that will allow it to stay at the slightly lower level?

Steve, one, welcome back to our conference calls after an absence of a couple of years.

Thank you.

Steve, in terms of the outlook for the year we have had some expense savings during the first and second quarter. We expect part of those savings to come back, therefore, they're timing, and that's included in our reforecast. I think that you really should be considering higher expenses in the third and fourth quarter, especially third quarter given that it is our peak leasing period.

Your expenses were down, your margin was up.

Right, exactly. I didn't understand your margin question. Now I do.

I phrased it backwards, sorry. Thanks.

You're welcome.

Your next question is from Chris Pike with UBS. Please go ahead with your question.

Good afternoon,everyone. Thanks for taking the call. Tom, couple of questions. First, with respect to the dispositions in the second part of the year, should we assume perhaps you guys may refinance some debt that's coming due in forward years a little earlier to take advantage of the yield curve and lock that capital in?

We've done -- we have analyzed that 12 ways from Sunday, and we have never come with a calculation that showed that refinancing, paying off debt early, unsecured debt early, had a positive NPV. It was always negative. And we're all about value creation. We're not driving -- our first goal is not necessarily FFO growth, it's value creation. And, frankly, paying off debt early, in every calculation we've ever seen, destroys value. So will it help our FFO if we did it? Absolutely. Next year absolutely would help it. But would it destroy value? Yes, we think it would destroy value. So the answer, long-windedly, is no.

I guess on cap interest going forward, should we assume maybe a dip in capitalized interest in Q3 versus the Q4 level? I mean Q2 level.

No. I think--.

Should be running the same levels?

I think it would run the same level.

Okay. Great, thanks a lot folks.

Your next question is from Jay Leupp with RBC Capital Markets. Please go ahead with your question.

Thank you. Jay Leupp here with Dave Bronco. In terms of just rent growth rates in the back half of the year, you've given some commentary both on market conditions both in the northeast and the West Coast. How hard do you intend to push rents in each of those markets and which markets do you think will have the fastest growth rates, east versus west?

This is Leo. With respect to how fast we're going to push rates, we're going to push rates until we see effects on occupancy. Our stated approach to operating the business is to run from a high occupancy platform. We believe that we get real pricing power in that 96, 96.5% realm. From that area, from that occupancy platform, we push rates, and we continue to push rates until we see occupancies soften, then we back off. And we -- in effect, we iterate around an occupancy level. Does that answer your question?

Yes. In terms of just geographically from your answer there, where do you think you'll see the fastest rent growth given your comments about how you think San Francisco is improving?

I think that the markets that have the most opportunity going forward are northern California because it fell the hardest, and northeast because it also fell the hardest. When we talk about Washington as Tim said earlier it didn't have as big of a downturn and it's probably not going to come back as aggressively. It runs in a more narrow range. So I think the real opportunities are there. Obviously when you look over attachment four, you see that we've been getting very strong rate growth in Southern California. Clearly we feel good about that but again Southern California didn't fall as far so really if you said where's the biggest opportunity, I'd say it's the northeast and it's in northern California.

Okay. Then earlier, a couple questions ago you were talking about acquisition versus development cap rates, 5% approximately for acquisitions and 6.5 for development, about 150 basis point spread. How does that spread compare historically to what you've seen, say, over the last five years in your markets?

Jay, Tim Naughton here. Just to clarify, when I was quoting the cap rates and yield before I was quoting redevelopment yields, the renovation yields, those are on assets that -- where we look in -- where we buy and reposition it. We would typically look to get maybe 100 basis points more than the going in cap rate of a typical improved property that wouldn't need renovation. In terms of redevelopment our average development yield is in the mid 7s, 7.7 as we reported this quarter on attachment eight. The discrepancy we're seeing between new development and what an income buyer would pay I would say is about 250 basis points but what a condominium buyer might pay for a piece of property, it's over 300 basis points.

Say five years ago, ten years ago, what were those historical spreads?

They were probably in the 200 to 250, but on a much higher cap rate, so when you look at the actual premium of asset value development over -- I mean when you look at the actual premium in whole dollars, or relative dollars was a lot higher, it's a lot higher today than it was four or five years ago.

Thank you.

Your next question is is from Dave Rodgers with KeyBanc Capital Markets. Please go ahead with your question.

Yes, my first question is for Leo. Leo, I guess two questions. One, do you, and second where do you think are you seeing impact to your concessionary levels from condos and not particularly other rental players.

Are you talking unfavorably?

Yes.

I would tell that you that the San Diego phenomena has to do with people moving out to condos. That's clearly where we're seeing some pressure there. Even when I talk about San Diego I believe that the market rents year-over-year are up 8%. So while we've seen some increase in concessions use in San Diego I will tell you that we're seeing much higher market rents to getting to a better net effective place and getting to rate growth, as you see reflected in the attachment.

And then for I guess Tim or Bryce, are you guys concerned with particularly targeting condo buyers for some of these assets given, Bryce, your comments in the opening about helping to equilibriate the supply and demand scenario, do you focus on condo buyers or if the cap rate is the same does it matter?

Dave, right now we're focusing on condo buyers because the cap rate is not the same. They're paying premium over what net income buyers would pay. We do look at it on a risk-adjusted basis, particularly when we felt the asset there is -- it's not without risk when you sell to a condominium converter from a residual construction liability standpoint. And the kind of premium that we look to get will be different across markets. We would obviously expect something higher and California the residual liability risk is just very different there than, say, they are in Virginia which, after five years they're almost negligible in the state of Virginia. We're selling where the premium's justified relative to the risk.

I guess I just asked because the recent sale you did in Connecticut was the forecast to an ongoing operator as an apartment and I was just wondering if you had a scenario where you had for a cap buyer a condo versus a rental do you lean to the condo guy for supply issue.

Probably in most cases if we built the asset and we think there's any kind of liability risk we'd probably lean to the income buyer, honestly. There is a benefit of, obviously of selling to a condominium converter, as you're implying, it does take some supply. We know some of it will come back in the form of shadow rentals but probably just on a risk-adjusted basis for that particular transaction we'd probably lean towards the income buyer.

Okay. Fair enough. Then I guess another question on asset sales looking ahead, you talked about the fixed assets you'd sell by year end. What's your view? Will this continue? Will you continue to look for condo sales next year, accelerate dispositions? Can we anticipate that that would be in the back half of the year given the way the development pipeline lays out for any additional 1031 exchanges?

We'll deal with next year next year. Not to be flip, but we have said for two years now that we will be agile, and we demonstrated that last year in terms of responding to the market. I think we demonstrated that on the call today by quadrupling our disposition volume that we could not have anticipated last December let alone last July, or we would have. Hopefully what you've taken away from our actions over the last couple of years is that we're pretty thoughtful about trying to anticipate the future but hopefully we're equally, if not more agile about responding to the specific opportunities. So right now we are responding to the opportunities today. In the fall we'll take a little bit more of a thoughtful look into '06 but the reality what we sell in '06 will be driven by the market conditions we experience there. We have no capital needs to sell. It is clearly just an opportunistic action taken to harvest value that we think is outsized at the current time.

So I guess I should take from that that other than growing the development pipeline as a normal course of your business you haven't made any adjustments to the development pipeline as a result of the recent decisions to sell more assets?

We are always looking to grow the development pipeline, we're always looking for new development opportunities. That is not impacted positively or negatively by our disposition activity.

Thank you.

At this time there are no further questions. I would like to turn the conference over to Bryce for closing remarks.

Thank you, operator, and thank everybody for your time today, and we look forward to updating you in October on our third quarter results. So thank you and enjoy the balance of your summer.

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