艾芙隆海灣社區公司 (AVB) 2006 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen. And welcome to the AvalonBay Communities second quarter 2006 earnings conference call. [OPERATOR INSTRUCTIONS]. Before we get started, 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 the Company's form 10-K, and form 10-Qs filed with the SEC. Definitions and reconciliations of non-GAAP financial measures and other terms may also be used in today's discussions and have available on the Company's website at www.AvalonBay .com/earnings. I would now like to turn the call over to Mr. Tim Naughton, President of Avalonbay Communities Incorporated. Mr. Naughton, you may begin the conference.

Thank you, Holly. With me today are Tom Sargeant, our Chief Financial Officer, and Leo Horey, our EVP of Property Operations. As we mentioned on our call last quarter, Bryce Blair will not be on the call today due to a previously scheduled family holiday.

Today Tom and I will provide some introductory remarks related to the earnings release. I will discuss overall operating performance for the quarter and provide an overview of investment activity. Tom will discuss our 2006 financial outlook, and other financial highlights for the quarter. At the conclusion of our remarks, Tom, Leo and I will be available for questions.

Last night, we released quarterly earnings per share of $0.90, up by more than 20% from Q2 '05. FFO per share was $1.03 for the quarter, which represented 6% growth over the same time period last year. When adjusted for nonroutine items in 2005, FFO per share grew by almost 11%. This marked the second consecutive quarter of 10%-plus growth in operating FFO. FFO growth was driven by strong property performance as same store NOI grew by 8.1% for the quarter, the result of 6.6% growth in same store revenues and 3.5% growth in same store expenses.

On a cash basis, same store revenues grew by 7.6%, as cash concessions declined by almost 70% from the same quarter last year, and now stand at just over $300 per move-in, or less than one week's rent on average. Strong operating performance was broad based as most markets experienced economic occupancies of 96% or greater, and mid to high single digit growth in same store rental revenues on a year-over-year basis. The strongest gains were in northern New Jersey, DC, Seattle, San Francisco, and L.A. Boston and Chicago continue to lag, although Chicago showed positive momentum on a sequential basis.

Three out of six regions posted double digit increases in same store NOI in Q2, and all six regions posted solid sequential revenue growth of at least 1.5% for the quarter. Given the improvement in the operating environment, and our performance to date, we have raised our full-year outlook for FFO by $0.08 per share from that provided last quarter and we expect same store NOI to increase 8 to 9% for the full year up from the original outlook of 6 to 7%. This improved outlook is being driven by very favorable fundamentals. Despite slowing economic growth over the last quarter, other factors continue to propel apartment markets forward.

While modest supply, condo conversion activity, and improving demographics are all contributing to positive apartment fundamentals, the greatest impact appears to be a long anticipated correction in the housing market. Over the last several quarters, we talked about the growing imbalances in the housing markets, as a combination of higher interest rates and escalating home prices drove affordability levels to unprecedented lows. These imbalances are starting to correct, which in turn is helping apartment market performance. This correction is seen in the recent performance of both for sale and rental housing.

Over the last year, for sale home inventories of existing homes have increased significantly from just over four months of supply, to around seven months. And it is is even more pronounced in condominiums. Average home prices are flat or slightly declining after having peaked in Q3 and Q4 of last year. And since the beginning of the year, public home builders have significantly reduced their business expectations and earnings outlooks.

Conversely, apartment absorption is very healthy. Vacancies have declined to multiyear lows, average rental rates are accelerating, and most apartment REITs have outperformed their expectations. This correction in the housing market is still in the early stages, but it is is starting to affect our business in a number of other ways as well. First, we're seeing increased deal flow for new development opportunities, as condo builders scale back their business plans. In many markets, for sale builders are walking away from land options, at times leaving six or seven figure deposits behind. While we're seeing increased deal flow and more lenient terms, we haven't seen much of an impact on land pricing, as land owners have not yet adjusted their value expectations.

A second way we're affected is greater availability of materials and subcontractor labor. Particularly in markets where condo builders have cancelled or delayed their projects. Inevitably, shorter backlogs will help to relieve some of the pressure we experienced in construction costs over the last 18 months. In jobs we are currently buying out, we are seeing signs of greater pricing stability in construction costs.

And finally, on the transaction side, condo converters have largely exited the market. Although equity oriented income buyers have significantly increased their appetite for apartment product, well-marketed offerings are generally receiving 10 to 20 qualified bids. While income buyers are not paying the sub-4% cap rates that converters were paying at the peak of condo activity, cap rates remain low by historical standards and in the low fours in the west, and then in the low 4 to 5% range in the east. And importantly, there is much deeper pricing support for asset value today than during the height of the condo craze, when one or two outliers were often setting the market for asset values. As a result, there is a stronger foundation today for asset valuations than we've seen over the last 12 to 18 months.

Let me shift to investment activity for the quarter. Beginning with development, in the second quarter, we completed one community and started two others. Avalon Pines Two was completed for just over $25 million, and represents the second phase of a 450 unit community located in Suffolk County on Long Island. Avalon Pines is adjacent to the new Pine Ridge Golf Course and has been extremely well-received by many empty nesters in this market.

The two new starts were located in the Boston and Oakland sub-markets. Avalon at Lexington Hills and Lexington Mass is a site of a former state mental health hospital and represents the second community in the Boston area where we were awarded the purchase of a state-owned property in a public/private RFP process. Avalon at Lexington Hills will consist of two-thirds new wood frame construction and one-third adaptive reuse of existing structures. The other development start this quarter was in Dublin, California on the East Bay on a site adjacent to the Dublin BART station. This site is the former surface parking lot owned by BART, that served mass transit commuters. We're replacing the lost surface property by building a new parking structure on adjacent property obtained by BART.

Avalon at Dublin Station is a 305-unit first phase of what will ultimately be a 710-unit community. This is another example of another development opportunity that is secured by a public private venture, this time with the regional transit authority in the Bay Area. Increasingly we are increasing development rates from city, state, and other public agencies and institutions who are looking for a reputable and reliable partner. These public/private partnerships typically include development and post-development obligations on the part of the private sponsor, and as a well-capitalized investment builder, operator and owner, AvalonBay can minimize various transactional and operational risks to these public land owners whose interests generally extends way beyond the initial land transaction.

With the completions and starts in Q2, total development volume increased to over $1.4 billion by the end of the quarter. As we stated in the past, total volume underway should stabilize in the $1.5 billion range over the next few quarters. Yields on new development averaged 7%, which is consistent with expectations, although with property NOIs continuing to increase we do expect this basket of development communities will ultimately stabilize at yields in excess of 7% upon completion.

In addition to new development activity this past quarter, we completed two re-developments and started one other. The two completions are located in Columbia, Maryland and the new start, Ravenswood at the Park is located in Redmond, Washington, adjacent to Microsoft's headquarter campus. So far this year, we've begun re-development on three communities and expect that we will start another 3 to 5 prior to the end of the year.

Shifting to transaction activities for the quarter, first with respect to dispositions, as previously disclosed, we sold one asset in Stanford, Connecticut this past quarter. Avalon Corners was sold for just over $60 million, to an institutional income buyer. The unleveraged IRR over an eight-year hold was just under 17%,, and so far this year, we've completed $198 million in dispositions at a 4.4% cap rate, and a 16.6% unleveraged IRR.

During the quarter, we purchased one community in northern New Jersey for $57 million, and in July, we purchased another community in southern California for $47 million. Both of these assets were purchased through the investment management fund. Including anticipated re-development costs, we have committed approximately $420 million in capital to date, or about one-half the fund's capacity. The transaction market continues to be very active, with total volume in the first half of 2006 running close to the robust levels experienced in 2005.

While condo converters are not the factor they were just 12 months ago, many institutional buyers are increasing their cap allocation to apartments. The cap rates these investors are willing to pay have remained stable over the last few months and are near historical lows, as they continue to buy aggressively into the strengthening fundamentals of apartment markets.

So in summary, apartment markets continued to gain momentum this past quarter. Property performance continued to improve and we are now enjoying the best pricing power in over five years. We continue to ramp up new development and re-development under construction, and strong fundamentals combined with healthy capital flows continue to support strong valuations in the apartment sector.

With that, I would now turn it over to Tom who will discuss financial highlights for the quarter and our revised financial outlook for 2006.

Thanks, Tim. Good afternoon.

I would like to first start with additional color on our actual results for the second quarter compared to our earlier outlook. I will then review the revised outlook that we included in last evening's press release. And then I will end with comments on how our balance sheet supports the investment activity that Tim mentioned earlier. Tim mentioned the strong operating fundamentals that are driving NOI and operating FFO growth to the highest levels in five years. In April, we provided outlook for the second quarter of $0.97 to $1.01 with a $0.99 midpoint. We actually achieved $1.03 per share which is $0.04 above the midpoint of our range and this outperformance is driven primarily by better-than-expected revenue, but also by lower-than-expected expenses.

So overall, it was a pretty simple quarter for us, and basically to resummarize, we achieved solid revenue growth, supported by stronger market conditions. We were diligent in containing expense growth and finally there were no one-time items in the second quarter of 2006 operating numbers. So again, a very simple quarter to understand. Looking forward, we expect strong operating fundamentals to continue for the foreseeable future with favorable demand/supply conditions from sustained job growth, and modest net supply.

For all of '06, we expect NOI growth of about 8 to 9%, which is about 200 basis points higher than our original range in January. And this is higher than the year to date NOI increase of 7.8% and will be driven by higher revenues, and moderating expenses. This will result in FFO in a range of there are $4.28 to $4.38 with a $4.33 midpoint.

If you exclude all of the nonroutine items from both 2005 and 2006, these anticipated results for the full year should generate operating FFO per share of about 13% growth. Cumulatively, this new outlook is $0.28 higher than our original outlook in January, and is comprised of $0.17 and a gain from the sale of a land parcel, and $0.11 coming from better-than-expected operations.

And while it is easier to see the underlying support for the future revenue growth, seeing the ability to control expense is a little more challenging, given the pressures we're seeing on salaries, property taxes, utilities, and insurance. But for the remainder of the year, we do expect to keep expenses in check, which will help contribute meaningfully to our out-performance for the year. Expense management is supported by new cost control systems that we've implemented, as well as the natural operating efficiencies that arise with a high occupancy platform, and strong rental demand. Further, we've completed all of our insurance renewals for the year, with a net increase in property-related coverage of about 20%, which is about what we expected in our original plan.

So that is the operating results and the outlook for the quarter and the year, and I would now like to turn to some of the key balance sheet statistics. And the balance sheet again was further strengthened by the strong operating performance for the quarter, and further supports the investment activity that Tim discussed. Our debt to total market cap stands as 22%, which allows for ample room for additional corporate unsecured borrowings. Approximately 85% of our assets are encumbered. And we have a fixed charge coverage level that exceeds 3.7 times. One point to note in our outlook is that we are including an expected charge to earnings of about $0.01 per share for the accelerated amortization of deferred financing costs related to refinancing our credit facility.

We do expect to enter into a new facility this fall with lower pricing and additional capacity. Floating rate debt comprises about 2.7% of our capitalization. And we expect to increase the use of floating rate debt over time through this expanded credit facility as well as the use of newly issued variable rate tax exempt debt. This activity will add to a balance sheet that is clearly prepared for more valuable rate leverage and provides liquidity to support the current level of expanded development activity.

So just to summarize our comments before we open for questions, there are a few thoughts that we hope to leave you with this afternoon. First is that operating fundamentals are strong and remain healthy. We expect year to date NOI growth of 7.8% to improve for the balance of the year, with a full-year NOI growth of between 8 and 9%. This will lead to per share FFO growth in the range of $4.28 to $4.38 for the year, which is $0.08 than our outlook just last quarter and $0.28 higher than our January outlook. Our development under way and future pipeline now stands at about $4.3 billion, and this is the largest pipeline we've ever had. The $1.4 billion currently under development is the largest we've ever had under development at one time, and will drive NAV and earnings growth in 2007 and 2008. And finally, we had the organization and the support infrastructure and the balance sheet in place to execute the accelerated volume development activity that we have underway and plan to start.

With that, Operator, we'd like to open the call for questions.

Thank you. [OPERATOR INSTRUCTIONS]. The first question comes from Christeen Kim of Deutsche Bank. Please proceed with your question.

Hi, good afternoon, guys. Congrats on a good quarter. Just a quick question on markets. I saw you had some really great rent spreads. Most of them fell in line with what we would have expected except for northern New Jersey, which was up 9.1%. Was that mostly because of an easier comp or is there something unique going on in that market?

Christine, this is Leo. I would tell you that when you look at northern New Jersey, and you look at just the demand and supply fundamentals, you know, clearly there is no reports that there is any meaningful job growth. I think that our properties, which are located along the river are really benefitting from the performance of the New York market. So I don't believe that there is any comparison issue. I think that supply is low along the waterfront. A lot of condos, there has been a lot of condo conversions, and while the reported demand/supply statistics don't look as favorable, certainly from a demand side, with the job growth in northern New Jersey, we really are benefitting from our proximity to New York, and I feel good about that market, and the direction it is going.

Great. Just keeping along the same lines, are there any markets that we haven't seen a turn in, like Chicago or Boston, that you expect to turn in the near future?

A turn, could you explain a little more?

Turn for the positive, I guess, I mean Chicago and Boston have typically lagged, do you see them catching up at some point within the next 6-12 months?

Yes, I guess Boston is where we have our biggest portfolio. On the Boston side, there is some job growth over the last six months, and there is some supply coming there. What we really need to see to get a pickup in Boston is just some more demand. The amount of supply that's there is not inconsistent with history.

I will tell you in our portfolio, we have seen improvement in a couple of the markets, in Boston, and we have seen some softening in others. To be specific, when I've talked to people, you know, the south shore, and the north shore had a little more softness, we've absorbed a lot of the product coming through there and those markets are improving. But when you go to 128 and the metro west area, we've seen a little softening there as more supplies come through. So Boston, we just need some more demand. On the Chicago side, that's a very small portfolio for us, job growth has been modest, the supply that's been taken on the market by condos has really been in downtown and our portfolio is in suburban areas.

Just to give you a perspective, the most recent physical occupancy in our Chicago portfolio has increased to just over 96%, and the increase, the sequential in Chicago was obviously pretty positive for us. So we believe we do have that market moving in the right direction.

Great. My last question is on the acquisitions made for the fund, are those stabilized assets or are those re-development opportunities?

Christine, this is Tim Naughton. One of those, the one in southern California would be re-development opportunity. The one in northern New Jersey is actually a fairly young asset, and it is more of a management repositioning opportunity, but not a re-development opportunity.

Great. Thank you.

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

Good afternoon, guys. Leo, where are you sort of pushing rent on a percentage basis on -- in June and July? It looks like, you know, year-over-year, your second quarter number on average rental rate was almost -- up almost 6% but if were you to look at what you've been renewing and/or signing new leases for, how much greater is it than that 5.8%?

In June, both renewals and new move-ins were in the low to mid sixes.

Okay.

So on average, across the portfolio.

And do you expect that sort of level in the back half of the year? Or given where you are, and given the tightness of some of these markets, you think you're going to get it higher than that?

We believe that we're still seeing that trend, just to give you a perspective, the early indications for July are that our revenues on a year-over-year basis are in the low sevens. As you know, we're coming up against more difficult comparison periods from an occupancy perspective, because of the way our occupancy trended last year. So even more of our growth is coming from rate -- I've been talking about this for a while, we've been very focused on it since the beginning of the year, and we are making progress on the rate perspective, and we have stabilized occupancy in that 96.5-plus range.

Okay. And where was turnover and move out to home purchases during the quarter?

Turnover for this quarter was at 61%, which is down 1% on a year-over-year basis. Last quarter, we were at 43, which is down 3%, so on a year-over-year basis, for the first half of the year, turnover is at about 52%, down about 2%. Move outs to home purchase remain in the low 20 percents. And if you recall we run historically at 20 to 25% and we peaked at almost 30, the upper 20s and this quarter again it was in the low 20s.

And last question, Tom, did I miss -- when were you talking about the expenses, and the expense growth should be more muted in the back half of the year, did you give any sort of range as to where you're expecting that to be?

We didn't. We are just giving NOI ranges and we're not parsing the revenue and expenses.

Okay. Thanks, guys.

Your next question comes from John Litt of Citigroup. Please proceed with your question.

Hi, it is Craig Melcher here with John. Tim, you mentioned you expect on the assets currently in the active pipeline to generate a yield above the 7.0 that is currently in the supplemental. What do you assume in terms of NOI growth or rent growth to get to that 7.0 relative to current in-place rent?

Craig, the 7.0 assumes -- does not assume any rent inflation. As you probably know, we typically underwrite our deals based upon current rents and current construction costs and when they actually go into the development, on the community pipeline, it is based upon rents at the time that we started construction, and we typically do not update those rents until we're actually have begun the leasing. There may be exceptions from time to time, with markets that have moved dramatically, over the course of the wound year or -- the one I don't remember or so before -- one year or so before we start leasing but we typically don't move those rents until we start leasing and you can see in the community pipeline, a lot of the communities are not yet in lease-up, and that's why I offered that remark earlier on.

So the rents even today could be higher than what is currently shown in that --

Typically, yes.

You raised your EPS guidance, or sorry, you lowered your EPS guidance. You can talk a little bit about your asset sales plans for the second half of the year?

Sure. Just stepping back to the original outlook, original outlook was about -- was 225 to $300 million in asset sales, and I mentioned we sold about 200 million year to date, I think we still expect to come to that range, since the original outlook but the mix is likely to change and that's what is driving the downward revision to the EPS. There was an asset that we thought we were going to sell that we are now not going to sell that had an unusually large gain.

And just going back to the earlier question on the rent increases you're seeing, what's the difference between on a new lease versus a renewal, are you giving any sort of a longer increase on the renewal?

The effective rent increases that we're getting on new leases and renewals are approximately the same. We do expect that over time, the new move-in rents are going to exceed that which we achieved on renewals.

Thank you.

Your next question comes from Dave Ronco, RBC Capital Markets. Please proceed with your question.

Yes, Tim, could you quantify for us the opportunity that the markets afforded you maybe versus six or 12 months ago for re-developments within the portfolio? You said three to five in the back half, new starts, but maybe in dollar terms, or unit count in terms of the overall portfolio opportunity?

Well, yes, I think what we said is we expect it to be a growing part of our business, this year we will do 6 to 8 and next year maybe slightly more than that. And a typical community is going to be about 300 apartments to give you a sense, typical investment, capital investment is probably going to be in the neighborhood of 5 million to 8, so to the extent these things take a year and a half, two years, we may stay in the kind of 15 under development at any point in time, representing, 70, $80 million in capital, incremental capital investment due to re-development.

Given what you're seeing in the underlying market, as well as construction costs, do you anticipate the yields to be better in the future relative to the 9.7 I think you quote in your supplement today?

It is hard to say because it depends on the mix, Dave. The 9.7 is somewhat misleading in the sense that it is a mix of our stabilized portfolio which in some cases the investment -- the original investment may have been made 10 years ago. And the yield on that piece of it may be well north of 10%. And it is a mix of that plus new deals that are coming in maybe at a 5 or 5.5% cap rate. So you kind of need to look at the -- you kind of need to look at the mix between the stabilized portfolio, and the re-development being done on behalf of the fund to really answer that and that is likely going to change over the course of the next couple of years.

Okay. And another one for you, Tim, or maybe Tom, historically, you have match-funded your development completions with dispositions, with the disposition -- or the development completions accelerating a bit next year, I estimate about $500 million. Do you still expect that to hold true in terms of disposition volume?

In terms of disposition volume for 2006 or 2007, Dave?

I guess 2007, or just, even theoretically going forward, do you continue to match fund or will you --

Not necessarily -- with.

-- incur the debt.

Not necessarily with dispositions

We look at dispositions as one form of capital and always weighing that against the other forms of capital that are out there and available to us. So our capital plan is always evolving, and haven't put it firmly in place for 2007 yet, and we have some ideas but it may be dispositions, it may be some other form of capital.

Maybe asked another way, given the flexibility in the balance sheet today, do you feel you have flexibility to add more debt going forward?

Well, Tom, why don't you address that?

Dave, let me expand a little bit. If you do the quick math, we, can with the balance sheet at 22% leverage, we obviously got room to increase leverage. But just off of NOI growth you can support substantial increases in meant and stay balance sheet neutral and we can issue 300 million in debt annually based on the growth of NOI and remain balance sheet neutral.

You can then sell a lower volume of assets, say $250 million a year, which is just good normal asset management, pruning the portfolio, and suddenly you've raised, 550, $600 million a year, and you really haven't affected your balance sheet and if anything, you probably continued to deleverage through those asset sales. So there is a lot of flexibility in the balance sheet in terms of funding the future development, whether it comes from more debt offerings or other capital market offerings or dispositions.

What we are pleased about with the balance sheet is the flexibility we have to raise capital in the most cost-effective way.

Last question for Leo. I didn't hear if you addressed this earlier. You talked about condos helping you, I think Tim did, in the opening remarks. Are condos at all negatively impacting the business from a leasing standpoint to this point?

So far, we're not seeing any negative from condos. Traffic on a year-over-year basis is essentially flat for us. Our conversions are about flat for us. I also watch reasons for move-out, and with respect to reasons for move-out, going to another community is no change year-over-year. I watch the relocation, relocation is up a little bit, and that's probably somewhat, because we're pushing rents pretty hard, and there may be a few people gone there, but I can't tell you that I'm seeing any specific effect from condos at this point that's unfavorable.

Thank you.

Your next question comes from the line of John Stewart of Credit Suisse. Please proceed with your question.

Just to follow-up on the condo question real quickly, Tim, I believe you said that the inventory of condos was more pronounced in the four to seven months of single family homes, and -- I mean obviously I'm hearing you that you haven't seen any impact yet but what's your expectation going forward?

From -- in terms of the inventory condominium or the impact that they will have on the rental market?

Well, the impact that the inventory will have on the rental market.

Well, I think it is likely to have some offsetting impact, as some of those will, likely come back on the market as rentals. In fact, John, when we look at our projections in new supplies, we do anticipate that approximately 30% of those condominiums do come back in the form of net supply. Even with that, the demand/supply fundamentals are very favorable and the net new supply being added for 2006 and 2007 is still well under 1%.

And I think perhaps the bigger risk is just existing homes, that are out there, and if we're running around 7%, I'm sorry, seven months inventory today, I mean if that number grows, keeps growing to, 9, 10 months inventory, some of that product may start coming back in the form of rentals, particularly with homeowners that may have very favorable mortgages that they're not necessarily looking to give up value in the price of the home and the value of the mortgage.

That's helpful, thank you. You also mentioned that there is a stronger foundation for asset values today and you said the Connecticut asset you sold was to an institutional income buyer. Who are the other 19 buyers supporting the foundation for those asset values?

Well, there is a lot of income buyers. When I was talking about supporting the values, I didn't necessarily mean that there are 19 guys out there willing to pay the same value. I'm just contrasting to what we're seeing 12 months ago or 18 months ago where condo converters, where there may have been a single converter out there willing to pay a 10% more than the next highest bid and that's a pretty thin basis to rest asset values on and today what we're seeing 15 or 20 bids there may be four or five guys, income buyers that are all within a percent or two around what ultimately is the market clearing price. So that's what I meant by a lot more -- a lot stronger support, and those are generally equity-oriented income buyers, pension fund advisors, and other institutions that -- and including REITs that are supporting those values.

Okay. Thank you. And then lastly, with respect to land values, if builders are walking away from options, surely the -- I mean it can't be too long before land values come down as well. What's your expectation for that piece of the puzzle?

I think land values that builders are paying for entitled ground will clearly come down. I think we're still in the period of adjustment where as I mentioned in my remarks, what we're seeing is more lenient terms and seeing more deal flow, and there just hasn't been enough distress or pain or information yet to force land owners to part with their properties at a size that they think are 50, 60, 70% of what they might have been worth 6 or 12 months ago. I think we're just still -- we're still working our way through that process.

Are you holding off land acquisitions in anticipation of that happening?

It depends on the opportunity. We haven't been holding off on land acquisitions over the last year, year and a half when prices were going up. The kind of deals we were chasing were probably a little different. The deals, longer entitlement deals and deals more complex and just by their nature were not attractive to condo builders who were obviously a lot more focused on market timing so we're always going to continue chasing those deals, and if anything, we're seeing more of those kind of opportunities today than we were just six months ago.

Okay. Thanks a lot.

Your next question comes from Craig Leupold, Green Street Advisors. Please proceed with your question.

Hey, Tim, just looking at your development yield, it looks like for those projects on your development construction activity page, that the vast majority of those where you both end up leasing has seen pretty good increases in average rents that you guys haven't -- it doesn't appear you've moved the yield, in fact the average yield is down maybe 10 basis points, and is that just a mix issue of new lower yielding projects being started? Or have you not revisited the yield based on those better rent numbers for the projects better now in lease-out?

It is more of the former, Craig, you're right, most of the rents have come up, and in the case of Mission Bay, which was the biggest increase, I think you just need to remember that that is a joint venture deal and so essentially we're only counting our capital component of that, which is only the 20% of the capital, as it relates to the average yield that our investors will ultimately enjoy. But the two new deals that came in, you should, they're sub-seven relative to the rest of the portfolio, which is right around 7%. But I think the net change from last quarter was like five basis points, just to give you some percentage.

And I guess a question for you, or Tom, and just touching on the leverage question that was asked by David earlier, and I mean previously, you guys had managed to leverage ratio that was much closer to 40%. And now obviously, coverage ratios are different in all, but I'm just curious, do you feel that you're under levered today, or are you intentionally trying to increase your financial flexibility? Or are you concerned maybe about asset values and that's why you're keeping your leverage much lower than it has been historically?

Craig, this is Tom. I wouldn't use the term underlevered. We have a $4 billion-plus pipeline we need to get through, and the balance sheet position to pull that through, and over time, I think you would expect that we will take that leverage up. The last several years, with all of the asset sales, we've chosen asset sales to fund our development as opposed to issuing debt, and by nature, selling assets and reaping that equity is delevering.

I think at a time where you do have negative leverage prevalent, that it is probably not a bad thing to only have 22% leverage, especially when it is negative leverage in terms of out of the market financing. And I do think over time, that you should expect this leverage will move up, just because we don't think we should be operating over time at 22%, and something, you know, north of 35 to 40% is probably a better long-term measure for AvalonBay.

Okay. Great. And one last question. This pertains to market selection. Chicago, it has been an underperformer for you guys for a while, and you got lack of portfolio concentration there, and also the market represents a difficult market in which to acquire and/or develop. At some point do you reconsider your exposure to that market?

Craig, this is Tim. I think I can say that about almost any market. We certainly were having those discussions 18-24 months ago about Seattle. We're glad we didn't exit that market at that time. Based upon its performance. And frankly could have said the same thing about Boston in the early '90s. But if anything, we really have probably been -- we have been increasing our commitment to Chicago.

We feel it has had a six or seven-year run of very low job growth and we are starting to see signs of job growth and amount of supplies are miniscule relative to the size of the market, there is not a lot of institutional players there and we just view if there is a time that it makes sense to take a run of that market it is probably today. And as you've seen within the investment management fund, we brought three assets there. We have people on the ground in Chicago now looking for new development opportunities. And we're going to play it out here over the next few years and see where it takes us.

Great. Thank you.

Your next question comes from the line of Alex Goldfarb of UBS. Please proceed with your question.

Yes, hi, good afternoon. Just quickly, on the institutional capital comment that you made, your view on that is that that capital has -- that queue has increased since the condo bids have gone away? And then in your view, do people line up to invest in property in general and then they will slot where the easiest asset type is to get into? Or your sense is that people divide up in terms of the asset class that they want to invest in directly?

Alex, this is Tim again, the first part of your question again had to do with the institutional capital you have. And there is clearly more institutional capital than there was a year ago across the markets nationally, probably a year ago, a third of the product was being bought by condo converters today, and some is zero, and we haven't seen a decline in volume, so essentially that gap has been made up by increased institutional capital.

And in terms of where they line up for property versus sector, it is my sense they're increasing their allocation consciously to apartments right now. Obviously, we don't have as keen of a view as it relates to some of these other sectors but just in terms of talking with people, they have all increased their business plans from where they were a year ago, or two years ago.

Okay. Thank you.

Your next question comes from the line of Ross Nussbaum of Banc of America. Please proceed with your question.

Hi, guys. Good afternoon. I may have missed this earlier, did you give us a number for what rent growth is running on move-ins year-over-year?

I did. This is Leo, Ross. I did. On a year-over-year basis, on new move-ins in June, it was in the low to mid sixes.

Okay. And I think you said that the renewals wasn't that different.

Yes, the renewals are about the same level.

Got it. Okay. And then actually I appreciated very much the comments you had made on the housing market and how that's been benefitting multifamily demand. I'm just curious, I mean obviously, the run-up in housing prices is -- it looks like it is starting to unwind in the frothiest of markets and it looks like that activity is going to accelerate over the next 6-12 months, given the inventory that is out there. At what point, just internally, are you guys forecasting housing prices to really start falling and to what magnitude, and to what extent does that start limiting your ability to raise rents because the spread between the cost of owning and renting will ultimately narrow and I guess sort of the second part of the question is, what do you think the impact on consumer sentiment and consumer spending does as people watch their home equity get erased?

Ross, Tim Naughton here. The first part of your question, I guess I would say the spread is so large, we're not even focused today in terms of how much it can correct. Just to give you a sense, I think Bryce spoke to this last quarter, and over the last four years, since 2000, our rents are essentially flat. Our same store portfolio rents are essentially flat, while at the same time home values in our markets are up 80% and basically represent about you know, cumulative increase.

If you look at price to income ratios, they've gone up in that same time period from about 3.5 to 5.3, as of Q1 of 2006. So we think it is kind of -- our sense is, is probably a bigger correction out there than the press is, that's come out in the press. And so we think it has probably got a way to go yet. In terms of its impact on consumer spending, I think we're already seeing consumption was down quite a bit in the second quarter, relative to the first quarter, and it is likely to have a moderating impact on the economy, and we're seeing it. So I mean obviously some of that is being made up by business investment, but whether it turns decidedly negative, I think that's to be seen.

Thank you.

Your next question comes from the line of Rich Anderson of BMO Capital Markets. Please proceed with your question.

Good afternoon. First, just two questions, the first one is, on the NOI growth, to the 8 to 9% range, and I guess I heard you on the July revenue number, looks to be a little bit higher than it was in June, if I read you correctly there, but how much of that NOI increase was the combined impact of both revenue and expense savings to get you to that higher range during the second half?

I think I can address that. To get to a 200 basis point increase in NOI, Rich, the lion's share of that is going to have to come from revenues so it is mainly being driven by revenues.

Okay. And the second question is, I don't know, and you probably won't say what you think your implied cap rate is on your stock today, but I'm around the 4% range, and if you're seeing cap rates in the market in the 4.5 to 5 range, in the form of dispositions, why wouldn't you sell stock in lieu of selling assets to raise capital?

Rich, this is Tom. I can't really comment on the implied cap rate analysis. I don't have it in front of me. I think sometimes it is difficult to separate the amount of NAV in your calculation, which results in be implied cap rate from operating assets compared to land under development, and land to be developed. So I think that sometimes can skew the numbers. In terms of capital markets activity going forward, we just don't comment on that.

Okay. Thanks, guys. Good quarter.

[OPERATOR INSTRUCTIONS]. Your next question comes from the line of Richard Paoli, ABP Investments. Please proceed with your question.

Hi, guys. Most of my questions have been addressed. But I just have, one quick question and one follow-up. The first one is with respect to what you guys are seeing in the way of traffic, and I'm going to kind of parse this with are you seeing a lot of traffic coming from what I would call kind of recent, recent job recipients versus, just I guess more traffic from people that ordinarily would have been like you said, at one point, you peaked at 30% of move-outs to home purchases, and now people are just perhaps trading up from a lower quality apartment to a higher end apartment. I don't know if you track that. And then I also have another follow-up question.

Rich, this is Leo. I did mention the traffic is basically flat year-over-year. I haven't tracked whether it is coming from people with new jobs, and I can tell that you we continue to get more and more of our leases that are coming via the Internet, and that we've had a lot of progress there. But I can't tell you that it is coming specifically from people with new jobs in the area. I don't have tracking on that.

And I'm going to, I guess, poke a little stick here, Tom, and I know you said you don't talk about the capital markets transactions, but I'm wondering if you had looked at, at all, and what your thoughts are, with respect to the convertible offerings that some of your peers have done? It seemed like pricing was kind of aggressive, and similar to Rich's other comment, done on a near term basis accretively, and whether you think some of these were close to 20% premiums on the conversion, which I think would probably address the, where you are on an implied cap rate question, but what are your thoughts on convertible? Is there room for something like that in Avalon's capital structure?

Well, you know, Rich, I don't really follow what the other companies do. I know all of the --

Sure you don't.

I follow, what the security, the attributes of various securities out there, and some securities work better for others. I really, though, I think it is best that we stay away from commenting about other people's capital markets activities, and how they may well --

I wasn't asking that. I was just asking if -- is a convertible something that Avalon has ever done before? I can't recall.

AvalonBay has never done a convertible.

Now I'm getting cute with you. But, you've never done --

Since we've merged with Bay in 1998, we have not issued any convertible securities.

And is there a particular reason why? I'm just kind of curious. Is that something you guys just don't like or it just hasn't been maybe attractive or something like that?

Well, I just would rather not go into future possible capital markets activity. There is -- I think you know all of the reasons why people in the REIT area do and don't do convertibles, and historically, we've seen that the premiums have been nominal, and that has not attracted REIT capital to securities -- to that security.

Got you. Okay. Thanks.

Your next question comes from the line of Jordan Sadler of KeyBanc. Please proceed with your question.

Hi, guys. I just wanted to follow-up on the rent question in terms of rate. You guys have talked a little bit about how -- why the affordability spread is in your markets relative to rate and I'm just -- could you -- have you done any work, either Leo or Tim, to look back historically and figure how far you can push it at this point? Maybe in the next 12 to 24 months in terms of rate before you start ebbing up against the affordability issue?

Jordan, this is Leo. I'm going to give you some information and maybe Tim could add as well. I will tell that you we have gone back and looked at where we are in comparison to the past. And if you go back to 2001, I can tell you that markets like northern California, the midwest, Boston, northern New Jersey, and the Pacific Northwest are still all considerably below where we were in 2001.

As you know, markets like the mid Atlantic and southern California never had the significant downturns that some of these other markets had. Though we don't have a crystal ball and tell you where it is going to go, we do feel like there is still running room here.

Jordan, just to add that again, as I mentioned earlier, we've seen home prices appreciate about 80%, and rents have appreciated about 4% in our portfolio, so there has been a 75% gap, if you will. So rents are coming off the high base and homes are coming off a low base.

I understand. I'm saying if you take that five years and say it is going to revert back, you say 75%, but for the reasons you just laid out, it is not that you got to -- you got to factor in interest rates as well. Interest rates are not as high as they were in 2001, either. But our sense is that it is -- it it is certainly double digits, in terms of -- in terms of the disparity, and I think the big question is how much of it is going to come through the declining or flat home prices versus increased rents and that's going to be somewhat of a function of the health of the economy and the amount of -- the amount and type of supply that comes into the market.

And Leo, just a follow-up, are you getting any push back in terms of rent bumps at the ground level?

We're really -- I mean are we getting pushed back, we always get pushed back, I expect push-back and if I'm not getting pushed back, then I'm concerned because we're not pushing hard enough. But to give you, from the standpoint of renewals, our turnover has been flat year-over-year to slightly down. When you go to the new move-in side, traffic as I said, has been flat and our conversion remains the same. Do I believe we're pushing rents hard? Absolutely. Do I expect us to continue to push rents hard? Yes. Do I hope people push back? Yes. Because that means we're pushing them hard enough. But it is not affecting, our occupancy is stable, we got the portfolio in a good position, and we continue to move it forward productively, as you see.

And just a technical one for Tom, I noticed that the capitalized interest bumped up about 30, 35% from the third -- excuse me, from last quarter, and I was just curious, I know you added a couple of assets to the pipeline, the development pipeline, but it didn't seem to swell that much that it would drive your capitalized interest up that much, how much of it is a function in the change in interest rates? If you had to breakdown the increase.

The change in interest rates really don't affect capitalized interest that much because you really anchor the rate you use by all of the entities, debt rates, and that just doesn't move that much from any period to any period. The increase in capitalized interest is primarily related to increased volume, and you have to look at the timing of when that occurs during a quarter, because that can skew the results. But it was not related to the capitalization rate.

Thank you.

Our next question comes from the line of Alan Calderon , European Investors.

How are you doing? Building on Jordan's question, the capitalized interest, is that kind of a run rate that we could expect during the last two quarters of the year?

Well, what I would refer you to is the outlook that we provided at the beginning of the year that covers capitalized interest, and I think if I recall correctly, it was $45 million.

Okay.

And I think that for the year is still a good number to use.

Okay. And also, on the capitalized costs, last year, in the second quarter, of '05, you had about 214 per unit, and nonrevenue Capex is about 164 this quarter. Was there any big reason why there was a big difference?

It is just timing of expenditures.

Okay. And final question, do you guys have the ability to put existing properties into the fund structure?

We do not have the ability to put AvalonBay existing assets into the fund. We cannot put assets in, nor can we buy assets out of the fund.

Okay. Thank you very much for your time.

You're welcome.

At this time, there are no further questions. I would now like to turn the conference back over to Tim Naughton for closing remarks.

Thank you, Holly. We really don't have any closing remarks other than to say thanks for attending, and hope everyone has a great summer. Thank you.

This concludes today's conference call. We do appreciate your participation. You may now disconnect.