艾芙隆海灣社區公司 (AVB) 2006 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the AvalonBay Communities fourth quarter 2006 earnings conference call. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session later in the call, and instructions will follow at that time. [OPERATOR INSTRUCTIONS] As a reminder, this conference call is being recorded.

I would now like to introduce your host for today's conference, Mr. John Christie, Senior Director of Investor Relations. Mr. Christie, you may begin your conference.

Thank you, Crystal, and welcome to AvalonBay Communities fourth quarter 2006 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion, and 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-Q filed with the SEC. As usual, the press release includes an attachment with definitions and reconciliations of non-GAAP financial measures and other terms which may be used in today's discussion. The attachment is available on our website at www.avalonbay.com/earnings, and we encourage you to refer to this information during your review of our operating results and financial performance. And with that, I will turn the call over to Bryce Blair, Chairman and CEO of AvalonBay Communities, for his remarks. Bryce?

Thank you, John. And welcome, and thank you all for joining us on our call today. With me on the call are Tim Naughton, our President, Tom Sargeant, our CFO, and Leo Horey, our EVP of Operations. On our call I will provide an overview of our fourth quarter results and a brief summary of our '06 full year activity. I will then touch on general market performance, and provide some comments on our '07 outlook. After that, I will turn it over to Tim, who will provide a summary of our investment activity. And then all four of us will be available to answer any questions you may have.

Starting with the review of our quarterly performance, last evening we reported EPS of $0.62 and FFO per share of $1.09. The year-over-year growth in FFO per share was 17%, which was driven primarily by strong growth in same store sales NOI of 9 -- of 10.9%. This is the strongest quarterly NOI growth we've shown in over five years. This performance reflects the strength of our markets, the quality of portfolio, and certainly, the talents of our property operations group. While we had a very strong quarter, it was part of an overall very strong year. We ended the year with FFO per share of $4.38 which represents a 16% increase over the prior year. This FFO performance for the year exceeded our original expectations, and it is the highest annual growth rate in FFO since 1998.

Overall for the year, we saw same store revenue growth of almost 7%, moderate expense growth of approximately 2.5%, and NOI growth of just over 9%. This NOI growth was broad based across all of our markets, ranging from a low of 5% in the Northeast, to a high of 13% in Seattle. As a result of solid performance, record level investment activity, and healthy sector fundamentals, we enjoyed another very strong year in terms of total shareholder returns. For '06, our total shareholder return was 50%, which when combined with our 28% return in '05 and 65% in '04, results in a three year average annualized return of 45%. This is the highest in our sector, and brings our ten year total average shareholder return to approximately 20%.

Now as you know, earlier this month we were added to the S&P 500's Index of Leading Companies. This was an important milestone for AvalonBay, and also for the REIT sector overall. It's an affirmation of the success of AvalonBay's strategy, but it is also an indication of the continued importance of real estate to the nation's economy, and as an established asset class within the investment community. Concurrent with the entry into the S&P 500, we issued 4.6 million shares of common equity, raising approximately $595 million of new capital which will be used primarily for investment in our large and growing development pipeline.

In order to put our '07 outlook into context, I want to spend a few minutes discussing how we expect our markets to perform in '07. Overall I would say most of our markets are settling into more moderate rates of revenue growth after several very strong quarters. And I group our six regions into three broad categories. The strongest regions, steady performers, and regions where we're seeing mixed results. In terms of the strongest regions for AvalonBay, they would include Seattle, Northern California, and Washington, D.C. We're expecting each of these regions to see revenue growth in '07 of 6% or greater, with Seattle's revenue growth expected to be the highest in our portfolio, as it continues to benefit from above average job growth and relatively limited supply. In the steady category, I would include Chicago and Southern California, both of which are expected to experience revenue growth in the 5% to 7% range. While Southern California continues to be a solid performer, its fundamentals are expected to moderate next year or this year in '07, due to lower expected levels of job creation and some increases in supply. Finally, in the mix category would be the Northeast. Working through the markets within the Northeast, Northern New Jersey continues to be very strong, Connecticut, Long Island and New York steady, and Boston and Central New Jersey lagging. In total, for all the markets within the Northeast, we expect the region to experience revenue growth in the 3% to 5% range.

Earlier this month we released our '07 financial outlook and we held a conference call earlier this month, so I won't go into too much detail here. But in short, we see '07 as another strong year for the apartment sector and for AvalonBay. While we do see the strength of both the nation's and the economy, and our markets moderating in '07 versus '06, we still see it as a very strong year, expecting NOI growth in the 5.5% to 7.5% range. Overall, we have an optimistic view of '07, which is based upon three key factors. First, continued healthy apartment fundamentals. We see renter household demand remaining solid in '07 and '08, driven in part by relatively strong job growth of approximately 1%. A job growth at this level, while slightly less than we saw in '06, would continue to generate demand for new rental housing of approximately 200,000 units. The demand side will additionally be helped by the continued weakness in the for-sale market, which we expect will persist through '07. In the supply side, we expect the level of new apartment activity to increase in '07 versus '06, but still be at levels that are expected to be easily absorbed by the new demand.

Second reason for optimism are AvalonBay's platforms for growth. We have a portfolio of approximately 50,000 of some of the highest quality, best located apartments in the country, from which we're expecting solid NOI growth in '07. We have the largest pipeline in the sector, totaling $5 billion of communities under construction or in planning, which is a continuing source of earnings and NAV growth. We have an active investment management platform, allowing us to pursue value-added acquisition and redevelopment opportunities, which is coupled with an active disposition program, allowing us to recycle capital back into our creative development opportunities. So if the first reason for optimism is continued healthy apartment fundamentals, and the second is our platforms for growth, the third is that -- or important is that we have the balance sheet and the organizational depth to execute on the growth opportunities that we see. And ultimately our optimism was reflected in our decision to increase our dividend by 9%, raising our quarterly dividend from $0.78 to $0.85 per share. This 9% increase follows a 10% increase that we announced approximately a year ago. And if you look over the past ten years, the compound annual growth rate in our dividend has been about 6.8%. And this is almost twice the sector average. And importantly, we achieved this dividend growth while maintaining the lowest payout ratio in the sector. So with that, I would like it turn it over to Tim, who is going to provide a summary of our overall investment activity.

Thanks, Bryce. I would like to share some highlights regarding recent investment activity, as well as some of our expectations for 2007 in this very active area of our business. Let me start with development, where, as Bryce mentioned, our current development pipeline now stands at almost $5 billion, with over $1.3 billion of development communities under construction, and another $3.6 billion of development rights in the planning and entitlement stage. During the fourth quarter we completed two communities and started two others. The completions were both second phases of urban high-rise communities, one located in Manhattan, and the other in San Francisco at Mission Bay. These communities were completed for a total cost of $207 million, representing a cumulative cost savings of $12 million. Both of these communities have experienced solid rent escalation during construction, which combined with the capital cost savings attained, resulted in a cumulative increase in their average projected yield of 110 basis points above our original projections at the time construction began.

For the year we completed six communities totaling $376 million, at an average projected yield of 7.7%. The two new starts in Q4 were located in the Boston and L.A. markets. Avalon Acton is a 380-apartment garden and town home community located in the western suburbs of Boston. And Avalon Canoga Park is a 210-apartment four-story community with deck parking, and is located in the Warner Center area of L.A. These starts totaled over $120 million. For the full year 2006, we started almost $700 million, and now have $1.3 billion currently underway. In 2007, we expect the level of starts to increase to more than $1 billion, which when combined with projected completions for the year, should result in total development volume underway approaching $2 billion by late 2007. The average projected yield for those communities currently under construction stands at 6.8%. Similar to recent completions, we anticipate that the average yield of these communities will increase during construction, and should stabilize in the low to mid 7% range.

As you recall, we project yields based upon current gross potential, or in other words, based upon rents currently being attained in the market, and we do not trend these rents in our projections. The projected yields of communities starting construction in 2007 should be in the low to mid 6% range. But given healthy market conditions, we expect that yields on these communities should increase to 7% or more upon stabilization. Our expectation for yields to increase during the period of construction is certainly consistent with the last cycle, when yields often increased by 100 basis points or more from the time construction began until lease-up stabilization.

Our development rights pipeline expanded significantly in Q4, as we added 8 new development rights totaling almost $700 million in projected capital investment. This is a result of a number of factors, including the softening for-sale market, improving rental market fundamentals, and finally, a strong franchise position in the Northeast, where much of the activity took place. A couple of points worth noting here include the addition of a large development right in the Manhattan neighborhood of West Chelsea, and the addition of four new development rights in northern New Jersey, where we've increased our focus over the last couple of years. Based upon our current assessment of the markets and the range of opportunities that we are pursuing, we expect that the pipeline will continue to expand in 2007 to a level of $4 billion or more. We expect that thew development rights added in 2007 will be more evenly distributed across our regions, as we are pursuing new business with established development teams in virtually every market today. In addition to new development activity, this past quarter we started two redevelopments, one in L.A., and the other in the Chicago market. Both of these communities are assets that are held in the investment management fund. And for the year, we started five redevelopments in 2006, and expect to ramp this up in 2007 when we anticipate starting redevelopment on ten to 12 communities.

Shifting to transaction activity for the quarter, the transaction market continues to be robust, with cap rates for core deals generally in the 4% to 5% range, depending upon the market. We've yet to see any let up in institutional appetite for apartments, and given healthy fundamentals which are expected to continue over the intermediate term horizon, buyers still appear to be motivated to increase their apartment allocations. We will continue to focus our efforts on value-added opportunities where we can leverage our market, operational and development experience to generate higher returns.

During the quarter we were very active in the area of acquisitions, acquiring three communities and a partnership interest totaling $147 million. One of the acquisitions and the partnership interest are wholly owned by AVB, and the other two acquisitions were bought for the IM Fund. Let me provide a little more color on the purchase of the partnership interest, where we bought out our partner in Avalon Run, a community located in the Princeton, New Jersey, area. Avalon Run was completed in 1994 by a venture where AvalonBay served as the general partner and developer, and where our partner contributed most of the capital. While the value of AVB's promoted interests grew significantly over the last ten years, our participation in cash flow has been limited, as most of the cash flow was distributed to our partner in the form of a preferred return. By buying out our partner, we essentially unlock the value that accumulated over time in our promoted interest. And in addition, by owning the asset outright, we can more easily combine operations with two additional phases of this community that were subsequently developed and wholly owned by AVB.

The two assets purchased for the IM Fund this past quarter are located in Columbia, Maryland, and Lombard, Illinois, which is a suburban employment center located along the I-88 corridor, just west of downtown Chicago. In addition, in mid-January we acquired a recently completed high-rise community in downtown Baltimore, that had a purchase price of $78 million, or around $200,000 per apartment. This community was purchased at approximately 50% discount to replacement cost. For the full year 2006 we purchased six communities and a partnership interest totaling $320 million. In 2007, we expect to buy assets principally for the IM Funds, which should total about $300 million to $350 million for the year. Combined with capital commitments to date of approximately $570 million, we expect by the end of the year we will have essentially completed all investment commitments for the fund.

Switching over to dispositions, in Q4 we sold one asset located in Stamford, Connecticut. Avalon Bedford is a sixty-zero 368-apartment high-rise that we previously purchased in redevelopment -- and redeveloped in a partnership with another party. This asset was sold for $75 million and an economic gain of $16 million, of which approximately $4 million accrued to AVB. Combined with the sale of Avalon Corners earlier this year in that market, this asset sale reduces our exposure to the Stamford market, which has been an objective of ours over the last couple of years. For the year, we sold approximately $280 million in existing communities and land, representing an economic profit of almost $96 million, and an unleveraged IRR in excess of 15%. In 2007 we expect disposition volume to be down moderately in the $150 million to $200 million range. And as usual, we'll revisit our plans and capital needs through the course of the year, and may elect to expand or contract our disposition program as conditions may warrant.

So in summary we're very active in the area of investments, and expect this to continue in 2007, when new development underway should approach $2 billion, the development right pipeline should expand to more than $4 billion, where redevelopment volume is projected to ramp up to the highest level since the mid to late 90s, and when we expect to add approximately $300 million of value-added acquisitions. Importantly, we have grown and scaled the organization over the last few years so that we may effectively execute and manage this expanded volume, and capitalize on the opportunities available in the market. We have a development and investment platform that we believe is unmatched in its ability to generate value for investors. Value that should translate into external earnings growth over the next several years. With that, I would like it turn it back to Bryce for some concluding remarks before we open it up for Q&A.

Well, thanks, Tim. What I hope you take away from our fourth quarter results and our comments today are first, that we did have a very strong quarter, which is highlighted by NOI growth of 10.9% the best in five years, and FFO growth of 17%. Secondly, that we see '07 as another strong year characterized by healthy, but moderating fundamentals. These healthy but moderating fundamentals are expected to drive NOI growth of 5.5% to 7.5% and operating growth of -- operating FFO growth of about 14%. Third, our sector leading development activity will contribute to earnings and NAV growth in '07, but even more significantly into '08 and '09, as the higher level of development activity stabilizes. We're pleased with the quarter, optimistic about '07, and about the positive momentum in our growing development pipeline. With that, Crystal, we would be glad to entertain any questions.

[OPERATOR INSTRUCTIONS] Steve Sakwa, Merrill Lynch.

Bryce, maybe you could just address the development pipeline, I guess, specifically as it relates to Boston, which is clearly maybe the weakest market right now for you. And I realize you can't time these perfectly. But it represents about a third of the development pipeline, and I guess when you look down the development rights page, it is maybe on the top ten or 12, it is probably another third. So I just -- help us understand kind of the developments in Boston, and how those will stabilize. And I guess, is there risk in the development yields as you look out over the next 12 to 24 months?

I'll have Tim address that question.

Steve, you're correct in looking at the -- at our pipeline, seeing Boston making up a big portion of it. I think we talked about this last quarter, as well. We have a wonderful history of creating a lot of value through the development process in Boston. And it is very difficult to time the development cycle, as you know, particularly in the Northeast. And I will say it is a great pipeline of really fine real estate. Currently we're seeing, even with some of the pressures we've seen in Boston, we're seeing yields in the 6.5% to 7% range. So they are in line with what we're experiencing, based upon current market conditions, with the rest of the development portfolio. And I guess the last thing I'd say is, certainly you can -- we think about the development strategy a little bit different than the portfolio strategy. As long as we're continuing to create value through the development process, obviously, the ultimate investment decision, in terms of whether you hold an asset or ultimately dispose of an asset, can be different or pulled apart from that. And I think right now in Boston you can expect over the next few years, we'll probably be recycling some capital in that market.

Okay. Thanks.

Alex Goldfarb, UBS.

Just want to talk a little bit about the price of land. One of your peers yesterday announced a deal where the per-door cost in L.A. is about $100,000, although that has some entitlement increases to it. Where do you think the cost of land is today on a per-door site? And where do you think it is relative to what's in your existing portfolio?

Tim Naughton here. In terms of -- first of all, I can tell you what our basis is in our development right pipeline. We've got almost -- about $3.5 billion worth of development rights. Our basis is just a little over $40,000 a unit, about $42,000 a unit, to be exact. Now, on average those development rights have probably been in the pipeline for 18 or 24 months. We have contracted for land as much as $100,000 to $125,000 a unit, in markets like L.A. and New York. But typically most of our deals are in the $30,000 to $50,000 a unit range.

So as you buy new deals, what do you think that does if the price of land is, it sounds like maybe double, what does that do to your yields?

The projected yields in the development right pipeline are similar to what I mentioned in my prepared remarks. For communities that we expect to start in 2007, roughly low 6s, 6 to mid 6s, depending upon the market.

Okay. And are you guys seeing any change in move-outs for condos or single-family as the prices in certain markets of condos or single-family comes down?

Alex, this is Bryce. Before Leo addresses that, I just wanted to add one thing to Tim's comment on the land. I don't think it would be a correct assumption to assume that land has doubled, when the $100,000 that you referenced or that Tim is alluding to is an outlier. It is not the average that we're seeing in today's marketplace. So, Tim, I think we would say that if our basis is low 40s, the market value of that land might be -- .

Well, today, probably about $60,000.

$60,000. So when you're looking at $100,000 per unit, you're looking the a very unique urban site, to mention a L.A. or a San Francisco or a New York. But for suburban wood frame sites, the number in today's market would be quite lower than that. So I just wanted to clarify that. Leo, do you want to address the second question?

Alex, this is Leo. On move-outs due to home purchase has been pretty constant. It is just below 24%. As I've said in the past, our historical average is between say 20% and 25%, so we have not seen any change. It is something that we do monitor closely, but it has been very stable.

Okay. And just one final question. Given the strong demand for REIT paper and the fact that one of the largest issuers is likely going to be leaving the market, are you guys seeing better pricing in the unsecured market for your debt?

Alex, this is Tom. We went to the market in September and got great spreads. 80 basis points for ten years, which was at the time, viewed as great pricing. With large borrowers exiting the market, there has been a shortage of paper, and it has driven spreads down. And so I think temporarily you've seen some market reaction to that. But over time, the capital flows, you can't really predict where they're going to be. And right now, they are very tight spreads. And we expect that when we go out to the market this year we'll enjoy great spreads on our paper.

Thanks a lot.

Jonathan Litt, Citigroup.

It is Craig Melcher here with John. What were the cap rates on the purchases for the -- in the investment fund during the fourth quarter?

Craig, this is Tim Naughton. Cap rates are generally, as I mentioned before, 4% to 5% across our markets. The particular assets that we bought were closer to the high end of the range, just given the markets that they're in. But just remember, for the most part we are looking at value-added acquisitions, often which -- often they have some redevelopment component. And so we would expect ultimately the stabilized yields to be something north of that.

With that fund selling out towards the end of this year, would you look to expand that fund? Or do you think you are going to put your capital more into development?

I am sorry. Could you repeat your question?

Would you expect to do another similar fund, once this fund is filled up?

Well, we expect that we will do a second investment management fund, once we've completed this fund. We're not sure exactly if it will take the same mandate, and that being strictly a value-added fund. We'd like a broader mandate that allows us to participate in different types of assets. But we do plan a second fund when this is complete.

Thank you.

[OPERATOR INSTRUCTIONS] Christeen Kim, Deutsche Bank.

Just on the additional equity you guys raised last -- well, a couple weeks ago now. Do you think that allows you to start more development this year than you would have otherwise?

No. We had the capacity to begin all the development on our books without regard for that equity issuance. We look at the sources and uses on an annual basis, and make sure that we always have adequate liquidity to fund the development. The issuance of the equity is more of a longer-term decision based upon a number of factors that came together at that time, certainly one of them being the introduction into the S&P 500. But on a broader level, looking at the total level of our development pipeline over many years, so it is not going to impact directly the volume in '07.

In terms of capacity, with approaching $2 billion under construction and $4 billion in the shadow, can they get much bigger than that, in terms of the total pipeline?

Christeen, Tim Naughton here. I suppose over time, it is difficult to ramp it up say to double it in a year, just based upon the organizational capacity, let alone capital capacity or balance sheet capacity. So I think today we probably have, if I looked across the markets, we're still probably in the neighborhood of 10% market share. Probably 3% or 4% on either side of that. So, certainly if we -- strategically, if we wanted to expand market share, we could potentially do that. But I would suspect it would happen over a period of time. Bryce, you have anything you want to add to that?

Well, I think maybe a useful framework, the way we think about it is what drives the size of that are a few factors.First, what does the field of opportunities look like. And as Tim mentioned, as the condo market has slowed, we've seen the field of opportunities increase. So that impacts -- that's one factor. The second, and is what can the organizational support -- what can the organization support, both now and into the future, to make sure that we do not bite off more than we can chew. So that's a gating factor. And the third is obviously having it consistent and balanced with our overall business plan and financial strength of the Company. So those, opportunity, organization and balance sheet are kind of the three metrics that we're always looking back and forth on when we think about the size of our development pipeline, and how we feel about it.

But given the size of your platform now and the additional opportunities you're seeing with the softening of the housing market, that was kind of my underlying question, whether it could expand much more beyond the $6 billion, given the capacity that you have now.

Well, to be clear, it is not at 6 now. What Tim -- .

Oh, yes, getting up there.

Yes, Tim was projecting that it will increase because of those reasons.

Okay. Great. Thank you.

[OPERATOR INSTRUCTIONS] Dennis Maloney, Goldman Sachs.

Just wondering, was there anything notable on the expense -- the operating expense front this quarter? Your numbers came in a bit heavier than we had modeled.

Yes, this is Tom. We are -- same store expense growth was about 0.3% year-over-year. Overall, we came in largely as we expected, based on both our October outlook and our outlook we provided two weeks ago. I guess I would point out that the fourth quarter is always a volatile time in terms of operating expenses and other expenses, including G&A. So we frequently do make adjustments in the fourth quarter for accruals. And that sometimes catches analysts by surprise. But overall, we were very pleased with the overall level of operating expenses, and they came in as we expected, largely as we expected.

Okay, great. And then just you guys had mentioned that you expect greater supply to hit the market next year. If supply is roughly 1% of stock in your markets this year, where do you see that number growing to next year? And which submarkets do you think you might have an impact on your operations?

Dennis, this is Tim Naughton. I will take that. First of all, in terms of supply this year, we actually think it is quite a bit less than that, particularly when you net out the impact of condo conversions, which we try our best to do. We think it was actually about 0.3% in AvalonBay's markets this year. And we're actually projecting it to be about twice that next year, about 0.6%. So versus nationally, about 1%. So we do expect the supply situation to remain relatively contained. Having said that, I think probably the markets that's likely to see more supply next year, certainly Washington, as a number of condo communities are likely to switch, some already have, and some are likely to, to rental. We're expecting supply there about 1.5%. And then probably Boston is the other market that's worth pointing out, where we expect supply as a percentage of inventory to increase by more than 1.5% next year. So those are the markets that we're expecting some supply pressure. And frankly, I think it is just the Boston market that we're a little bit concerned about in terms of the impact to fundamentals.

And then just could you address the outperformance, the continued outperformance in Northern New Jersey? I mean, it has been doing quite well. But if you drive up and down River Road and Edgewater and what not, there is a ton of new supply coming on line. What's your outlook for that market?

Dennis, this is Leo. In general, we feel really good about Northern New Jersey. If you look just at the fundamentals for Northern New Jersey, you might pause, right? Because job growth has been seen as lagging, supply is reasonable as a percentage of overall inventory, and the demand/supply ratio is roughly in balance. But with respect to our Northern New Jersey portfolio, it is majority along the Hudson River as you said, and it really trades off of New York. In fact, last quarter I think I quoted a percentage of residents that actually reside in the City that live at our properties along the waterfront. I believe that percentage was around 60%. And basically, when you look at the New York market, job growth is very robust, supply is very limited, the demand/supply ratio is very favorable. And I believe that the properties in our Northern New Jersey portfolio really are those that benefit from the very positive market fundamentals in the City.

Okay. And then just lastly, what's the anticipated FFO contribution from the Fund in '07.

Well, just looking at the fees, Dennis, the overall fees would be about $6 million to $6.5 million from all sources of fees that are thrown off the investment management fund. $6 million to $6.5 million is the right number.

Thank you very much.

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

We must have been very complete in our comments. This is one of the shortest calls we've had. So we'll take that as a positive sign. And thank you all for your attention today. And we'll see many of you at upcoming conferences. Thank you very much.

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