艾芙隆海灣社區公司 (AVB) 2012 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the AvalonBay Communities third quarter 2012 earnings conference call. At this time, all participants are in a listen-only mode and we ask that you please refrain from typing and having your cell phones turned off. Following remarks by the Company, we will conduct a question-and-answer session and instructions will follow at that time.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would like to now introduce your host for today's conference, Mr. Jason Reilley, Senior Manager of Investor Relations. Mr. Reilley, you may begin your conference.

Thank you, Charlene, and welcome to AvalonBay Communities' third quarter 2012 earnings conference call. Before we begin, 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 afternoon's press release, as well as the Company's Form 10-K and Form 10-Q filed with the SEC.

As usual, this press release does include 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 also 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 Tim Naughton, CEO and President of AvalonBay Communities, for his remarks. Tim?

Thanks, Jason. And welcome to our third quarter call. Joining me today are Sean Breslin, EVP of Investments and Asset Management, and Tom Sargeant, our Chief Financial Officer. Sean and I have some prepared remarks and then the three of us will be available for questions. I'll start by summarizing our results for the quarter and then discuss our recent development and financing activities. Sean will provide color on operating performance and current trends in our portfolio and discuss recent investment of redevelopment activity.

To begin, last night we reported EPS of $0.89 and FFO per share of $1.44, a 23% increase over the third quarter of 2011. This past quarter marks the fifth consecutive quarter of 17% plus FFO per share growth, driven by a strong performance in our operating portfolio, as well as new communities coming online through redevelopment. FFO per share exceeded the midpoint of guidance provided in July by $0.04, which was a result of a promoted equity interest and connection with the buyout of our joint venture partner at Avalon Del Rey. In addition, revenues outperformed expectations during the quarter by about a $0.01 per share, but was offset by higher interest expense from our September bond offering, which occurred about two months earlier than planned. Overall, the year continues to track more or less as expected and we have upped our full-year FFO per share outlook modestly to account for some of these non-recurring items.

[Portfolio] performance continues to be strong, as same-store rental revenues increased 5.6% in the third quarter and are up 6% year-to-date. Occupancy for the quarter was 96.3%, positioning us well as we move into the slower winter leasing season. And while there's been pressure on real estate taxes and insurance, we've been able to mitigate expense growth in a number of other areas such that year-to-date expenses are up only about 1.5%. Despite slower than expected job growth and the uncertain political and economic environment, we continue to see healthy demand across the portfolio.

The third quarter marks Northern California's fourth consecutive quarter of double-digit revenue growth, and the sixth consecutive quarter of double-digit NOI growth. Seattle, New York, and Boston are all benefiting from hiring within the tech sector. Meanwhile, Southern California is now seeing year-over-year employment gains in the 2% plus range. On the supply side, completions are up year-over-year, but in the aggregate, 2012 deliveries within our footprint remain in line with the long-term average of about 0.7% of existing stock. As we noted, the mid-Atlantic and downtown Seattle are experiencing the most new supply this year. So far in the Mid-Atlantic, these deliveries have impacted a limited number of communities and in Seattle, job growth is driving healthy demand for apartments, thereby absorbing new supply.

Looking ahead, if forecast per job growth in 2013 and '14 materialize in the range of $2 million to $3 million as expected, resulting demand should continue to support healthy rental market conditions in most of our major markets. Demographics remain favorable, as population growth in the prime rent age 25- to 34-year-old cohort, is running close to $800,000 annually. In addition, this cohort is even less likely to purchase a home today than they have been in the past, as their homeownership rate has declined 500 basis points since 2002, to around 42%. And while 2013 completions are expected to rise towards 15-year averages nationally, this level of new supply is significantly below levels absorbed the last time demographics were as favorable.

Moving on to development activity, during the quarter, we started four new communities, two in the East Coast and two on the West Coast, totalling $260 million. We also completed two communities totalling $100 million this past quarter. Total development underway stands at $1.8 billion, which amounts to roughly 11% of total market capitalization. The projected stabilized yields for the development portfolio is almost 7%, and for those communities in lease-up, rents are generally at or above pro forma and yields are exceeding expectations by about 30 basis points to 40 basis points. In addition, execution remains excellent, as total development costs remain at or below original budget and standing inventory contained as absorption keeps pace with new deliveries.

Despite a more competitive land market, we've been able to replenish the pipeline over the course of the year. This past quarter, we added two development rights at a projected cost of about $145 million, and year-to-date, we've added a total of $730 million in new development rights, with another $450 million in due diligence. The initial projected yields for our development right pipeline of over $2.5 billion averaged 6.5% to 7%, or roughly consistent with those communities currently under construction. Land inventory remains modest, at just over $300 million.

Lastly, I want to turn to financing activity, where we were very active this past quarter. In July, we completed our second continuous equity program and initiated a third CEP in August, with capacity of $750 million. For the quarter, we issued around 1 million shares, raising just under $150 million at an average stock price of $142 per share. For the year, we've raised $300 million of equity through the CEP at an average price of $141. In September, we completed a 10-year, $450 million unsecured offering at a coupon of 2.95%. The effective rate is 4.3% after accounting for the impact of fees and hedges. The sub-3% coupon established a record for the lowest 10-year unsecured offering by a REIT and stands as the sixth lowest Triple B, 10-year coupon executed by any issuer in any sector.

Including this issuance, average years to maturity for all fixed rate debt increased to 5.9. This $600 million of financing activity during the quarter underscores the strength of our balance sheet and our ability to raise multiple forms of capital at very attractive pricing. In addition, we have ample liquidity to continue to fund our development business well into 2013, with $700 million in cash and nothing drawn on our $750 million line of credit. And with that, I'll turn the call over to Sean for his remarks. Sean?

Thanks, Tim. As Tim mentioned, I will comment on portfolio performance during the quarter, current trends, and our investment in redevelopment activity, starting first with portfolio performance, same-store NOI increased 7.1% year-over-year. Revenues increased 5.6%, consisting of a 5.1% increase in rate, and 50-basis point increase in occupancy. Sequentially, revenues increased 2.4%, driven by a 1.9% increase in rate, and a 50-basis point increase in occupancy. Northern California and Seattle continues to outperform, posting year-over-year rental revenue growth of 10.5% and 10%, respectively. On a sequential basis, each region generated greater than 3% revenue gains.

It's worth highlighting that year-over-year rental revenue growth in Seattle has now been north of 8% for four consecutive quarters. NOI was up nearly 20% year-over-year in Q3, and momentum remains healthy. Both Northern California and Seattle continue to benefit from job growth that remains well above the national average. In Northern California, the tech sector is driving unemployment gains, generating high quality jobs that support increased rent levels.

New supply has not been a material issue in Northern California this year, but we are expecting more deliveries in San Jose as we move into 2013. In Seattle, the economy is also performing well, benefiting from growth in not only the tech sector, but also from retail trade, which is being driven partly by Amazon's expansion, and aircraft manufacturing at Boeing. New supply will come online next year in Seattle, but it is highly concentrated in the downtown, or near downtown submarkets, where we have very little presence. Metro New York, New Jersey, New England and Southern California all posted year-over-year revenue gains in the 4% to 5% range, with sequential growth of 2% to 2.5%.

In the New York metro area, tech hiring is having a meaningful impact on apartment absorption, both in downtown and in northern New Jersey. Steady demand, coupled with modest new supply is supporting occupancy rates close to 97% and has provided a boost to pricing power. Boston is also benefiting from job creation along the 128 Corridor, where TripAdvisor, Google and others are adding jobs. Although new supply is on the horizon, particularly in the urban core, it is not impacting current fundamentals in the market.

In Southern California, as job growth has accelerated, as Tim mentioned earlier, and is now running at an annualized rate of greater than 2%, San Diego, which lagged the region in job growth earlier this year, is now producing jobs at an annualized rate of about 2.5%, third strongest of any market in our footprint over the past six months. While some of the job gains are military related, the market is also benefiting from robust job growth in the leisure, hospitality, and warehouse distribution sectors. As job growth ramps up, the Southern California region will continue to benefit from very low levels of supply. In fact, the Southern California markets are projected to have the lowest level of supply of any of our markets over the next couple years.

Moving lastly to the Mid-Atlantic, the region produced year-over-year revenue growth of 3.8%, 1.8% sequentially. It's no secret that reduced stimulus and fiscal uncertainties continue to limit job creation in the region as new supply comes online, impacting our ability to push [ramps]. As indicated in our earnings release, turnover was 65% in the quarter, down 200 basis points from Q3 2011.

Move-outs due to home purchases increased about 20 basis points from Q2 to roughly 15% and remained well below the long-term average of 20%. Move-outs related to rent increase declined by about 200 basis points sequentially to 17%. As you might expect, we continue to see the highest move-out percentage due to rent increase in Northern California and Seattle, which is in the low 20% range, but we're clearly backfilling with new prospects, able to pay higher market rents. And these new residents don't appear to be stretched financially, since their average rent to income ratio remains consistent, with historical levels in our portfolio at 20%.

Shifting to operating expenses, year-over-year expenses were up 2.6% during the quarter. As we have mentioned in the past, operating expenses can be somewhat lumpy from quarter-to-quarter, based on a number of factors, so judging operating expense growth on a year-to-date basis tends to give you a better picture of where we are headed. Year-to-date expenses have increased 1.4%, with property taxes putting the most pressure on overall expense growth. The most significant tax increases are occurring in the Mid-Atlantic, New York, New Jersey, and Pacific Northwest markets, which are seeing 8% to 10% bumps this year through both increased rate and assessments. We benefited from two successful tax appeals in Southern California, which contributed to the favorable year-to-date expense variance in the region.

Overall rent change averaged about 4% during the third quarter, roughly 5% on renewals, and 3% on new move-ins, while we increased occupancy each month of the quarter, from 95.9% in July to 96.6% in September, and reduced availability. The portfolio is well positioned right now, with economic occupancy trending in the mid-96% range, a full 100 basis points above where we were at this time last year. Additionally, availability is about 5%, roughly 50 basis points below last October. October's committed renewals are in the high 4%s and given our healthy occupancy and low availability, November and December renewal offers went out in the low- to mid-6% range, which is similar to the offers we made in Q4 of 2011.

Shifting to investment activity, we completed the purchase of our partner's 70% interest in Avalon Del Ray during the quarter. We developed the community in 2006 for approximately $70 million and as a result of the transaction, we gained control of an attractive asset on the west side of L.A., while unlocking the value of our $4.1 million promoted interest.

Looking forward, we have several assets in our acquisition and disposition pipeline. On the disposition front, we currently have about $375 million of assets under contract, the majority of which are owned by Fund 1. With all the pending Fund 1 dispositions settling in Q4, we would have 10 assets remaining, or about half the fund's value to sell in the next couple of years. From an acquisition point of view, we have about $100 million under contract and in due diligence. Assuming the properties clear diligence, they would close in Q4.

In terms of the transaction market, year-to-date trading volume is down about 15% in our markets. And the markets with increased volume, like Seattle, have not been targets for us. As a result of the reduced volume and healthy pricing, acquisition volume remains below our original plan for the year. Currently, we expect transaction activity to total approximately $950 million for the calendar year, which includes roughly $300 million in acquisitions, 80% of which is for the parent entity, and $650 million in dispositions, about 40% of which is for the parent entity, and 60% is for Fund 1.

Moving finally to redevelopment activity, we completed five redevelopments during the third quarter for an incremental total capital investment of about $32 million. These five projects were all completed via our occupied turn program and outperformed our pro forma rent projections by about 5%, or $100 per home, resulting in a weighted average return on enhancements of roughly 20% as compared to our original expectations of 12%. Execution has been strong, as each project was completed on schedule and either in line or below our original capital budget. Now, I'll turn the call back to Tim for a few comments.

Thanks, Sean. So in summary, 2012 continues to track, largely as planned; attractive fundamentals continue to support strong performance. The portfolio is well positioned, headed into the seasonally slower fourth quarter, and we continue to deploy costs effective capital into attractive development and redevelopment opportunity. And with that, operator, we are ready to open the call for questions.

(Operator Instructions)

Eric Wolfe, Citi Financial Group.

I know you are probably not ready to give guidance for 2013 quite yet, but obviously with one of your peers giving guidance, someone's probably going to ask about it. So just wondering if there's anything you can say anecdotally about how 2013 should stack up relative to this year and whether some of the -- I know the commentary you heard on the call earlier today in terms of 4% to 5.5% rent growth sounds like a reasonable number.

Eric, Tim here. Yes, I am aware that one of our peers did, I think, give preliminary outlook as related to same-store revenue growth. We had not done that and don't intend to do so until January. But maybe provide a little bit of color in terms of how we're generally looking at the market and how 2013 might shape up. I would say generally from a fundamental standpoint, we expect demand and supply to be roughly in balance with job growth and new supply being added at about a rate of about 1.5%. That's an elevated level for supply, but relative to what we see in the past, but at a time where we see job growth increasing to around two million nationally, about 1.5% across our markets. Sean mentioned we have a very high occupancy platform, which I think is important consideration in the mid-96% range.

From our perspective, in terms of how 2013 will play out, I think it's somewhat of a question about, how -- what happens with homeownership rates and frankly, the marginal propensity for rent for those incremental households that are created over the next year. I think the consensus is that homeownership rates will continue to trickle down a bit. I think that will be good for the sector. And then I think the second issue is really this notion of pent-up demand and whether any of that is really released into the market, which shifts that balance of demand and supply in favor of more demand. A number of third parties have estimated there's around two million households that are out there that are pent up and that are likely to get released over the course of the cycle. We haven't seen it yet, but to the extent you start seeing that in 2013 and '14, I think that can bode well for the outlook for 2013.

That's very helpful. I guess one of the points you brought up there in terms of thinking about how changes in homeownership is going to affect the apartment business next year, and moving forward, it seems like most of your peers don't really see much of a risk from people moving out from your apartments into single-family homes. I mean, would you say that you share that opinion, that you don't see in the near term or medium term, that as a risk?

Well, I think housing has bottomed, it's my own view. I think Sean mentioned that we've seen a marginal increase in the order of 20 basis points of people moving out to purchase homes. But still, around 500 basis points lower than long-term average. I suspect that we'll see that drift up over time as consumer confidence takes hold. This is all assuming in an economy that stays on a moderate, slightly better than 2012 growth trajectory. But I suspect you see savings rates improve. They are not getting much return from any alternative investments. So I think you will see some folks at the margins take those savings and become home buyers as we move further into the cycle. But I don't know anybody that's really anticipating a strong turnaround in home buying. And then when you couple that with the amount of excess inventory that's already been absorbed. I think just the builders, the reduction in capacity that you're seeing in the building system, I think it's likely to translate more in the form of increased home prices than it is maybe in volume.

Great. And then just one last question. You started a couple of developments in New Jersey this quarter. Looking at your New York Northeast portfolio, you have a decent amount outside of the five boroughs. So just curious if you could talk about your strategy around allocating capital between the more immediate New York City area versus going outside of the five boroughs and investing in Connecticut and New Jersey, Long Island City, and places like that.

Yes, Eric, I would tell you we've always been relatively agnostic between urban and suburban investment. I think I talked about this last quarter. Clearly, over the last 10 years, urban has outperformed suburban. On the other hand, that hasn't gone unnoticed by the market and it's being reflected certainly in asset pricing and in land pricing. So our view is more of a mix strategy is probably hedging our bets. Hedging our bets is probably the right approach to our markets. And particularly when you look in the New York area, when you look at places like Connecticut and Westchester and New Jersey and Long Island, we're seeing opportunities there that we have never seen really in our history in terms of, that would have gone condominium, we can build wood frame, relatively close in, very high end bedroom communities that really have outstanding economics, 7%-plus type yields. New York, the Manhattan, certainly doesn't give you those initial economics, but perhaps gives you a little bit stronger growth over the long run. But we think a mixed strategy with respect to urban and suburban across all markets probably makes the most sense, New York included.

Gaurav Mehta, Cantor Fitzgerald.

A couple of quick questions on your development pipeline. When you think about your development pipeline over the long run, what's the optimal development size that you aim for?

Yes, this is Tim. I wouldn't say that there's an optimal size. As I mentioned, it's currently running about 11% of market capitalization. I think it's gotten as high as 20% in the past, probably as low as the mid-single digits. So those are probably the relevant guard rails when we talk about size from a balance sheet capacity. There's also an issue of organization capacity. We think right now, the organization's geared to do about $1 billion or so a year in new starts, which supports about a $2 billion, $2.2 billion, $2.3 billion size pipeline. So we would need to increase organizational capacity to get much beyond that level of production. And then it gets [some of that] based upon the opportunity set and the marketplace and the share that makes sense in order to see what we think are the most attractive investments. It seems that during the expansion period, it seems to be in that $1 billion, $1.1 billion, $1.2 billion range. Over longer term, when you look through down cycles, there's probably a little bit less than that.

Thank you. That's helpful. A follow-up question on the development, how are the construction costs trending over last couple of quarters and what do you expect in 2013?

Well, 2013's a tough one to project. In part, because part of what we've been seeing has been a removal of production capacity from the construction industry over the last few years. But what we've seen over the last year, on wood frame, we're seeing wood frame up in the 4% to 6% range, on average, across the board. High-rise, a little bit more than that. Concrete construction, a little bit more than that, around 6% to 8%. A lot of that pressure has been coming from certain commodities, like lumber and composite materials, were up around 25% year-over-year, and drywall and insulation in the 10% to 20%.

And then labor, just generally across the board, as contractors are restoring profit. They were doing back in 2010 and early '11, they were doing business basically to cover overhead and they are back to restoring this profit margin to 5% to 10%. So that's really what's driven the price increases over the last year or so and we're probably somewhere in between where trough pricing was in the prior peak pricing. As it relates to 2013, we're still feeling some pressure. Supply, as I have mentioned, is likely to grow nationally next year, start to flatten I think in our markets. And then it's just a question of how new production capacity comes online relative to when the other sectors start gearing up. So at this point, we expect there to be pressure probably something on the order of what we've seen over the last 12 months and we look forward.

Dave Bragg, Zelman.

Could you talk about your operating strategy over the course of the third quarter? It was interesting. Seems as though you might have positioned more defensively than usual, looking at occupancy rise, 50 basis points sequentially, nearly the opposite of what happened the last year, and then your new move-in and renewal gains of 3% and 5% compared to 6% and 7% last year.

Sure, Dave. This is Sean. The trend obviously was a push for occupancy during the quarter. So we probably pushed occupancy up maybe a little bit beyond where we wanted to be, but maybe only 20 basis points, 30 basis points. So as you work through it, it's real-time pricing each week. So we make adjustments through our revenue management system to reduce availability and push occupancy, and certainly there's a lot of science behind it. There's a little bit of art as well. And so we may have given up a little bit on rate to push occupancy up, but we wanted to end the quarter in a strong position and I think we did. So that as we look forward into the fourth quarter, the renewal offers that we've sent out reflect that being in the 6% to 6.5% range as we look forward into November and December. So I think we'll gain some of that back. But clearly, there was a bias to push occupancy in the third quarter, which is not inconsistent with what we've done in the past, maybe some slightly different results based on how hard we were pushing or not pushing from year to year. But typically, there is a bias in the third quarter to make sure that we end the quarter on a strong note from an occupancy and availability point of view.

That's helpful. Thank you. Tim, going back to your opening comments, can you talk about your view as to what's driving the lower transaction volume in your markets? What do you need to see to get you more active on the purchase front?

Well, maybe I could start and ask Sean and see if he's got any thoughts on that as well. I think as we came out of this last correction, Dave, I think there was just -- our markets were in demand. As people were looking for liquidity, we were looking for the safe trade, it made sense to give the market what it was demanding, which was more core coastal market product. And so we saw a disproportionate amount of, I think our footprint get released into the market. I think as fundamentals continue to be more widespread, other markets were starting to show improvement. People were starting to either get a little worried on pricing in some of our markets and just wanted to look at a broader set of opportunities. That just opened the market for some secondary and some of the tertiary markets from a transaction standpoint. But, Sean, anything to add to that?

Yes, what Tim said is absolutely right. So typically what you see as things open back up, people are looking to buy core product as a discounted replacement cost in the coastal market. So that's the first wave. Second wave tends to be people looking at value-add product in the coastal markets, and then as that pricing becomes much more competitive, then people do start looking at secondary or tertiary submarkets within our markets and/or some of the commodity markets, where the yields tend to be a little bit higher in terms of trading cap rates. So I think that's what we're seeing play out over the last couple of years here.

I think last quarter you mentioned that you weren't very actively looking in D.C. and I think you just mentioned earlier you're not looking actively in Seattle. Could you talk about in what markets are you looking? Maybe anecdotally, give us an idea of how far off you are on the bids that you're submitting versus where the assets are trading?

Sure. First, as relates to the two markets you mentioned specifically, we've not been active in buying assets in D.C. over the last 12 to 18 months. We have been somewhat active in selling assets in D.C. We sold a couple large assets last year, as an example, in submarkets where we felt like the supply was going to be such that the -- it made sense to trade out of those assets and get better returns elsewhere. I would say I wouldn't be surprised to say that we would be looking at assets in D.C. over the next 12 months to 18 months, as that supply comes online and it impacts NOIs, impacts people's underwriting of rents, and therefore cap rates get the same returns. So I wouldn't be surprised to see us do that as those opportunities become available.

As it relates to Seattle, we feel pretty good in terms of our allocation to Seattle, right now with the existing portfolio plus the development activity that we have underway there. So we're not necessarily looking to grow in Seattle and to the extent that we were, we probably would be buying in Seattle at a different part in the cycle. It tends to be a little bit more volatile in terms of the pricing in that market, reflecting the underlying base there, being primarily tech and other industries that tend to be more cyclical. In terms of where we've been looking, we've been looking somewhat in the Northeast, in submarkets that we feel are pretty supply protected and are getting yields that make sense to us. We've also been looking, I would say, in Southern California, where you still have a couple of places like L.A. and Orange County where we're still not back to peak rent levels that were achieved back in '08. So either for the Fund or for AvalonBay, you are seeing us buy some stuff there over the last 18 months.

And in terms of spreads, it really depends. We're not bidding on assets in Seattle so it would be hard to tell you what those spreads are. We monitor pricing, pricing overall. I would say for higher end product in Seattle is in the low 4%s, maybe even in the high 3%s for core urban product. We're not chasing that, so I can't really tell you what the spread would be. But generally on the West Coast, cap rates are in the 4% to 5% range, maybe a little bit below 4% for core stuff, that's infill. As you come to the East Coast, that's probably in the 4.5% to 5.5% range except for New York, which, depending on how you value the abatement, can be in the 3%s to low 4%s. So that's a range of where pricing is and hopefully that's helpful.

Alexander Goldfarb, Sandler O'Neill.

Just going to the promoted income, you guys, I recall the Chrystie Place, there's a promote that you guys have occasionally earned out of that. So a two-part on the promote. One is, is there anything we should anticipate out of the sale of Fund 1? And two, how much visibility do you have it, in the sense of, this is something that you can let us know that, this year or coming quarter if we sell this, we could recognize or promote anywhere of X to Y? Just so that we can think about the value -- clearly, it's value that you guys are creating and it's nice to think about it in advance rather than just reading about it in the press release after?

Yes, Alex, this is Tom. One point on the Chrystie Place, we continuously receive a promoted interest almost immediately because of the structure of that transaction in the low floater bond. So we continuously recognize joint venture income on a promoted basis for that asset. When it comes to predicting or projecting a promoted interest, that is so sensitive to really the end of the life of the funds because of the way this is structured, that it would be very hard for us to give you much guidance very far out. Fund 1, because of the timing of those buys and right before the downturn, the opportunity to promote there is less than for Fund 2. Fund 2 would have a life span that's so far out that it's probably not even meaningful to talk about today. We do have a few cats and dogs out there in terms of other opportunities for promotes. We don't have that many joint ventures, but there could be another promote coming down the road in the next three to six months, but it's hard to predict that at this point. I think we'll just wait for guidance to come out in January before we let you know anything about that. Tim, do you have anything?

Yes, and just another thing to add to that, Alex, I would just say that any joint ventures where we don't have discretion, or just they tend to be episodic, because it's always a functions of where our partners' objectives are. So, and that sometimes just happens during the course of the year, like it did here in Del Ray, where we had an opportunity to have the conversation. There have been other times where we've actually triggered a buy/sell to unlock, but that's usually the result of a pretty dynamic discussion that's going on with your partner before you get to that point.

Okay. Yes, no, it's good. I mean, it's clearly value that you guys create. Second question is, with all the talk of a new normal and consumers making do with earning less and consumer confidence rising as people get comfortable with the new normal, clearly, your tech tenants and others are willing to pay the rents needed. But curious how this has manifested as far as apartment design. Some folks are talking about scaling down kitchens. I don't know if you go to kitchenettes, but curious as you guys continue to develop the Ava brand and build new product, if all the changes that are going on mean that you can actually design smaller units, maybe units that have less infrastructure because people are eating out more or doing more socializing.

Alex, this is Tim. To speak maybe specifically to Ava, they are -- Ava, by its design, are intended to be smaller plans, on the order of 150 square feet to 250 square feet per like unit in, say, an Avalon community. An average one-bedroom may be 600 square feet or less. And then an Avalon community may be, call it, 725 square feet, 750 square feet. In addition, really a pure, pure Ava play like the one that we're building on H Street here in D.C. It tend to smaller community, not highly amenitized, so to your point, the amenity, in many ways, is the neighborhood. So you can save a bit in terms of some of the infrastructure costs and as you get back to the units, they tend to be more, at least on new construction, more open, almost loft-style design that does allow you to minimize certain spaces like kitchens or maybe combine even bedroom and living areas that allow you to squeeze some square footage out of some of those spaces. So that's probably more focused on the urban side but we are seeing some of that translate into even some of our suburban opportunities where we are introducing some of these smaller floor plans and to even some of the wood frame suburban deals that we're building.

Does the greater density translate to higher yields or merely just offset the increased land costs and other costs?

I wouldn't say it translates into higher yield. What we're trying to do is position it to where we think demand is within a particular submarket. So if we think demand is deepest at a price point of, call it $1800 or $2000, we're trying to design a product that can deliver value within that price range and oftentimes that means smaller floor plans or communities that don't have quite the same level of amenities. You can do that through new construction. You can also do it through redevelopment. In fact, in Ava about half of the communities we've identified are new construction, about half are redevelopment.

David Toti, Cantor Fitzgerald.

I just had a quick follow-up to Gaurav's questions. I know I ask these often. If we look at the metrics in the quarter with rent growth sequentially coming down a little bit and occupancy numbers going up, is there a read-through to the RMS system? Is there a takeaway that you guys were a bit more cautious in your rent aggression in the quarter? This is a pattern that we've seen over the past couple of years, or is it just purely seasonal? What's your thoughts on that dynamic in the quarter?

Yes, David, this is Sean. In terms of the revenue management system, as I mentioned, there's a lot of science behind it, but there's also some art to it in terms of the different variables that you play with. I would say that last year, when we were running through revenue management in the third quarter, we had a buy through occupancy. We probably didn't adjust the variables quite as much as we needed to, to get to the point where we wanted to be. So this year, we probably were a little more aggressive in doing that. As I mentioned I think in my prior response, maybe a little too much so that occupancy, as I mentioned in September, was a 96.6%. We would have been happy at 96.2%, 96.3%, as an example. So we probably did give up a little bit in the third quarter. I wouldn't say it was intentionally defensive, though, to your point. So I think we're positioned where we would like to be in the relevant range, maybe a little bit high, but we weren't being defensive in nature.

Okay. Are you -- maybe I missed this, but are you able to share what you're seeing in October and potentially what some of the models are indicating on a go-forward basis on a 30-day, 60-day?

Sure, sure. October, the committed renewals that we have in hand are in the high 4%s. In terms of November and December, renewal offers went out in the 6% to 6.5% range, which really reflects the strong position we're in today, with both occupancy and availability.

Karin Ford, KeyBanc Capital Markets.

I wanted to ask a question about, Tim, your comment that you expect demand and supply to be generally in balance in 2013. Could you just talk about which markets, if any, would be on one side or the other of the balance, if you have a group of markets that you think demand will exceed supply materially or vice versa?

Sure, Karin. Well, I think certainly the Mid-Atlantic, both D.C. and Baltimore are markets I think everyone has identified as where the relationship between demand and supply is likely to be -- it will be weaker, without question. In terms of in terms of other markets or regions where it may be below average for our footprint, parts of New England, bedroom communities, if you will, where job growth is expected to be a little less robust, even though we don't necessarily expect to see a whole lot of supply. Then in terms of relative strength, we do expect still some strength in parts of the Bay Area, particularly East Bay, which is not getting a whole lot of new supply. We do expect Orange County and San Diego actually to start showing some improvement, just given some of the job growth figures we've seen of late that Sean talked about. And then also New York. Despite production being up a bit in Manhattan, it's still -- job growth and the job fundamentals there both continue to be very, very good. We expect there to continue to be relative strength there.

That's helpful. Do you happen to recall when the last time historically demand and supply were roughly equal and in balance like that?

Well, I think it's typically you see it in the middle of the expansion cycle. When -- oftentimes at the beginning of the expansion cycle, demand is outstripping supply, because it just takes a while for supply to gear up. And by the time supply gears up, it's usually two years or three years and you're generally in a pattern in terms of job growth that's more indicative of average job growth of, call it 1.5%, anywhere between 1.5% to 2.5%. So I'm not looking at a time -- it goes back too far, but my guess is probably, it was probably '05 to '07 period, where in the middle of that '04 to '08 expansion. And then I think when you look back into the '90s, from '95 to 2000 I think was, I think you had a pretty good period where, if anything, demand outstripped supply, but within a constant margin, if you will. But I would tell you I think it's typically at the middle of the expansion period. So I would --

That's helpful.

(multiple speakers) next couple years.

Right. Okay, and just last question, do you have a sense that if you got no market rent growth from here, what your 2013 revenue growth might be based on the current rent roll?

Karin, this is Sean. As Tim mentioned, we're not providing much of an outlook for '13. But if you're going to -- what loss to lease looks like, I think it's where you were headed with that question. Given revenue management, that number moves around a lot. You can change it day by day almost in terms of pricing market rents. I would say if you look back over the last three months or four months as an example, I would say loss to lease is probably in the range of 4% or so, just to give you some perspective of what's baked in, if you want to think about it that way.

Philip Martin, Morningstar.

Just a question regarding, when you look at your development pipeline going forward, Southern California, can you characterize or quantify a bit as to what your development potential is in Southern California? What percentage of the land portfolio would be there? Just trying to gauge the potential.

Sure, Philip. This is Tim. Hard to quantify. I would say it's the one region where we've been adding the most resources on the development side over the last six to twelve months. We just added a new officer into that region. For instance, we do have a number of development rights. I don't have it in front of me, but I want to say it's on the order of $350 million or so right now, and just given the expanse of that market from San Diego up through L.A. and beyond, into Ventura. I do think it's probably likely to be a little more cyclical, just given the nature of the West Coast markets, but it wouldn't surprise me where you may have some years where you might start a couple hundred million and the years where that number's closer to zero. But I do think it's probably a region that we could start a couple of deals, two deals to three deals a year with production north of $100 million a year.

Okay, okay. When you look at the new supply coming online in your markets, how truly competitive is it with your product?

Well, maybe I'll start and Sean, maybe you can talk to specific markets, submarkets where we might be more exposed to new supply. Generally, our portfolio, while the average age is16 years or so, there is mostly still Class A. So I would tell you that and anything coming new into the market is Class A, by definition. So I do think most of those, if they were to have a new community pop up next door, it would impact and be competitive at some level. But in terms of actual markets and submarkets where we might be more exposed to new supply, Sean, additional color there?

Yes, just a few comments there, Philip. In terms of the regions where we're watching supply closely, first obviously is the Mid-Atlantic. And if you look at, -- break that down into suburban Maryland, D.C., Northern Virginia, where you see most of the supply come through in suburban Maryland is going to be in the Rockville, Gaithersburg area, and/or Silver Spring, Wheaton maybe. We don't have a lot of assets, existing assets up there right now. We sold a large asset there last year. I think we're down to three assets in that area. So while something new coming online could be competitive, we just don't have much there. And as you go into D.C., the same thing. We have two assets in D.C., so even though there is a fair bit of supply coming online there, it wouldn't be all that competitive with us from a broader portfolio perspective since it's pretty small.

Northern Virginia, a fair bit of supply coming into the Tyson's Corner market. We do have a couple of assets there, quite a bit coming into Old Town Alexandria, as an example. We have a very large asset that we sold there last year, it was 500 homes almost, so we exited that market. And then Loudoun County is expected to have quite a bit come online in '13 and we really don't have any product there. So in terms of metro D.C., I think the question comes down to would any deliveries be competitive from a product point of view. I think the answer is generally, as Tim alluded to, it would be yes. But in terms of specific submarkets, we think the portfolio's pretty well positioned in D.C. If you go to Seattle, which is another market that everybody talks about, most of the supply is going to be in downtown or immediately adjacent submarkets. We really don't have much there. We have one smaller asset in downtown Seattle in Belltown and one just outside in Queen Anne, and then we have a development in Ballard. Those are really the three assets out of our portfolio. A lot of our other products are on the east side in northern Seattle, so not nearly as much going on there as there is downtown.

And then probably the third metro area to talk a little bit about is San Jose. Most of the products being delivered in San Jose is either central or northeast, with a high percentage being in the northeast quadrant. We had an asset there that we sold a couple of years ago, so we don't have a lot of exposure to the northeast. We do have some exposure in central San Jose, where we have two or three assets there. So probably more comfortable being protected in the mid- to upper peninsula assets. But with some that's in the core of San Jose that we own, again, three or four assets would be more subject to that new supply. So that's three of the metro areas. Hopefully, that's helpful in terms of an explanation.

Yes, it is. I have a few other questions, but I'll wait for offline on that. But I appreciate your answers. Thank you.

(Operator Instructions)

Michael Salinsky, RBC Capital Markets.

Tim, I believe on your last call you mentioned $700 million of development starts in the second half of the year. That puts you at about $440 million in the fourth quarter. Is that still correct?

Mike, one or two of those might slide into the first quarter of 2013. So a couple of them are slated right at the end of the year, and whether officially a Q4, Q1 start, not really sure. I mean, a lot of it comes down to whether you get, whether you're able to pull the permit before the holidays. But the deals that we identified at the end of the year, we do anticipate starting imminently, but some of them may slide into early 2013.

Okay. Any changes to the capital raise in guidance you guys had put out there when you updated in the second quarter?

Mike, this is Tom. No real changes. We may be just a little bit less than what we anticipated for the year, which was about $800 million of external capital. We may be closer to $700 million, but -- or $750 million, but I think we're largely on target there.

Okay. Tom, while I got you there, can you talk, how much of the forward starting swaps are still left as we look ahead to next year? And then also, you guys have had great success on the expense front, particularly in the bad debt side. Can you give us a little sense of what you're seeing on that? And also, you provided a little bit of detail on '13. Just curious, bigger picture, what you expect on the expense side in '13?

Well, we're not going to talk today about 2013 in terms of expense growth. I think Tim gave some overall market commentary on the revenue side, but we're going to ask you to be patient on 2013. That was about 75 basis points for the quarter and it was about the same last year this quarter. So that number continues to stay the same or drift down a little bit.

In terms of the hedges, just a little background. In April of '11, we put in place two hedges that basically provided interest rate protection for about half of our anticipated debt needs in '12 and '13. And at the time we did those hedges, we locked in at what we thought would be an effective interest rate on the hedges of about 5.4%, 5.5%. So at that time, we said when treasuries were about 3.50%, if we can issue 10-year debt at 5.5%, that works for us and we move forward. And we hedged half of our projected offering. Today, the market's more like 3%, and so when half of the issuance we did in September, we effectively had already locked in a rate at 5.5%, and then on the other half, we benefited from rates declining to the 2.95% that Tim mentioned. And that basically blends to the effective 4.3% that you saw in our September offering. So we cleared that hedge.

The second hedge, which was, again, for about half the debt we expected to issue in '13, matures in April of next year and at that time, it's our expectation that we will clear that hedge. Again, that was done at a rate environment of about 5.5%. Rates have come down, so the good news is we benefit from the decline in rate on half of that, but obviously, issued that hedge at a time where rates were about 5.5%. So It would be my expectation that we would end up in a similar effective interest rate on debt we do next year, if we do about the same amount. One thing I would comment on hedging is that you really need to think about hedging as if you issued the debt at the time that you did the hedge, because you're locking in at the interest rate roughly at that time.

The only thing you don't have is you don't have the cash on your balance sheet and the potential drag that, that cash brings with it. So that's one of the benefits of not actually having issued the debt, but if you go back to November of '10 where we issued debt at 3.95% and we were high-fiving and [looking] large, that debt deal is out of the market today by probably $25 million, because we -- our interest rates continued to fall. In fact, fell another 25%, or 100 basis points, as evidenced by our September offering. So think about these hedges as if we issued the debt back in April of '11, but we didn't have the interest carry dragging us on the earnings side during that period.

I appreciate the color there. And then final question. As you guys have been pretty active there marketing some of the Fund 1 assets, and also I think you mentioned $100 million under contract. As you're out there bidding -- as you're out there completing sales and also bidding on properties, are you seeing any changes in underwriting, maybe in the last 90 days that have been noticeable?

Let's see, Mike, this is Sean. I wouldn't say anything that's terribly noticeable now. As I mentioned, we might start to look to be a buyer in D.C. over the next 12 to 18 months. I think certainly there's some questions about underwriting in D.C., but I wouldn't say there's any overall shift in underwriting from what we're seeing. Pricing is still pretty aggressive. I mentioned the cap rates, both East and West in some previous Q&A. It's still fairly healthy out there. So I don't see a big shift in underwriting at this point, no.

Andrew McCulloch, Green Street Advisors.

Couple quick ones. On the four land parcels you bought, did you already control these via option, or are those new deals?

Andy, this is Tim. Those were deals that we had controlled. A good piece of it was closing out the Willoughby West option in Brooklyn, which was subject to a number of take-downs over time. But there were a couple deals in Boston, L.A., which were also option deals, if you will. So they weren't quick-close, ready to go deals when we first put them under contract.

And as you're looking at more land parcels, is it more raw land you're looking at now as opposed to entitled stuff.

Yes, it's -- I can give you a little bit of color on that. It's almost entirely raw land that requires entitlements. Year-to-date, I think I've mentioned we've got, we put $730 million into the development pipeline, have actually another $470 million in the due diligence. That represents a total of 17 deals. I think the $730 million represents eight deals and all of those need entitlement work at some level. Some have quasi-approvals. Others just need to go through the approval process from scratch. And of the nine deals that are in due diligence, first of all, most of them are suburban deals, if not all of them suburban deals and the majority of those are entitled and need significant entitlement work. Yes, most of those are option deals that they require anywhere between 18 months to 36 months of entitlements.

Great, and just one more question on development. The rents you show on your development schedule that haven't begun leaking, that represents rent at the time a project started, right?

Correct.

I don't know if you can share this, but what was the average that, that 6.8% yield you show on the current pipeline, [age] you if you marked all of those rents at current rents today?

We honestly don't look at it that way. I suppose we could look at the average market change for each of those deals, but we haven't done that. My guess is a lot of these did start in the last year, so my guess is it's 2% to 3%, maybe higher, in terms of the average rent on the deals that haven't been marked up yet. As I mentioned before, the deals that are in lease-up, they are outperforming by about 35 basis points or so. That number moves around based upon concessions and things like that. But collectively, the basket, they outperformed by about 35 basis points, or about 5%, if you will, on the yield, which probably translates into 3% or 4% higher rents than what we originally underwrote.

Paula Poskon from Robert W. Baird.

Thank you. My questions have been answered.

That concludes today's questions. I'll now turn the call back over to Mr. Tim Naughton.

Okay. Well, thank you, operator. And thanks to all of you for joining us today, and we look forward to seeing many of you at NAREIT in San Diego in a few weeks. Have a good day.

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