艾芙隆海灣社區公司 (AVB) 2014 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to AvalonBay Communities second-quarter 2014 earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's conference call, Mr. Jason Reilly, Director of Investor Relations. Mr. Reilly, you may begin.

Thank you Keith, and welcome to AvalonBay Communities' second-quarter 2014 earnings conference call. Before we begin, please note that forward-looking statements may be made during the 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 in 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 the review of our operating performance and financial results. And with that, I will turn the call over to Tim Naughton, Chairman and CEO of Avalon Bay Communities, for his remarks.

Thanks, Jason, and welcome to our second-quarter call. With me today are Kevin O'Shea, Sean Breslin, and Matt Birenbaum. The format for the call today will be the same as the last two quarters. We posted a management letter and slide deck this morning on our website before the market opened. I'll be providing management commentary on the slides, and then all of us will be available for Q&A afterwards.

My comments will focus on providing a high-level summary of the quarter's results as well as our updated annual outlook. I'll also touch on some of the key economic and apartment market factors that are impacting performance and our outlook, including recent trends and portfolio performance, and lastly, I will just touch on development activity, performance, and funding.

So let's go ahead and get started starting on slide 4 of the deck. Generally, performance remains in line with our business plan. In Q2 FFO growth was up around 10%. Core FFO growth was up around 5% after adjusting for non routine items.

Same-store revenue growth was up 3.1% on a year-over-year basis and 150 basis points sequentially. If you include redevelopment it would be up 3.3% and 160 basis points sequentially. On a year-over-year basis with the different basket, which is just the Avalon bay legacy assets, same-store revenue was up 3.7% and 4.1% if you include redevelopment.

Development completions this quarter totalled almost $200 million with an initial projected yield of 7.3%, and we started another $400 million on four deals, all of which were in California. We were also active in the capital markets this past quarter having raised $440 million through a variety of sources, including the CEP.

Now let's talk about the updated outlook for 2014 moving on to slide 5. Our updated outlook is largely unchanged from our initial outlook that we issued at the beginning of the year. FFO growth has increased, but most of that is attributable to the projected Christie Place promote, which once that closes we'll be disclosing more detail around. That doesn't include all of our distributions from the Christie Place sale. The rest of the distribution is embedded in the gain and the revised EPS guidance, which represents gain on our $6 million equity investment in that asset.

Core FFO growth is projected to increase by 40 basis points over our original outlook from 8.7% to 9.1%. Same-store revenue and NI growth are largely in line with our original outlook with some minor adjustments. Similarly, development starts in funding needs are largely unchanged at right around or just under $1.5 billion for the year.

So now let's discuss some of the key economic assumptions that drive performance and support our outlook, starting with the consumer. The economy is improving and the consumer is definitely on the mend after a slow Q1. Consumer confidence is recovering as shown in that upper left-hand slide. It's driven by a number of factors, including healthier balance sheets as debt financial obligations are at a generational low. An improving wage picture, with weekly earnings up quite a bit over the last few quarters. And a better opportunity set with job openings up back to pre-downturn levels.

Moving to slide 7. Importantly, jobs are going to those with higher rental propensity profiles, specifically young adults, which account for about half the net jobs created over the last six quarters, which we think explains in part the modest housing recovery, where home ownership rates are still more than 400 basis points below peak, still more than 700 basis points lower for young adults from peak.

So really it's a combination of demographics, living preferences, and purchase behavior that is all favoring rental housing today. Overall department demand is benefiting from the improved economy, growing confidence, and demographics.

Let's turn to the supply side of the picture for a couple minutes. We are seeing deliveries trend up as expected as shown as slide 8. But supply is being absorbed relatively easy by healthy markets, at least to this point.

Moving on to slide 9. And while deliveries are elevated over recent years, supply is projected to peak in 2014 and level off next year at just under 2% of inventory -- or of available stock. Metro DC as you can see will remain challenged with completions totaling almost 7% of stock during 2014 and 2015 with only modest job growth projected over this time frame.

Moving to slide 10 and looking beyond to 2016 and after, completions should continue to flatten or taper as multi-family starts have been flattening out over the last two to three quarters. The starts data on the left does include condos, seniors and student housing, and other products. So it can sometimes mask what is actually happening in the multi-family rental market rate supply trends, which we are actually projecting to taper off a bit in our markets starting in 2016.

So why are deliveries leveling off? I think the answer is on the right-hand side of this chart. We do think it's a combination of economics and capital availability. In terms of economics, construction costs are now outpacing rent growth since the trough, which is starting to squeeze yields a bit. And then as you look at the overall capital picture and the availability of equity capital, equity capital is starting to rotate to other sectors, and is more or less neutral as it relates to our space.

And so overall, we look at this as a pretty disciplined response to fundamentals. Redevelopment is rising early in the cycle but begins to level off in line with structural demand mid cycle.

So let's move on; what does this all mean for our portfolio outlook? As I mentioned before, in general our overall outlook for the year remains intact with some regional variation. The West Coast continues to lead the way and even a bit stronger than we expected at the beginning of the year. And the Northeast a little bit below our initial expectations.

The outliers of course continue to be Northern California, which is still running strong in the 8% range, and Mid-Atlantic on the other end, which is flat to slightly down for the year.

But as we know, and I'm moving to slide 12, it is a cyclical business. Market performance varies and leadership does rotate over time, and I think Northern California and Mid-Atlantic are perhaps two of the best examples of markets that we have been active in for a long time. They are both strong markets, they have outperformed over a prolonged period, in this case 15 years. But importantly, they don't move together or necessarily in the same way over the course of the cycle, which we think provides healthy diversification and helps smooth our overall growth profile.

And I think this chart is a reminder as you just look at sort of the movement over a five-year increment that today's underperformers are often tomorrow's outperformers and vice versa. While we are not sure exactly when these markets will turn, we are just pretty sure that they will, and that leadership will rotate as it has in the past. And in general we expect most of these markets deliver 2.5% to 3%, maybe 3.5% growth over an extended period of time.

Turning to slide 13, as it relates to what we're expecting for the balance of the year, we do expect modest improvement in the second half of the year with Q2 representing the low watermark for same-store revenue grow, moving from the low 3% range to the mid to high 3% range in the second half. And we've actually already started to see that in June and July where same-store revenue growth has been in the 3.5% and projected to be close to 4% in July.

And turning to slide 14, I think you can see why that is. It's really being driven by what we've been seeing in the portfolio over the last few months as same-unit rent growth has increased every month this year. And in fact, the year-to-date rent change since January has actually grown by 7% for the combined same-store portfolio. This chart is for the AVB legacy. But when you look at the combined same store portfolio since January on a sequential basis, it's grown by 7%, which is actually stronger than what we experienced last year in 2013.

Turning to slide 15. Another trend that is emerging in our markets is the outperformance of the suburban submarkets. Something we have been projecting given the concentration of starts and deliveries in our urban submarkets, a trend that should persist for the next couple of years as urban deliveries are expected to deliver more than two times the rate of suburban submarkets over the next two and a half years. This is, I think, just another example where our exposure to both urban and suburban submarkets provides this additional diversification over the course of the cycle.

Shifting now to development and slide 16. Lease-up performance remains very strong with rents $200 above pro forma and yields up 50 basis points above original expectations. And that's on about a $1.5 billion that's currently in lease across 17 communities. And performance has not come at the expense of absorption. In fact, absorption has been very strong running at over 30 units per month per community over the last quarter.

And when you look at this portfolio along with what we've completed so far this cycle, the total is about $3 billion, which is a meaningful source of NAV and FFO accretion as yields are averaging over 200 basis points above prevailing cap rates and over 300 basis points over initial cost of capital for capital resource so far this cycle.

Turning now to slide 17. The financing environment remains very attractive to capitalize this investment. Pricing has improved since the beginning of the year, most notably for equity. Debt and asset sales obviously remain very attractive and particularly relative to historical precedent. Today, we believe we just have a full menu of options in front of us in terms of capitalizing very accretive investments for the development platform.

Now moving to slide 18 and the last slide of the deck. We've actually sourced all three of these capital markets so far this year. Actually, being most active in the disposition market as we continue to match fund development commitments. Year to date we've raised about $750 million. We have about another $350 million in net proceeds pending on the disposition side, including the sale and the ultimate closing of Christie Place.

That leaves remaining to fund about $300 million and just given our current liquidity and credit metrics, we have plenty of flexibility in terms of how we choose to fund this remaining need.

In summary, 2014 is shaping up more or less as expected. Healthy market, apartment market conditions continue across most of our footprint. We're experiencing another year of strong growth driven by the stabilized and lease-up portfolios, and we have ample liquidity, balance sheet capacity, and the talent to support continued value-added growth this cycle from really what's an incredibly attractive development pipeline of representing more than $6 billion in new investment. And with that, operator, we're ready to open it up for questions.

Certainly.

(Operator Instructions)

We'll take the first question from Nick Joseph with Citigroup. Please go ahead. Your line is open.

Great, thanks. Appreciate the updated heat map. Can you talk about the plan to fund the remaining $300 million across these three avenues?

Sure. This is Kevin. As Tim mentioned, we have under contract or in marketing about $350 million in net proceeds that we expect to receive from dispositions. That leaves us about $300 million left to fund. We don't, as a matter of practice, comment with specificity on anticipated capital market or transaction market activity beyond what we've already disclosed in our press release.

But I will say that essentially when you look at the heat map and you think about our capital alternatives and principal funding markets that we've tapped over the years, unsecured debt, the transaction market, and the common equity market, they are all open and available to us and attractively priced. And you can probably expect us to think about accessing them over time in a relatively balanced manner with the focus on maintaining a leverage-neutral balance sheet strategy.

Can you touch on the current leverage levels compared to the targets that you actually seek?

Sure. Well, there is a couple of metrics that we follow. Probably first and foremost is net debt to EBITDA, which for the second quarter annualized was running at about 5.5 times. In terms of what we're targeting on that metric, we typically seek to have it range between 5.0 times and 6.0 times. It's certainly been a little bit lower than that in the past and a little bit higher. Essentially, we are roughly in line with what we're targeting for that metric.

Another metric is unencumbered NOI, which is around 69% currently. We like to have that right around that level, maybe a little bit higher over time. As you know, we took on more secured debt in connection with the Archstone transaction, which shifted the mix of our debt from about a 50/50 blend of secured and unsecured more to about a 2 to 1 ratio secured/unsecured immediately following the transaction.

We have since moved that ratio back down toward a 50/50 blend but we're not quite there. As we continue to shift our debt portfolio back more toward a 50/50 mix of secured and unsecured, you can expect to see the unencumbered ration move up over time.

Thanks. And then just finally, can you talk more on the New England portfolio? It seems like that's the portfolio, the part of your portfolio that's performing worst relative to original expectations?

Sure, Nick. This is Sean. As it relates to New England, there is really two markets there. The greater Boston area and then Fairfield. Fairfield has certainly been the weaker of the two markets. Essentially, flat revenue growth for Q2.

And that's a combination of a couple of factors. One being the pretty meager employment growth that we have seen in that market I think for the last six months. It's been barely positive, 2,000 or 3,000 jobs. As well as some meaningful supply coming into some certain submarkets. I would highlight Stanford in particular where BLT is building on the waterfront and has been building and continues to build there, putting some pressure on supply in that particular submarket.

So while the current environment there is somewhat challenged, I would say over the long term we have been pretty successful with our development franchise there. So we'll continue to be active. So that's certainly one factor.

In terms of Boston, Boston essentially just got a pretty slow start given the difficult winter, and rental rates really didn't start moving until sometime in the mid of the second quarter, and it's just barely, as you look at it even through June in terms of market rents from probably January 1 through June. So rents have been relatively flat. Occupancy has been down. So that has been a pressure in Boston.

You might be thinking it's a result of some of the spot that's coming online. We have experienced a modest impact at the Prudential Center as a result of some of the new supply that's up and leasing in the urban core of Boston. But it's not been material to date in terms of performance. I'd say it's more a reflection of the very slow start to the year.

Thanks.

And we'll take the next question from Nick Yulico with UBS. Please go ahead.

Thanks. You mentioned the lease-up assets being 50 basis points ahead of underwriting. Can you talk about whether there are certain markets where that spread is bigger or smaller than that?

Sure, Nick. This is Matt. I can speak to that a little bit. It's actually pretty evenly spread. I mean, the place that's probably got the most dramatic outperformance is Northern California. Our Bay in the 55-9 deal, the yield there is north of the 7%, and we underwrote it to a little bit under a 6%. So that's not surprising given the rent growth has been going on in Northern California in the two years since we started that deal.

But it's been -- other than that, it's been relatively consistent across the regions. The other one that I would say has been the biggest outperformer has been the Avalon Exeter, the tower. The fourth tower, the first new product in the back bay there at Prudential Center where we rent just greatly exceeded our initial underwriting given the lack of really anything to comp it off of in that particular location. There really wasn't anything else that was a true luxury product in the back bay of that size and scale.

And then maybe you could also talk about land prices, where they are today and, say, New York City and San Francisco obviously being affected by condo developers. What do you think that that does to these markets in the next couple years as far as maybe preventing some additional apartment supply or even further sort of boosting apartment valuations in these markets? Thanks.

Yes. There is no doubt -- this Matt again -- that land prices have gotten very heated in New York and San Francisco in particular, and we have not -- it's very tough for us to compete for land sites in the heart of San Francisco and in Manhattan right now, particularly in Manhattan. Pretty much all the land that's trading is trading at condo valuations. So I think you're right that there is a wave of supply coming to Manhattan. NAV deals have started in the last year or two. But it's hard to make rental numbers, pencil looking forward right now in that particular location.

The other thing you are starting to see is people team up and do rental condo hybrid buildings. We did buy a piece of land earlier this year in Brooklyn. Not in Manhattan, where we are looking to partner in a JV with a for-sale builder where we would build the building together. We would take the lower piece as rentals. They would take the upper piece as condos. That might be one way you see folks provide some more rental product in those locations. But it does make the rental economics more difficult on the land in those urban cores.

Thanks.

And we'll take our next question from Steve Sakwa with ISI Group. Please go ahead.

Thanks. I know you're not giving a lot of detail on the Avalon Christie sale, but just to be clear it sounds like the $0.44 gain that you're talking about is really not the full I guess what I'll call economic gain that you intend to receive? This is really just a piece of it, is that correct?

Yes, that's correct, Steve.

Okay. And I just wanted to maybe just follow up on the sequential trends that you are talking about. Obviously, you guys have a kind of ramp going into the back half of the year. I'm just curious, given the notices that you've sent out presumably for August, September, and maybe even October, how much visibility do you have into that ramp and what potential risks might there be?

Yes, Steve, this is Sean. We have pretty good visibility. I'd say a few things. One is, as Tim mentioned in his prepared remarks, we pretty much know where we are for July. It's pretty well baked given it's July 24. That's in the high 3% range.

We also know where the renewals went out for August and September, which is in the 6.5% to 7% range, which is between 50 to 100 basis points higher than where they went out for June and July. Pretty good visibility on where those are trending based on sort of historical capture rates.

We also have good visibility in terms of our comps because it's baked in terms of where occupancy was in the first half of 2013 versus the second half of 2013; as opposed to it being a headwind in the first half of 2014, it's going to be a tailwind as we get into the second half. Kind of put all those pieces the together plus the improving economic environment, everything that we're seeing in terms of job growth, unemployment rate, all of the things that Tim talked about, the macroeconomic environment certainly supportive of our plan and we see it in the numbers, as I mentioned.

Okay. If I could just ask one more. On page 9 you talk about the peaking supply and it sounds like you expect a little bit more to hit in 2015. I'm just trying to figure out how much of that was maybe a shift of projects from 2014 into 2015, maybe due to delays, and how much of that was actually just kind of new starts that had maybe taken place in the middle of this year that weren't captured in your previous expectations but are now likely to hit in 2015? And as you kind of look into 2016 it sounds like you think that number may fall even further?

Steve, this is Tim. When we were looking at it in the beginning of the year our projections for 2014 was right around 2% of stock and for 2014 about 1.6%. For 2015, there has been a little bit of shift from 2014 to 2015 just from deals getting delayed or things coming online a little bit later than we anticipated. I'm not talking about ours, but the market. Now the numbers are right around 1.9% and 1.8%. So there has been a net increase, call it 10 basis points over those two years.

In 2016 I think at the end of year we were projecting about 1.2%, we are now closer to 1.5%. Obviously less visibility at the beginning of the year than there is today right now. And we have been able to identify some other projects that just weren't as clear at the beginning of this year. So that's what we thought. But we do expect some taper.

As I mentioned in my earlier remarks, development still makes sense. It's a healthy business. That's when you should add capacity into a market is when underlying fundamentals support it. So we think structural demand can handle that particularly given some of the things that rental housing has going for it. But we do see it leveling off. When you start looking at that start data and peeling it back and trying to understand how much of it is multi-family for rent, and the fact that the notion that some of that could convert over to condominium, we feel pretty good about that outlook.

Right. Okay. Thanks. That's it for me.

And we'll take our next question from Jana Galan from Bank of America Merrill Lynch. Please go ahead.

Thank you. On expenses, can you comment on which line items are contributing to the lower expense growth in the second half? And I think you mentioned the repairs and maintenance were a little bit front loaded this year?

Yes. This is Sean. You're correct. The last part of your statement there in that we expected the first half to be elevated for a number of different reasons that we alluded to in the first-quarter call. Some of the specific categories for the second half, it does depend on which bucket of assets you're talking about. So I'll talk about it in the context of the combined bucket, the Avalon and [earth sun] bucket for now.

We do expect Q3 to trend down a bit as it relates to utilities is one, which is running at an elevated level right now for a couple of different reasons. There is some fixed costs in office ops that we know are going down in the third quarter is an example. There is also a number of non-routine projects as you get into the fourth quarter that come off pretty quickly in terms of -- the peak for that activity is typically during the Q2 and Q3 season as opposed to Q1 and Q4. So it tends to ramp up in Q2, remain a little bit higher in Q3, and then fall off pretty quickly in Q4.

And then there is also some costs that are trending down as it relates to some other categories, big one really that moves the needle is taxes. We do expect some healthy savings in taxes as you move into particularly Q4. So those are some of the major pieces that are driving it as you look at the second half of the year.

Thank you. And then I know it's still very early to make any comparisons on AVA and Eaves and Avalon brands, but anything you could share there on the performance in second quarter? And then maybe just in terms of the lease ups on AVA's versus Avalons, if you're noticing that the market sees one more in demand?

Sure. This is Sean. I could talk a little bit about brand performance within the regions. I think that's the best way to talk about that as opposed to overall just because market differences west versus east. Northeast versus the Mid-Atlantic, et cetera. It does make a difference.

But generally what we're seeing is the Avalon communities are outperforming in New England, New York, New Jersey, and the Pacific Northwest right now. The Eaves are lower priced communities are outperforming in the California markets, both Northern Cal and Southern Cal. And then the Mid-Atlantic, the Avalon and Eaves products is running at a pretty similar pace in terms of growth. It's more depending on whether you are in through Maryland or Northern Virginia or DC is really the driving factor right now within the Mid-Atlantic as compared to product type or price point really. At least for our portfolio, that is.

And in terms of the lease ups, that's also somewhat market driven in terms of what is your healthier markets, higher price point communities, et cetera. It's not necessarily a common thread there in terms of a particular brand outperforming in terms of lease-up pace.

Thank you.

And we'll take the next question from Dave Bragg with Green Street Advisors. Please go ahead.

Thank you. Good afternoon to you. As a follow-up to Steve's question, I assume that the increase in your expectations for 2016 completions is due to your very granular market-level analysis of projects that have been started so far, or at least are planned. But directionally what does this improved job growth environment and the fact that debt cost has stayed quite low, especially with more Fannie Freddie activity, which acts as a takeout for developers, what do those factors mean for the outlook for starts in 2015 and 2016 to you?

Dave, this is Tim. As we said, you look at the underlying fundamentals, I'm the not sure -- and then when you start comparing to other sectors and where they are and their cycle, I don't know that we see anything that leads us to believe that it ought to ramp up dramatically. We don't see anything that leads us to believe it ought to ramp down automatically either.

As I said in my opening remarks, I think it's been so far what you've seen is a pretty -- is a disciplined market response. Frankly, since the early 1990s, that's basically what we have seen in the multi-family rental business. We haven't really seen a period of oversupply really since the late 1980s in our business.

I do attribute that quite a bit to just the quality of the data and certainly the visibility and transparency coming from the public companies. Again as they spiral out. How we're looking at availability of capital, most of the REITs are trading somewhere around NAV, and as we look at the NAC equity availability index, nothing really points to a significantly increased appetite over the last couple of years for our product.

Okay. Thanks for that, Tim. And another question relates to page 15 of your presentation. The suburban versus urban performance. Where do you rate Avalon's portfolio on these metrics urban versus suburban? What percentage of your portfolio falls in each bucket? And what are your long-term objectives for the portfolio on these metrics?

Yes, Dave, in terms of our portfolio, the stabilized portfolio is about two-thirds suburban today, about 65%, and about a third urban, which currently under construction is about 50/50. If you look at the development pipeline it's about 75/25, the development [right ] pipeline, it's about 75/25 tilted towards suburban.

I do want to be clear what suburban means for us because I do think it's sometimes a bit misunderstood. For the most part, the suburban is office center and inside. It's not bedroom, leaf community, and there are very few expectations to that.

And then if you look at just within our suburban footprint, a fair bit of it is TOD. We sort of classify as TOD suburban, which is on the order of 15% to 20% depending whether you are looking at stabilized or development portfolio. So right now about two-thirds suburban maybe trending up 200 or 300 basis points as the current development starts to lease up. And then probably start to trend down again as the development right pipeline starts to come through the system.

Okay. Great. And the last question relates to your write up in the management letter on West Hollywood. You mentioned 85 apartments would be marketed via your high-end signature collection. I'm not sure that I'm familiar with that. Is that a new brand? Or what is that offering?

Hey, Dave. This is Matt. I'll speak to that one a little bit. Really it's -- the thought is it's a sub brand. It is within the Avalon brand, but even within the Avalon brand there is an appetite in the market for kind of a top niche product that serves a sub segment of the Avalon customer base, and we are actually doing a little bit of this already.

There are certainly high-rise communities we have in New York and other locations where we'll take the top two or three floors, make them penthouse levels, finish them out to a different finish standard. But we're trying to create more of a program around that going forward. So over time it will have a separate section on our website and bundle it with some other services.

And we think it's actually a growing market. We have had great success with it. Kind of on an ad hoc basis even in places like Rockville Centre in Long Island where we have a number of apartments that are finished to that higher standard as well as again I think we'll be -- we will have some at the top of the building. So it's really a way that we can kind of further evolve the brand and further segment the customer.

So it's your customer but at the very high end?

Exactly.

And I think that there is senior housing in this project as well? It's not related to that, is it?

No, it's not. You're right that the entitlement includes 77 units of affordable senior housing that we're actually developing in a partnership with a local non-profit there, and we're going to build it for them and then they will buy it on completion.

And is that just a one-off incident, or should we expect to see some more of that from you?

It's very deal specific. We do it -- as you may know, a number of our communities that we develop have an affordable component. Usually it's anywhere 5%, 10%, 15%, 20% and those apartments are scattered within the project.

But occasionally there are sites like this where it's approved as a separate opponent of the community. In this case it was seniors. By doing it in that format you can avail yourself of federal tax credits and other subsidies that aren't available to us as a normal REIT. I wouldn't call it a trend. I think it was more of a one-off that we might do from time to time as a way to maximize the value of a site.

Okay. Thank you.

We'll take our next question from Ryan Bennett with Zelman and Associates. Please go ahead.

Hi. Good afternoon. I just wanted to follow up on the suburban-urban breakout. You said suburban was beginning to outpace urban and I was curious which markets you are starting to see that more so, and based on your current revenue growth forecast where you see that spread ending the year?

Yes, this is Tim. I don't know that we have a spread for you as it relates to how it is going to perform.

Maybe I will just share a couple other statistics, too, just in terms of how we're seeing the markets generally. As I mentioned before, in terms of apartment completions we're expecting just a little over 5% added over the 2014 to 2016 period into our markets. When you break that down between suburban and urban, suburban we're expecting about a 3.5% addition to stock. Urban we're expecting about an 8% addition to stock. And then when you look back at 2013, those numbers are comparable where urban added about 2% to stock and suburban a little less than 1%.

And so while we're just starting to see suburban performance outperform, we've been seeing it in the same unit rent for some time now. You need to see that before it actually starts translating into performance. So if you have heard us talk about this over the last couple of quarters, we have been talking about it pretty confidently that we expect this to happen in part because we are seeing it in the numbers that are often generally the leading indicators to performance.

But as it relates to specific markets, I may let Sean speak to that. But generally across the board we are seeing suburban outperform urban when you break it down into same-unit rent growth. Whether it's DC, whether it's New York, whether it's Boston, whether it's Seattle, or even in San Francisco where East Bay and San Jose is outperforming San Francisco. So I tell you, it's pretty much across-the-board trend.

Ryan, really not much else to add there other than what Tim said. If you think about all the different markets and where the majority of the supply has been, it's been more in the urban core. And so we have seen that in terms of effective market rent growth over the past couple quarters. That is slowly bleeding into revenue growth.

Got it. Appreciate the color there. And one last one for me just on slide 11. Just curious how this slide would look in terms of your market-level outlook for the second fourth quarter for the Avalon and Archstone assets, if there is any significant differences in terms of your revisions when you tie-in the overall same-store guidance?

Yes. Ryan, this is Sean. There are some differences in terms of overall performance. We have not necessarily provided all the detail in terms of the -- all the Archstone level detail market by market. We have provided at this point the AvalonBay bucket year to date, which we'll continue to report on, as well as the combined bucket on a year-over-year basis.

But in terms of the differences within the representative markets, I'd say probably the most pronounced in terms of the gap is really in the Mid-Atlantic, and that is purely a function of portfolio allocation. If you look at the Archstone portfolio that has come at the same store, 95% of that is, based on revenue, is in Northern Virginia and DC, as compared to about 65% for the legacy AvalonBay portfolio, and what's outperforming right now in Metro DC is suburban Maryland.

So that's probably the most pronounced difference in terms of performance. There's a little bit in New York in terms of same thing, portfolio allocation where we've got two big Archstone assets in midtown west that are exposed to a little more near-term supply as compared to the legacy Avalon portfolio, which is mainly the Bowery, Morningside Heights, Brooklyn, supporting a little bit better revenue growth. So without going through every single market, those are probably two that are the pretty good examples of where the variance is.

Great. Appreciate the color. Thank you.

We'll take the next question from Alexander Goldfarb with SandlerONeill.com. Please go ahead.

Thanks. It's pretty cool now that we're a tech company. Just quickly. Two quick questions here. First, just following up on the earlier question on the Northeast, if you look at what the environment was like at the beginning of the year, I mean, Fairfield County wasn't in any great shape.

Obviously the development that's going on in Stamford Harbor area has been going on for quite some time and the Windsor was well known and was ongoing. So curious why you guys thought that New England collectively would do better when it seems to be performing as we'd expect?

Alex, Sean. Certainly, when we provided our original outlook in January we didn't necessarily have a sense of what would be happening with full extent of the Windsor and the contraction of the economy that occurred in the first quarter. That was not anticipated. So our belief is that, particularly in Boston, things could be quite a bit stronger than they are today.

In terms of Fairfield, we did not expect to have significant outperformance there by any stretch. I'd say it's been relatively closer to our expectations. What's underperformed is really Boston. I don't think there has been a material change in Fairfield. We thought it would be a little better job growth, to be honest, and there really has been almost zero. So Boston is really the market in New England where it underperformed our expectations that we originally set back at the beginning of the year.

Okay. And going to the heat map, appreciate the changes especially in equity. I doubt we will ever see the equity near 100 on your heat map. But just given how the stock has rebounded, obviously you guys retapped the ATM, at the same time market still seems pretty healthy for dispositions and obviously a desire, as you guys did with Danvers and you did with Christie Place, there is still a desire to capitalize, lock-in value that you created.

How do you balance dispositions which are still healthy versus taking advantage of your stock which is up over 20% year to date and using more equity going forward, the heat map aside, just how do you consider that tradeoff given where you were not even six months ago?

Sure. I may start with a couple of comments. Tim may want to add something. But essentially the heat map does provide some insight as to how we think about the question, although it's certainly not dispositive.

As to the equity component of where we're showing it now, there is actually four subcomponents that we track and feed into that overall number and probably of those four subcomponents, as you might expect, the one that's most important to us from a standpoint of just assessing the relative attractiveness of issuing common equity would be how our shares are trading relative to NAV. And so we look at that relative to consensus NAV as well as our own estimate, which as you know we don't publish. Tracking it relative to consensus NAV, that screens at a higher level than what you see as the overall rating and more in line with where you see assets trading on the heat map.

I guess for us it's ultimately not a binary choice as between whether we are going to issue equity or fund equity through asset sales. As you know, looking back at our Company's history, we've typically traded a slight discount to NAV, call it about 3%. Not surprisingly over time we have funded development activity primarily, at least the equity component of development activity, through selling assets and recycling the balance sheet. It's an approach that's worked very well for us. It's an approach that we're very comfortable with going forward. But from time to time it makes sense to tap the equity markets, we're prepared to do so.

So we do look at the relative implied cap rate on issuing shares versus the realizable cap rates that we have on dispositions and take a look at those. We also effect both yields or prices for asset sales versus issuing common equity by transaction costs which can be meaningful in the case of transaction costs, and also meaningful in the case of issuing equity to the extent it's done where you have both investment banking fees and investor discounts in the equation. We look at that really on a net-net basis to see what's more attractive.

There is also portfolio considerations that come into play in terms of our desirability to sell assets and enhance the portfolio and our exposure to given submarkets. So at the ends of the day there is an awful lot of factors that we bring to the equation. Those are some of the things that we think about. But going forward in an environment where we are trading at or above NAV, it's reasonable to expect that we're going to look at both the possibility of issuing equity and the selling of assets as attractive and try to make the best decision from a pricing standpoint and a portfolio perspective.

Okay.

Alex, one thing to add is just the type of market, too, and the dispositions that we take that into account as well as tax considerations. But I think Christie Place is a good example of that where you need certain agency approvals. And it takes several months to get it. By the time you actually price the transaction to the point of which it actually can bring the proceeds in, so that is a factor as well as we think about how we tap different sources of capital at different points during the year or during the cycle.

Okay. Thanks.

And we'll take our next question from Rich Anderson with Mizuho.

Good afternoon, everybody.

Hey there.

Hi, Rich.

So you have shown some willingness to think in front of the curve with your suburban kind of mindset versus urban. Can the same kind of thought process be applied to asset sales? That is, when do you start thinking about selling actually in San Francisco and Seattle and investing a bit more in DC and making that early stage trade before things start to turn in the opposite direction?

Rich, this is Tim. Absolutely. Yes, we're actually, as you know, we're pretty big sellers in the Mid-Atlantic two or three years ago. And I think we have to remind ourselves that the underperformance in DC has been two quarters now. We have been talking about it coming for about two and a half, three years I think as an industry, because you could see the supply kind of coming through the system. But in terms of really actual underperformance it's been really mostly the last couple of quarters.

So we did take -- obviously we tried to take advantage of it a couple years ago in the DC market in terms of selling. But we'll look to take advantage of it on the buy side as well. As I mentioned in my prepared remarks most of these markets have -- we think they are great markets. We love them all. Sometimes we like some of them with different points in the cycle than others. And we should be willing to sort of trade off of when we think market sentiment gets a bit distorted as it relates to asset value.

So it factors a lot into how we have been thinking about the fund business where it's a real limited light vehicle and you have very few windows to sort of pull the trigger. I would say it's maybe a little less pressing in terms of the balance sheet in terms of an open ended entity like a REIT is. It's something that we talk a lot about in terms of which assets and when and how to play the cycle, and ultimately we are looking to differentiate ourselves in terms of capital allocation. And that's one aspect of capital allocation.

Okay. How close do you think we are to a trigger point in San Francisco?

Rich, this is Sean. We have been evaluating dispositions and I'll say kind of Northern California and Seattle for some period of time. We've taken a few chips off the table both directly and indirectly. We sold a large asset in San Jose last year. We sold a fund asset that was pretty large in San Francisco.

I think one of the things that we're thinking about for San Francisco proper if that's what you are really referring to is there may be some option value there at some point in terms of condo activity. We have not seen that in any meaningful way in San Francisco at this point.

But we have seen some activity in New York. We have also seen a couple deals here in DC shift from rental to condo and particularly given the [topa] rules in DC. You want to do that basically when you are completing the building before you lease it up so you don't have that restraint.

So San Francisco we're keeping our eyes open. But I'd say at this point we think there may be good value there in terms of a condo exit at some point for some assets. So we're not hot to pull the trigger in terms of that particular market in terms of near-term dispositions.

But we're always evaluating all the markets. As Tim said, we look at a lot of different factors. We look at where rents are relative to the long-term trends. We look at forward IRRs on every asset in our portfolio as we develop our disposition pool and how does that capital price relative to other sources of capital.

And we try to be as opportunistic as we can. So you're right. We sold I think probably around $400 million in assets in DC over the last two or three years knowing the current environment was coming. But there hopefully will be a window at some point where we see pricing and expectations change in DC and it might be a good entry point.

For acquisitions we think of using them two ways. One is to reshape the portfolio in terms of portfolio trading, but also as certain entry points in the cycle to acquire assets when they are trading at discounts relative to where we think they should. Sort of a longwinded answer, but hopefully that made some sense. Tim might have a couple other things to add.

Rich, just one other thing to keep in mind on San Francisco or any California assets, the underlying difference between intrinsic value and market value needs to be a bit more distorted because of the whole Prop 13 and the frictional costs that you have with the mark on the taxes. It can be -- it can impact cash flow by as much as 10% when you mark taxes fully to market.

Okay. Next question is just looking at slide 5. Why is it that the Archstone, in conclusion of the Archstone portfolio at least the math suggests that a better operating margin there in that portfolio versus legacy AVB. What's the situation there? Why is that happening?

Rich, this is Sean. We talked just generally about the difference in terms of the portfolio. In terms of the operating margins specifically, the main driver of that is taxes. In terms of obviously the Archstone taxes are pretty much reset upon acquisition as opposed to the legacy AvalonBay portfolio. So there is some other subtle differences, but that would be the main driver in terms of margin if that's the specific metric you are concerned about.

I am looking at how it changed from your original forecast.

Right.

It seems to have --

-- in terms of the operating --

Exacerbated to some degree since the original forecast.

Oh, in terms of overall expense growth it's savings on taxes.

Okay. Okay. Okay.

Yea.

Okay. Got you. And then last question is the topic of senior housing was brought up and I couldn't help but ask the question to Tim about if he is learning anything on the seat of the HCN Board of Directors? If there is any coincidence there.

Yes. It has nothing to do with sitting on the Board of Healthcare REIT. So, no. That was just an entitlement requirement when we stepped into the deal that had already -- where the approval has been started by another developer in the case of West Hollywood, if that's what you are talking about, Rich.

Is there anything that you can apply from your experience there to AvalonBay?

Absolutely. Any time you step on a Board of another company you learn a lot of things about their business and how you might apply it. I don't know if there is anything there as it relates to which is primarily assisted housing to market rate rental where the customer is about 50 years difference in age. But in terms of how you think about capital and how you think about organizations and strategy, for sure.

Are you thinking about UK?

Are we thinking about UK as in United Kingdom?

Yes.

We are not considering other markets at this time, if that's what you are asking.

Okay. I'm just -- they are big in the United Kingdom. I just figured if --

Okay. Fair enough.

Thank you.

Thanks.

We will take the next question from Andrew Rosivach from Goldman Sachs.

It's been a long call. Just a speed rounder for Kevin. When you do your capital allocation and you are deciding whether or not to sell shares, I've got $20 on my price target that's associated with essentially the value of your development franchise and then do you take that into account? Because when you are selling an asset you are just selling the income rather than this underlying development business that, as far as I can tell, is adding a heck of a lot of value.

When we look at our own AV, we do take into account the value off our development platform.

Okay. It just sounded like you were going for a consensus NAV, which would mark-to-market the existing development rather than treating it like it's a recurring business.

Well, in terms -- the methodology that people use in their own NAVs varies from analyst to analyst. But you are correct that most of them typically focus on in place NOI and the value of development underway and don't necessarily describe value to the development platform per se.

Andrew, this is Tim. I understand what you are getting at. As Kevin mentioned before, for whatever reason we have traditionally traded at 3% discount to NAV. We think there is value there. The market doesn't generally give you credit for it. And if we normally don't raise equity and we thought the market was giving us credit for it, we'd never be raising equity, we'd be growing and wouldn't be any developments.

It is a reason why we use dispositions pretty aggressively in terms of recycling capital as well as expanding the balance sheet and looking to the unsecured markets as well as we grow EBITDA and, therefore, are able to expand the balance sheet through debt. But equity just still needs to be a part of the equation if we are going to be able to grow accretively, which we have a wonderful opportunity set particularly this cycle in front of us to do so through development.

We would like the market to give us that full $20 credit that you have got in your model. But the market for whatever reason has been a little bit of a show me market and we get credit for it seems like in arrears, not in advance.

Every time you issue that share, a share of that $20 gets split over a larger pool. So I just wanted to ask.

Yes.

Thanks for that, guys.

And we will take the next question from Vincent Chow with Deutsche Bank. Please go ahead.

Hey, good afternoon everyone. Yes. Just a quick question. Just we haven't talked about LA here, but just curious if you could comment on what you are seeing there. It does seem like looking at the rental rate growth year over year, did slow down there a little bit more than the average for the rest of the portfolio. Curious if you have any comments around that?

Yes, Vince, this is Sean. In terms of LA, it really is a function of where you are playing. And for us what's outperforming right now is really the Eaves product, lower price point communities, as I mentioned earlier, in response to another question. So I have got a number of communities in the Clairemont and even some lower price point communities in the Pasadena submarket that are outperforming. One in Cerritos.

What's underperforming a little bit right now, it's generally the areas where we're getting a little more supplies, a little bit on the west side, Wilshire, Mirina Del Rey, some of those submarkets are under pressure a little bit if terms of supply. But in terms of the overall outlook for LA, I'd say pretty positive generally for us for LA.

And frankly for Southern California overall is trending in a positive direction. If you look at what's happening with rent change in that market, Southern California has improved quite a bit as we've moved through the quarter and we get into July, just to give you some sense Southern Cal rent change in the second quarter was in the mid 3%s. And as we look at what's happening in July, and July is about closed out, it's trending about 5% in Southern Cal.

So we're getting pretty good momentum. Probably a little better momentum in Orange County as opposed to LA. But LA is catching up I'd say. So it's really a function of where you are as to how you feel about LA right at the moment.

Okay. Thanks for that. Appreciate it.

And the next question comes from Tayo Okusanya with Jefferies. Please go ahead.

Yes. Good afternoon. Thanks for taking my call -- or my question. Just following up on Boston, if you could talk in particular about the Assembly Row asset and just how those are leasing up relative to expectations?

Sure. This is Sean. I'll talk a little bit about general velocity. Overall, as you can probably tell from reading through the release, construction has been a little bit challenged at that particular asset. When we initially started the asset, part of the Windsor was challenged in terms of site conditions. It's also a community they were building with retail in conjunction with federal. So construction has been -- it's probably been one of our more challenging construction executions in terms of the portfolio, in terms of what's happening there.

In terms of leasing velocity, now that we've actually delivered product there, it's actually been pretty good. In terms of actual leasing absorption velocity, we've put 38 a month on the books at that community in terms of leasing velocity and 31 in terms of absorption. So now that we've actually got the product on the grounds, it looks good, velocity has been healthy at the product there.

And on the rental condo trending around $3 per square foot or so?

Rent -- there is two different product types there. So I am not sure which one you might be referring to?

At the AvalonBay product. Not the --

Tayo, this is Matt. I guess the -- what we're showing, this is one of our dual brand communities. So I he know there has been some talk about the rents. I think even federal talked about it. But the average rent that we are showing in the release this quarter is $2,405. That number reflects the Avalon component of the project, which is about half of it, which is substantially leased, and that has been running ahead of pro forma by more than that amount.

Then the AVA building which is the back half of the project, we really just started leasing there and we have not yet marked those rents to market because we haven't leased 20% of the AVA component yet. So I guess what I'd say is there is more lift to come in those rents there and I would expect next quarter that number would move up as we mark those AVA rents to market.

We have leased 10% of the AVA building, but we actually haven't been able to show anybody an AVA apartment yet. That piece has been all off plans. The AVA story you have to see it and feel it to fully experience it. So I think we have good momentum there and you can expect further growth there as we complete the lease up.

This is Sean again. I think the rents per foot are in the high $2 range. I am not sure we clipped $3 yet there. But as we deliver the rest of the product and get the AVA online we should have a better sense of whether we will get through that and mark the rents to market.

Sounds good. Thank you.

We will take the next question from Karin Ford with Key Bank Capital Markets.

Thanks. Good afternoon. Any changes in cap rates in recent months in your markets? And as you're weighing changes in construction costs, economic outlook, and the decline in your capital costs, can you just update us on your latest thoughts on sizing the development pipeline over the medium term?

Karin, this is Sean. I'll take the first one and then I'll let Tim and Matt comment on the second one. In terms of cap rates I think they are relatively level to slightly down in some markets. Probably a function of supply, just availability of deals on the market more than anything else. As well as obviously, the drip down of the 10-year has supported pretty good access to cheap debt capital, which Kevin showed on the heat map in terms of weakened access on the unsecured markets but also in terms of the secured markets.

All of the options are pretty wide open in terms of the GSEs, which were once 90% of the market are now pretty much about half or less. But banks, live companies, everybody else is pretty much wide open on the debt side in supporting relatively low cap rates overall and still generating nice returns on equity.

So the debt markets are wide open. Supply of available deals has been a little bit constrained. I'd say it's neutral slightly down, down 10, 20 basis points depending on a particular market and the availability of assets to trade. And then in terms of the development, Tim can take that.

Yes. Thanks, Sean. In terms of target levered IRRs, we are still seeing those mid 6% or so range for core product at our market. In terms of deals that we're looking at, unless we are hitting the target return, probably driven a lot by land cost. Matt had spoken to that before.

But looking at returns and target returns are only part of the equation. As you get deep into the cycle, just the projected basis goes up. When you look add land and construction cost just due to those things less sort of get through the screen if you will. So we do expect it -- and you probably noticed on the development right pipeline, it's actually come down by about $500 million over the last couple of quarters as we started to start deals and haven't replaced them at the same level, and that's partly by intention, and it's partly due to the -- frankly, due to the opportunity set.

So we do expect, as we said at the beginning of the year, development underway to peak around now. Will slowly work its way down I think over the next couple of years. Probably not going to go to zero. But we're probably at the peak today in terms of what's underway.

Thank you very much.

(Operator Instructions)

We'll take our next question from Michael Salinsky with RBC Capital Markets. Please go ahead.

Good afternoon, guys. Just in the interest of time, two quick follow-up questions. First of all, you gave new lease rents in the management letter. What were renewals actually signed during the quarter? And then also, Kevin, it looks like in July you sold the last fund one asset. I know you were holding the debt there to kind of repay that. Is there going to be a promote recognized on that, when that's finally wound down?

Go ahead, Sean.

Mike, it's Sean. In terms of the rent change during the quarter, 3.6% was the blended. It's 4.8% on renewals, and 2.2% on move ins. If that was the highlight you looking for?

Yes.

And Mike, this is Kevin. In terms of fund one, yes, you're correct. We sold the last and 20th asset in fund one in July. So there are no assets left in that vehicle. We will be winding it up here distributing final cash in the coming months.

In terms of whether there will be a promote, we do not expect there to be a promote on fund one. As you may recall, we put that vehicle in place in 2005. Like many funds from that vintage, its returns were not strong enough to realize the promote. But they were still positive. And on a net levered IRR basis to our investors we expect to give them a mid-single digit net levered IRR, which would probably for our assets foreclosed in funds of this vintage, would place it in the top third or so of close-in funds, all geographies, all product types.

Hey, Mike. If I could just add something to what Sean was saying. What Sean said was accurate. 2.2% on move ins for the quarter. The one chart that showed San Diego rent numbers going up through the course of the year, that is almost all coming from increases in new move-in rents, which I think is important when you are talking about health of markets.

In fact, June and July are more in the 2.8% and 3.3% range. Well above the average in Q2 and well above the 1% and 1.5% range that we saw in the beginning of the year. Renewals have actually been relatively flat, healthy but flat during the course of the year. That slide 14, that upward trajectory is really all coming on the back of new vintage. We think it's important as you move into the second half of year part of what gives us confidence in terms of our outlook for the balance of the year.

And we'll take our last question as a follow-up from Nick Joseph with Citigroup. Please go ahead.

Thanks for sticking around. Just a couple of quick ones. Just on the $350 million of disposition proceeds in the back half of the year, I've got to assume that includes the promote and Christie Place, the blended cost of that capital is extraordinarily low, call it, I don't know, 3%. Is that ballpark where we should think about the cost of that capital?

Yes. Michael, this is Kevin O'Shea. So in terms of the promote from Christie, the proceeds that we receive, the cash proceeds that we would receive from selling Christie are included in that $350 million of net proceeds from dispositions that you referenced.

In terms of the cost in the case of Christie, it would probably be more because as you will see in the attachment and our supplemental where we detail NOI from our various ventures, we are and have been for some time in the cash flow promote portion of that promote for Christie. So we have been receiving a cash flow promote off of Christie for some time.

So when you blend that all in, while the cap rate itself may be quite attractive from an FFO perspective, the cost of selling Christie is higher than what you are estimating. From our point of view, certainly that cost is something we thought about. It's not a positive, if you will. But promotes themselves are very dependent on current market values and they themselves can be short lived and based and disappear with changes in the capital markets environment.

So from our standpoint on a net basis it was desirable to monetize the position in that venture from our perspective in order to access that promote in the current environment.

So much that $350 million, the cost of that capital is what?

This is Sean. Mike, one piece of it I can address is the dispositions that are in the pipeline just to give you a rough sense of those communities setting aside Christie for the moment. The cap rate is probably in the sub 5% range for a blend of the assets, excluding Christie. And given the status of where we are on Christie Place, we are not at a point to be too precise as to what we think the real cost of that is until the transaction closes and we can provide a little more detail.

And then just clarification in terms of operating expense change between the two pools. You talked about taxes being an impact. But isn't it the weather impact in the first quarter that's impacting the legacy Avalon portfolio now that you've rolled that -- you've updated it effectively inclusive of the high weather-related expenses in the first quarter that obviously don't impact the 2Q to 4Q with regards to Archstone? Is that the main difference between the two?

Well, there's the difference in taxes as well. So you have a difference in taxes. So if I separate them in terms of the expense growth what's benefiting the Archstone portfolio the most is taxes and it doesn't have issues associated with the change we have in our business practice related to utilities, which is the pressure that's coming through on the Avalon portfolio. So Archstone main benefit, call it taxes.

AvalonBay legacy portfolio is burdened by a number of factors, including the items you talked about in terms of weather-related utilities, a change in the business practice that's putting pressure on utilities as well, as well as upward pressure on taxes. So it has the opposite of the Archstone portfolio in terms of taxes. More pressure on taxes than the AvalonBay portfolio that we've seen.

Things start to shift as we move into the second half of the year, as you pointed out. The majority of the Archstone benefit in taxes has come through in the second quarter, but there is some remaining benefit in the third and fourth quarter. In addition, the Archstone portfolio, because of when we acquired the asset and the way we treat certain expenditures, they were capitalized in the first portion of 2013 and they were expensed in the first portion of 2014. So that put upward pressure on Archstone that we won't have in the second half.

So as you go through each one there is different things driving the year-over-year comparisons. If you want to talk about it in more detail, certainly give me a call and I can walk you through. But those are the main highlights.

Yes Mike, just one last one as you can tell from Sean's comments. There is just going to be some noise in the Archstone portfolio on a year-over-year basis. Less so as you get to the end of the year than we did in the middle of the year. But we thought it was still better to try to provide a more expansive same-store portfolio for the last three quarters despite there are likely to be more noise in those numbers. But we'll do our best to explain the noise as we move through the year and sort of -- so people have a good a sense of it.

Okay. Great. Thanks.

This concludes today's Q&A session for your program. I'll turn the call back over to Tim Naughton for any closing remarks.

Well, thank you, and thanks everybody for being on the call today and I hope everyone has a great rest of the summer, and look forward to seeing you at many industry events here once fall comes around. Have a great day.

This concludes today's program. Thank you for your participation. You may disconnect at any time.