住宅地產 (EQR) 2017 Q2 法說會逐字稿

(technical difficulty) to Marty McKenna. Please go ahead, sir.

Thank you. Good morning, and thank you for joining us to discuss Equity Residential's second quarter 2017 results. Our featured speakers today are David Neithercut, our President and CEO; David Santee, our Chief Operating Officer; and Mark Parrell, our Chief Financial Officer.

Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the federal securities law. These forward-looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events.

And now I'll turn the call over to David Neithercut.

Thanks, Marty. Good morning, everyone. Thank you for joining us for today's call. We're pleased to continue to experience very deep and resilient demand for apartment living across our markets. And as David Santee will explain in more detail in just a moment, most of our market should meet or exceed our original expectation for revenue growth this year, which is driven by very strong occupancy, retention and renewal rates despite elevated levels of new supply, which continue to pressure new lease rates in some markets.

Across our portfolio, we see the benefits to our business of the growing economy, producing jobs, low unemployment and rising incomes, which continue to drive strong and steady demand for rental housing in our core markets. We also see the benefits of a remarkable customer service provided to our residents and prospects by our teams across the country. Their hard work and dedication really do drive our business and they inspire all of us each and every day. So now I'll let David Santee go into more detail about how our markets are performing during the extremely (inaudible) for leasing season and then Mark Parrell will give some color on operating expenses and our guidance for business. David?

Okay. Thank you, David. As we discussed on the last call, our relentless pursuit of delivering remarkable service to our current residents and getting them to renew with us in the face of elevated deliveries is our #1 goal. Our teams continue to deliver outstanding results, achieving renewal increases of 4.8% for the quarter and a 100 basis point improvement in retention.

Year-to-date annualized retention improved by 150 basis points. Our Q2 revenue growth of 2.1% was driven by better-than-expected renewal rate growth and a 260 basis point increase in the percentage of residents who chose to renew with us. For the quarter, new lease-over-lease growth of 1.4% was shy of expectations, driven mostly by a choppy leasing environment in Washington, D.C.

Demand across all of our markets continues to be very good as evidenced by a reported occupancy for the quarter of 95.8% and the 96.1% occupancy we enjoy today. And despite the elevated deliveries that we are experiencing across our markets, we see no indications that demand will soften beyond the normal seasonal trends through the balance of the year. The percent of people in America who choose to rent versus own is now at a 50-year high. With the resurgence in job growth and more visible signs of upward wage pressure among the highly skilled and highly educated, we remain cautiously optimistic that our markets will continue to absorb new deliveries in an orderly fashion and continue to exhibit strong pricing discipline.

As we sit here today with our projected forward occupancy expected to be 30 basis points higher than same period last year and an exposure that is 60 basis points lower than last year, we are well positioned as we exit the peak leasing season. Renewal rates achieved should be 5% for July, with August currently at 4.8%. With rates mostly baked for the full year, should we continue to experience better-than-expected occupancy through year-end, full year revenue results would be closer to the high end of our original guidance range.

Moving on to the markets. Washington, D.C. is our only market that will fail to meet or exceed our expectations, as job growth came to a grinding halt in April, while at the same time, new deliveries were at the highest of any quarter on record. Uncertainty around the new administration's ability to deliver on its agenda and a sharp falloff in procurement spending caused many government contractors to hit the pause button on hiring. As a result, occupancy for the quarter was 70 basis points below Q2 of 2016. As a result of the choppiness in pricing, D.C. was our only market to see an increase in turnover for the quarter and flat quarter-over-quarter results of the percentage of residents renewing as well as renters took advantage of attractive rental rates at newly delivered communities.

While renewal rates achieved in D.C. in the quarter were up 4.8%, our new lease-over-lease results were minus 80 basis points. But we remain cautiously optimistic that D.C. may be getting back on track. The market is expected to have few deliveries of new units in the back half of the year and currently, we're achieving occupancy and exposure results that are better than the same time last year. And today, our July billings show a 1.7% revenue growth versus July of 2016. This activity supports recent reports of job growth in D.C. being expected to reaccelerate. While we originally believe that Washington, D.C. would be our only market that would deliver better results in 2017 than last year, we now see Washington, D.C. delivering results similar to 2016.

And New York City is exceeding our expectations in that it is not as bad as we have planned. Despite the level of luxury product being brought to the market, owners have been remarkably disciplined with their pricing. However, peak 17 deliveries will not occur until Q3. Move-in concessions continue to be utilized mostly at new lease-ups, while stabilized communities remain committed to net effective rents with minimal targeted concessions. From the dollar volume perspective, year-to-date same-store concessions have averaged $485 per move-in or 3.8 days of free rent per move-in, which is down from first quarter of $575 per move-in or 4.5 days of free rent.

Renewal rates achieved in New York were unchanged from Q1 at 2.3% and lease-over-lease pricing improved from negative 6.2% in Q1 to negative 1.8% in Q2. Factoring in the use of concessions year-to-date, net effective rents are down 2.3% from a year ago.

Boston is on track to meet our full year expectations, as we expected new deliveries in the Financial District and Cambridge put pressure on new lease rates. Student churn is still in process, but based on our current occupancy and exposure, we should come out of peak season better positioned than we were in 2016. In Boston, renewal rates achieved for the quarter were 4.4%, while new lease-over-lease rates were up 1.4%. With deliveries evenly spread across the quarters and peak season just about buttoned up, we think Boston has the potential to do modestly better than our original expectations.

Moving over to the West Coast. Southern California, which represents almost 60% of our expected growth at the original midpoint of our guidance, is on track to meet our full year expectations. As expected, Downtown L.A. and Pasadena are producing the weakest revenue growth as these 2 submarkets have the greatest concentration of new supply. With new deliveries peaking in Q4 in both L.A. and Orange County, potential speed bumps remain ahead, although both submarkets make up a very small percentage of our total revenue for the region.

West L.A. revenue growth is accelerating as we had hoped as Silicon Beach continues its growth with virtually no new supply in sight. And San Diego will exceed expectations with only a 1,000 units left to be delivered this year.

For our SoCal portfolio, Q2 renewals achieved were 6.6% and lease-over-lease results were 2.4%. With both L.A. and San Diego sitting today with 100 and 180 basis points less exposure, respectively, than last year and Orange County flat to last year, it is clear that today demand remains very strong across the entire region.

San Francisco has certainly found its footing and should exceed our best case expectations for full year revenue growth. Despite delivering more units in 2017 than in 2016, the lease-up environment appears to be significantly more accommodating. Like many of our markets, San Francisco renewal increases are driving better-than-expected top line growth, while year-to-date move-outs are down 12%. Renewals achieved for the quarter were up 4.4% with forward months accelerating.

Lease-over-lease results were up 1.5%, which was better than expected and occupancy was right on target. While job growth in San Francisco has slowed compared to previous years, it still remains above the national average. With most -- almost 40% decline in expected deliveries for 2018, we see no reason why San Francisco won't continue to move up from here.

Now, we always believed that Seattle could deliver another year of very strong revenue growth, but with peak deliveries of almost 7,900 units, we hedged our bets in our guidance. However, like last year, Seattle continues to absorb units without a flinch. Amazon continues to try and rule the world and Microsoft is still a major player in cloud computing as evidenced by their Q2 results that were reported last week.

Renewal rates achieved were up 7.8% on lower turnover, continuing to drive top line growth that will exceed our full year most optimistic expectations. Our lease-over-lease results were up 10.4% for the quarter. So all across our markets, demand remained strong. Markets are absorbing new supply, some that were in minimal pricing pressure, some none at all. Our occupancy is better today than last year and our exposure and turnover are both lower than last year.

So in closing, I'd just like to give all of our folks out there a big shout-out for your focus, your commitment and most importantly, delivering great results.

Thank you, David, and good morning. I want to take a couple of minutes today to talk about our same-store expenses, our revised debt issuance plans for the year and our full year normalized FFO guidance.

First off, regarding our same-store expenses, we have raised slightly the midpoint of our full year same-store expense guidance from 3.5% to 3.625% to reflect the increased payroll costs as well as costs associated with the severe rains in California this year. And these costs were on both through payroll in the form of higher property level overtime and through the repairs and maintenance line item. These elevated costs have been somewhat offset by our expectation of lower gift card spending in 2017 due to the strong weather demand that David Santee just discussed and this should lower our leasing and advertising costs.

Our year-to-date same-store expense growth of 3.9% was primarily driven by increases in real estate taxes and in on-site payroll. We also had a relatively difficult comparable period. First half expense growth in 2016 was 0.9%, and we will benefit from an easier comp in the back half of 2017.

Now I'll give you some color on some of the major expense items. We saw a 4.7% increase in real estate taxes in the second quarter and that was driven by increases in Boston, Seattle and New York, with the New York increase in turn driven by the burn off of 4.21a tax abatements. For the year, we still expect same-store expense growth for real estate taxes to be between 4% and 4.5%. Away from same-store, we had a change in our estimates of the assessed value of several of our California development properties as well as a change in the expected timing of these assets going on the California tax rules at their full value. And this will increase non-same-store real estate taxes for the full year by approximately $5 million to $6 million.

Turning back to same-store and discussing payroll expenses. When we said on several prior calls that we expect pressure in this category throughout the year, this is due to a combination of wage pressure to retain our property level employees in a very competitive market and the addition of staff in some markets to provide even better service to our residents and support tenant retention. These factors drove our original estimate, then on-site payroll would grow by 4% to 5% for the full year. We now expect an increase of about 6% in this category and that change is due primarily to higher estimates for certain employee medical insurance and Workmen's Comp claims.

We now expect leasing and advertising expense to decline 6% for the full year versus our prior estimate that this expense will be flat for 2017 versus 2016. L&A spending increased 2% in the second quarter 2017 and 7.5% for the 6 months -- first 6 months of 2017. So we expect a meaningful deceleration in L&A expense growth in the back half of this year. Please recall that we spent approximately $1 million in gift cards in 2016, all in the second half of that year. Driven by strong retention, low turnover and high occupancy that we are now enjoying, we now anticipate that we will use less than $200,000 of the $700,000 in gift card spending we previously budgeted for 2017. In fact, as of June 30, we had spent almost nothing in this category.

Moving on to the balance sheet. As you may have seen, we're upgraded by Moody's to A3 and we are pleased to be recognized for our rock solid balance sheet and proud to be one of only a handful of REITs across all of the asset types to carry A ratings from all of the rating agencies. In our earnings release, we raised the midpoint for our anticipated unsecured debt offering to $500 million from $400 million as we consider a larger and earlier offering take advantage of the opportunities by locking in today's favorable rates. We had planned to use the proceeds from an offering to pay down our outstanding commercial paper and revolver balance, which today stands at a combined $900 million.

So moving onto normalized FFO, in our earnings release, we raised the midpoint of our full year same-store revenue guidance to 2% from 1.6%, driven by all the positive factors David Santee just enumerated. I just went over our expectation of a modest increase in same-store expenses, which collectively caused us to raise the midpoint of our same-store NOI guidance to 1.25% from 1%.

On the normalized FFO side, we're picking up a bit more than $0.01 per share from higher same-store NOI and smaller amounts from our expectation of less transaction dilution due to the timing of our acquisition and disposition activity this year and higher non-same-store revenue, though this better non-same-store revenue is more than offset by the increase in California development asset real estate taxes that I previously mentioned. Put all this in the blender and the result is a modest increase to our normalized FFO guidance midpoint going from $3.10 a share to $3.11 a share.

So all in all, revenues improved, expenses are generally on track, normalized FFO slightly improved and positive news in relations to our credit ratings and our anticipated capital markets activity. And I'll now turn the call back over to David Neithercut.

All right. Thanks, Mark. Really quickly before we open the call to questions, just a bit on capital allocation. As we noted in the press release last night, transaction activity was modest in the second quarter when we acquired one asset and disposed of 2. The property we acquired was a 136-unit asset, built in 2016, located in West Seattle, acquired for $57 million or $419,000 a unit at a cap rate of 5%. During the quarter, we disposed of a 312-unit property in a secondary submarket of Cambridge, Massachusetts, for $168 million or $535,000 a door at a disposition yield of 4.5% and a 288-unit property located in Franklin, Massachusetts, for $51 million or $177,000 a door at a disposition yield of 6.7%. Now year-to-date, the $267 million of dispositions have a weighted average disposition yield of 5.3%. This compares favorably to the recent acquisition at a 5% cap rate. We've also got several other deals we're currently underwriting which we believe could be acquired at cap rates ranging from the mid-4 to low 5s. As a result, while we maintain the guidance of $500 million of acquisition activity and $500 million of disposition activity for the year, we've narrowed the spread of that activity from 75 basis points to 50 for the year.

So operator, we'll be happy to open the call to questions at this time.

(Operator Instructions) And we'll take our first question from Nick Joseph with Citigroup.

How much of year-to-date revenue outperformance do you attribute to better-than-expected demand versus benefiting from some of the expected supply being delayed and delivered a little later than probably you originally anticipated?

This is David, Nick, David Santee. When we look at our deliveries, there's only a couple of markets that have really had any significant delays, specifically New York, but that's only 700 units that kind of got shifted from the first half to the back half. And then the only other market of any significance would be D.C., again, only 700 units that moved from the front half of the year to the back half. So I would say that most of this performance is driven by continued strong demand.

And then in terms of development, how does the 4.7 stabilized yield on the Fremont deal compared to your original underwriting?

David Neithercut here, Nick. Generally the ballpark that property was impacted significantly by this downturn or step back that San Francisco experienced a year ago. We started lease-up of that property in April of last year and you know that it was just around that time in the springtime that San Francisco began to weaken. So that number essentially sort of met our expectations. I can tell you that in 2015, early 2016, we had thought we do significantly better, but it's generally met our original expectations, which frankly, if you think about a type 1 construction yield in such a phenomenal location, that -- those are lower expected going-in yields.

And then just finally, what's the expected stabilized yield on the remaining projects? And maybe if you can provide a range on the low end and the high end?

Well, the other products, excluding Fremont, would have a weighted average of yields in the 5.5 to low 6s.

We'll take our next question from Nick Yulico with UBS.

I was hoping you could give updated thoughts on the submarket revenue growth projections. I think you have last updated them on the 4Q call.

Okay. So I'm going to give you the likely full year revenue growth expectations. Boston remains at 1.5; New York remains improved to minus 30 basis points; Washington, D.C. 1.4; Seattle 5.75; San Francisco 1.8; Southern California -- I'll give it to you by major market; L.A. is -- remains steady at 3.6; Orange County 4.5; and San Diego 4.25.

Okay. Appreciate that. Just going back to the supply topic. We looked at the day, it looks like second quarter and third quarter of this year, just using axiom metrics data was the largest amount of supply completions in the cycle. And we've gone through first half of the year and seeing some of the impact on fundamentals and you talked about a couple other markets like New York, D.C., I think, parts of Southern California, where the supply impact actually, the deliveries pick up a bit in the second half of the year. How should we be thinking about where we are versus the supply in this cycle? And because I think we're trying to -- a lot of us we're just trying to wrestle with have we gone through the supply or -- and we've seen the impact of rent growth or is there still kind of this lingering issue in the back half of the year and into next year where there's still a fair amount of supply that could pressure rent growth? I just love to hear your thoughts on that.

It's David Neithercut here. Nick, there is certainly supply coming this year and we expect supply next year. Then in some markets, we expect supply to diminish next year; in other markets, we expect there to even be sort of modestly more. But fortunately, as we already discussed, demand remains strong, occupancy is strong, retention is very strong. So, so far the market has demonstrated enough depth to absorb that supply. And while it's too early to call 2019 in many markets, our expectation is that we will see a decrease in supply beginning in 2019.

We'll take our next question from Steve Sakwa at Evercore ISI.

David Santee, I appreciate all the color that you gave on the new and the renewals by market. Do you sort of have a rolled up blended number for the portfolio on sort of renewals and new just for the whole portfolio?

So the combined number for new lease and renewals for Q2 was 3.2%.

Okay. And then maybe just kind of coming back to New York for a minute, could you just talk a little bit more about the new supply, the impact, maybe some of the submarkets and are there projects that you either see being put on hold or perhaps have been delayed or canceled at this point that maybe give you a little more confidence about the outlook, say, 18 to 24 months from now in New York?

We update our supply or our expected deliveries every quarter. Obviously, we wouldn't expect any cancellations in 2017. These deals are pretty much ready to open their doors. Certainly, the concentrations in New York are specifically Brooklyn and Long Island City. That's where -- we have nothing in Long Island City, but we are monitoring any potential impact that Long Island City could have on surrounding submarkets. New supply in Brooklyn is more North and East of us and downtown, but nevertheless, we are feeling some of the pricing pressure and Brooklyn would be our lowest performing submarket in the metro area.

Steve, in New York City, as we look at competitive product, which is all high-rise kind of product, you've got a 40-or-so month sort of building cycle in that marketplace. So anything delivered in 2018, we sort of know is there. Anything that's supplies in '18 always slip from '17 or supplies in '17 is going to be moved up from '18. And it's going to be very soon before anything that's going to be delivered in 2019 got to be underway. And so we've got a pretty good handle, we think, in New York City as to what the supply is this year and next year and we expect, based upon what our guys in the field are monitoring, a meaningful decline in new deliveries in 2019.

Okay. And I guess last question, David, just in terms of capital allocation, thinking about development. I know you've really taken your foot off the gas. Are there any kind of land parcels or any potential new developments that you guys are exploring or looking at it this point or it's pretty much deliver these 4 projects and kind of wait for the next cycle?

We've got a couple of projects that could begin yet this year, which are frankly quite small. We've got a deal in Seattle and we expect that we've already given approval to the guys to build which is just $62 million. We've got a small deal less than $50 million on a site adjacent to an existing property that we got in Archstone transaction, which could begin yet this year. So that's just $100-or-so million dollars. Beyond that, we've got some sites that we currently have in L.A. and in the Bay Area and in Boston that we could do something on, but we're not going to pursue those very aggressively at the current time. I mean, the teams continue to work on them, but I feel we'll just sort of see how things play out. We're not even looking and we continue to underwrite new land sites. The guys continue to look at what's out there, but there's nothing that we find attractive given where costs are today and the pressure on land costs, the pressure on construction costs and where yields are today. And I guess I'd tell you that the product that Alan George and his team are looking to acquire today, products built in 2016 or 2017, we believe there's opportunity to buy some of that product at current replacement cost or maybe even a modest discount thereto. So at the present time, we just don't look at that development as particularly compelling. But we do have some things in the pipeline. As I said, we could start this year some other product that will continue to keep a close eye on, but should not expect to see us be taking down new land sites in the near future.

We'll take our next question from Conor Wagner, Green Street Advisors.

David Neithercut, could you comment on the transaction market a bit more? Have you seen any change year-to-date, given that some of these markets have recovered has buyer or seller expectations, have they changed at all?

Though transaction volume is down meaningfully from a year ago, Conor, but as we've talked a lot about with various investors that we've met in New York in June, those transactions which are taking place continue to take place sort of at cap rates and valuations that I think remain very solid within -- generally within the same valuation ranges of a year or so ago. So transaction volume is down, but valuations and cap rates are pretty much where they've been. Now I can tell you that the brokerage community will constantly tell us that you're working on a lot of opinions of value and that they know a lot of owners that are interested in selling product, and we expect to see more product, but at the present time, it's down considerably from a year ago.

Great. And then maybe David Santee, if you could comment on how the rehab program has been going year-to-date in terms of the type of returns you've been getting on your kitchen and bath upgrades? And then if you can refresh me if those -- if that's been focused on any particular markets or if it's been evenly spread across the portfolio?

Conor, it's Mark Parrell. No, it's pretty well spread out throughout the portfolio. We continue to see cash returns on that in the 12%, 13% or so range. We are doing a little more this year than we have in past years. So this year it's more like 8% of revenue and typically it's been more like 7%. We mentioned that, I think, a couple of quarters ago we're doing that to sort of accelerate some things in terms of customer-facing improvements like clubhouses and the like and expect that to kind of go back down next year. So just in terms of geography, it's pretty well spread out throughout the portfolio.

We'll take our next question from John Kim, BMO Capital Markets.

I'm interested in your commentary on the demand in D.C. weakening this quarter. I think last quarter you alluded to it. Now, it's a little bit more pronounced. In your opinion, is confidence in the Trump administration's the key driver of future demand and if the approval ratings remain low, is there a chance that your 2017 figures in D.C. will not meet 2016?

Based upon things that I've read, I think a lot of it just has to do with actually filling jobs of -- and positions that actually can approve procurement contracts. So I think last call, there was probably almost 400 vacant positions across all departments. And many of these positions were folks that approved procurement contracts. So certainly, it appears that the market has rebounded. Although it's not going to see the rate growth that we had hoped, but the rate growth has improved, occupancy has improved, demand has improved. But yet, there is still potential obstacles ahead and procurement is going to drive the strength of D.C.

Okay. And then I'm not sure if you have disclosed this in the past, but what percentage of your leases are backed by guarantor? And I'm wondering if you have tracked this, how this has trended over time?

It's a very small percentage. Typically, we're talking about more student-oriented properties. And then where we have most students or in the case of international students, we actually refer these folks to the third party that they can purchase guarantee insurance that ensures us for the full balance of the lease should they default.

And are these excluded from the rent-to-income figures? And can you also just update that on -- that figure for this quarter?

Yes. We do exclude guarantors. Certainly, we actually exclude income below a certain level, I think, and above a certain level. So we kind of chop off the extremes so that we get at a more well-rounded number. The revenue -- the rent-to-income ratios really remain unchanged. I think what is more interesting is just how we kind of look at the total income of our residents that moved in last July versus the total income of the residents that moved in after this year.

Yes, I'll tell you that. So I mean we looked at close to 30,000 new leases for the 12 months ending July '16 and the 12 months ending July '17 of the same-store set so which was those leases that have been entered into (inaudible) in that trailing 12 months and the average incomes are up 4% year-over-year and the median income up almost 6% year-over-year. And in both instances, the average rent-to-income or median rent-to-income is down in 7 of 8 markets. So we continue to see very strong incomes and very acceptable and perhaps even low rent to income levels and even Seattle, which has experienced some of the biggest expense growth, continues to have the lowest along with Manhattan, the lowest average rent to income and median rent to income.

We'll take our next question from Vincent Chao with Deutsche Bank.

Just a question on Seattle. Just continues to sort of defy gravity in terms of the performance there, even in the face of a new supply. But I was just curious, I mean, the job growth there still very strong versus the rest of the country, but has been decelerating fairly quickly. I just curious if the demand side there from a job growth perspective has met your expectation and then I think last quarter you said that Seattle was expected to peak in the second half. Is that a third quarter or fourth quarter event? I don't know, maybe it's...

We run into tougher comps in the back half of the year, but -- versus last year. But I mean we just don't see any change in demand in Seattle. I mean, we project some softness that really just has never materialized, and we've kind of taken that approach over the last 4 years in some of these submarkets, especially when there's a community that's going up down the street or across the street, and we expect to see some softness, and frankly, we've just never seen it. And our barometer is the open positions at Amazon. And I think last quarter, they were 10,000 and I think last week, they were 8,500. And then with the continued growth in cloud computing, I think Seattle has created -- its created a niche as the backbone and the plumbing of all things that are generated out of Silicon Valley. So Seattle remains very strong.

Okay. Maybe if you just remind us, I know you talked about the focus on service and the turnover ratios have been reflective of that, and I think some of the increased wage growth has been part of that as well. Just curious, can you just remind us what you're doing at the asset level to sort of really drive that service level home with tenants?

I think it's really -- it all starts at the top, right? And I think we talked about our efforts on the last call. All of our senior team, myself, Michael Manelis, people from other departments visited each and every market, laid out kind of our expectations. We continue to try and experience -- try new approaches with resident experiences. We have a very deliberate and active kind of activity program that we're piloting in New York City. Our -- we're focusing as well on our employees giving them the training that they need. Certainly, we are watching compensation. Mark talked about our wage pressure in our industry, but I'm also pleased to report that, turnover through the first quarter of on -- of all on-site employees was down 120 basis points versus same time last year. So I think everything that we're doing is providing a very significant return on investment in our time. And I also like to say that, Tom Lebling, who is our Senior VP of Property Management, is very instrumental in making sure that all of our folks are all in the same page and that our messages are very clear, and we're all rolling in the same direction.

We'll take our next question from Rob Stevenson with Janney.

David Santee, given your comments about the weakness in D.C., are you seeing any meaningful performance differential between the various Northern Virginia submarkets between themselves and then also versus the district proper?

We had more supply in the RBC Corridor in Q2. We have a large percentage of our portfolio there. But I would say, just in general, the entire region seem to have hit the pause button. There's numerous -- the [Steven Fuller emphasis]. There's numerous publications that you can read, but I think it was just this dark cloud over the entire region partly fueled by a sharp falloff in procurement spending.

Okay. And then David Neithercut, how would you characterize your relationship today with Airbnb? You guys working with, trying to combat stuff, I mean, where does that stand today?

We continue to work with Airbnb on a handful of properties that have a -- well, we've learned, only because of our working with them, we've got a higher share, a large share of the activity to work with them to get some transparency in understanding and control as to the amount of activity that's taking place in our properties. So far, we think that that's working fairly well and is a better approach than what others are -- that have decided to tackle themselves.

What type of control are you getting relative to when you don't know that somebody is renting? I mean, are you getting approval process? How do you characterize that?

Because of what we're doing with them, we do know what's taking place in our property. And the only way one does know is by working with them. And so we have absolute understanding about what's taking place in our properties and have control of being able to turn people on and turn people off and limit the amount of activity that's taking place on any given property at any given time. So because of what we're doing with Airbnb, we do have knowledge and then we'll have control that for those who do not work with Airbnb won't have.

We'll take our next question from Jeffrey Pehl with Goldman Sachs.

Just I wanted to go to the Bay Area, if you could talk a little bit about the performance of the CBD versus the submarkets, if there's any differences there?

Well, I guess I would say that, certainly last year, the CBD, especially our same-store CBD, which were older assets but in great locations, went head-to-head with all of this new supply and the concentration in downtown. But we -- so year-to-date, downtown is -- it's performing on par with our full year expectations. So I said our advice number was, I think, 1.8% and today, San Francisco is currently billing positive. Downtown is billing positive at 1.9%.

Great. And then just also on the Bay Area, the concessions. If you can maybe talk about Rincon Hill versus the Design District in your asset, One Henry Adams there, what you're seeing maybe in terms of concessions, and then also, if you're seeing anything kind of towards the same into Peninsula area, if you're seeing any concessions there?

So as a general statement, we are not utilizing concessions at any stabilized properties across the entire San Francisco MSA. I would tell you that, demand at Henry Adams has been very strong. We -- depending upon our lease-up pace, we have kept concessions in place but at the same time, raised The Street rate. In some situations, we have removed concession, so it's -- it -- leasing up a building is a very dynamic process and you want to -- we don't set it and forget it, and we're always trying to optimize revenue by pulling the levers that are appropriate, given the pace of the lease-up. So we're seeing very good results at Henry Adams. And while we see very few concessions in the submarkets that we're in, we are not utilizing concessions.

We'll take our next question from Dennis McGill with Zelman & Associates.

One question, just going back to the phasing of deliveries in 2017. I think you touched on this in a few markets, but if you were to look across your markets, how much of the deliveries do you guys showed today being in the second half of the year versus the first half of the year, percentage-wise?

Across the entire portfolio, specifically, it's 30,000 units in the first half and 35,000 in the back half, across the entire portfolio.

Okay.

So not a whole lot of it.

Okay. And then just to clarify, I think a point you made earlier on the seasonality of the business. Just to clarify, when you look at the leasing trends that you've assumed within the guidance second half of the year, does that reflect normal seasonality -- better than normal seasonality versus the normal seasonality?

Just normal seasonality in the original guidance.

Okay. And then last question. I think there was a comment on, as you get out to '19, everything you can look at today would suggest you'll see a decrease in supply. The comment on '18 though was a little bit back-and-forth, I guess, depending on the market. Again, holistically, if you were to look at '18 today, is that more of a flattish trend in supply? Is that what you're implying, David?

Well, '18 numbers on a portfolio basis currently are pretty on par with our '17 deliveries. So you really have to kind of get down to the market level. So New York in 2018, we would expect more deliveries. Let's see -- Boston, we'd expect fewer deliveries. San Francisco, significantly fewer deliveries in '18. Seattle, slightly fewer. The big pop would be L.A. in 2018 going from 10,000 to almost 14,000 units, but that's -- that hasn't been a secret. Orange County, kind of -- same, 5,000 this year, 5,000 next year, and then San Diego, call it 3,000 units next year versus 2,500 this year.

We'll take our next question from Juan Sanabria with Bank of America.

Just on the expense side, you guys made allusion on the top line that you could be at the high-end if occupancy kind of holds in relative to where you are to date. Any comments on the same-store expense side on comfort level at the high or low-end? And then how you're thinking about that?

It's Mark Parrell. And -- no, I mean, I think 3.6 right at the middle is kind of how we feel right now. We don't really have a bias either way and relatively small amounts of money on a $600 million same-store expense budget can move us to 10. So I think, we're right kind of write-down in the middle of this juncture.

You have another question, Juan? Operator, we will...

Can you hear me?

Now, we can, yes.

Sorry. Just with regards to the new lease trends in the second quarter and in July, could you just give us a sense how those trended across the portfolio, kind of on a month basis, if you were getting the benefits of seasonality kind of through Q2 and into July?

Yes. I'm not really sure how to answer your question. Our new lease rates with the exception of Washington D.C., are trending equal to or slightly better than we had expected.

Was the year-over-year change in June better than April and May? Just trying to get a sense of the -- how the curve looked throughout the second quarter and into July?

Okay. The second quarter -- yes.

The new lease rates obviously were much better in Q1 than Q2. From April to June, the curve generally moves up and it moved up just as it has in previous years. So really no change to what we see from previous years. They're following the same curve just at the lower level.

Got you. Okay. And then just one last question from me. Are you guys doing any -- have any programs or plans in place to take advantage of maybe demand for shorter term leases as some of your peers are looking to harness that demand?

Well, I guess, I would say, we used to have a corporate housing company, Equity Corporate Housing, many years ago that focused on corporate leases. We're not really looking to get -- add additional volatility to our operations. In fact, we've kind of gone the other way. When you stick with LRO and our yield management systems, I mean, typically, the systems price shorter-term units in many cases, probably a 100% higher than a 12-month lease rate. So if somebody wants to pay double the rent, we certainly entertain that, but it's not a segment of the business that we're actively pursuing.

And we'll take our next question from Tayo Okusanya with Jefferies.

I'm just trying to reconcile the same-store NOI growth guidance for the year. First half of the year, you are averaging about 1.7%. For the year, the midpoint is about 1.25%. So we're still kind of talking about further slowdown in same-store NOI growth in the back half of '17, but we're talking about less supply and better demand trends at this point. So I'm just struggling a little bit to kind of reconcile why the slower same-store NOI growth in the back half of the year?

Yes. But maybe we can just dissemble that to the revenue and expense. I think if your point is, our current guidance would, of course, imply lower same-store quarter-over-quarter revenue, some number around 1.8% in each of the next 2 quarters. If things go as David Santee implied they may in the back half of this year and we continue to stay very well occupied and we have good renewals, then that revenue number will be much closer to the very top end of our range and you won't see that deceleration, so that, that NOI number will be higher. On expenses, we just spoke to that. I mean, we do have different -- very different comp periods. We had a tough comp period the first half of this year, we'll have an easier one the back half of this year, but we still think 3.6% is a pretty good number. So I guess, I'd sort of look at it that way, that the 2 pieces sort of aren't moving in sync necessarily. And on the revenue side, we may pick something up here if things continue to go pretty well for us.

We'll take our next question from Rich Hill with Morgan Stanley.

Wanted to just spend a little bit more time maybe understanding how your same-store revenue, maybe when it'll trough and maybe when it will begin to accelerate a little bit more? And so if I think about this in terms of guidance, I think you're guidance is implying around 1.5% same-store revenue for 2H. What's driving that? Because I know you already mentioned that there's a really strong demand trends in place, which I fully appreciate given everything that we're seeing. So is it really just a supply bottleneck that's occurring into 2H? We had heard some commentary previously that some 1H supply got pushed into 2H. So do you see a whole bunch of supply coming in 2H? And then when can we really start to see it reaccelerated again? Is it maybe a 1Q '18? Is it more of a 2Q '18? I do recognize that you said, by 2019, things are looking a lot better. So maybe anymore color about how we should think about the velocity of same-store revenue relative to what your guidance is implying?

All right. Thanks for that question. It's Mark Parrell. I'm going to start, we're going to kind of hand it off between because that's a big question with different aspects. But just mathematically, the implication is more like a 1.7% or 1.8% for the back half of this year. And if things go as we sort of hope and as David Santee implied in his remarks -- prepared remarks, you wouldn't see any deceleration in the third and the fourth quarter as quarter-over-quarter numbers would be the same number more or less, maybe slightly higher than the number we just reported at 2.1% for the second quarter of '17 over the second quarter of '16. So I don't know, David, if you want to comment a little bit on just on the supply...

Yes, so I mean -- I think the key point to remember is that, this 2017, in many markets, is peak supply, peak deliveries. For the most part, the expected deliveries that got pushed from the back -- the front half to the back half is really, it's minuscule. And we don't see it having any material impact on how we operate and our expected results. So it's just a matter of -- as an example in New York, as new supply continues to open the doors, does pricing continue to remain disciplined or does there -- is there more dislocation that could occur in the markets? So in D.C., you still have continued supply expectations for full year job growth and economic performance across the MSA is dependent upon of the Congress passing a budget. So I think there's many potential speed bumps that could have an impact on performance to varying degrees in some of these markets. But we see -- but going back to demand, demand continues to remain strong regardless of these other potential speed bumps that I mentioned. And so at the end of the day, it will be how the markets react to any changes in the leasing environment.

And we'll take our next question from Neil Malkin with RBC Capital Markets.

First, I don't think you gave this, but can you give what new lease rate growth has done so far in July? And I know it's basically over, so do you have an idea on that. Was it above the 1.8% that you did in the second quarter.

We don't have that number yet.

Okay. And then kind of toward the West Coast markets. I'm wondering if you guys think the Trump administration's sort of hard line on H1B visas and immigration. Can -- will either A, potentially have an impact on some demand in some of your apartments? And then secondly, if you think that sort of the reduction in legal immigration has had an impact on choking further the already heavily constrained labor issues going on in the market?

Well, first to address the H1B visa. I think when you look at what actually occurred, I think that is a net benefit to our portfolio. I mean, the only thing that the administration changed regarding H1B visas is making sure that they are used as they were intended to be used, which is for highly skilled, highly compensated labor versus many of the shops that were bringing over outsourcing employees that they -- these outsourced employees were coming in to IT shops and having to train these outsourced people. So I think -- and then there is -- there was no decline in the number of H1B visas. And so really, the only significant change was the elimination of the express approval in the H1B visa process. So, net, net, net, I think the focus on the H1B visa is a strong positive for our portfolio. As far as immigration, certainly, it is very challenging. From a construction perspective, there are definite shortages in construction which is driving up labor cost. We feel that in our day-to-day apartment turnover, repairs and maintenance, rehabs, it is definitely being felt and hopefully, it will be addressed going forward.

All right. Great. And then lastly from me. Given your balance sheet strength and the fact that your developing program is kind of idled for now, are you looking at any mezz lending or loan-to-own situations in -- on some West Coast developments that, I mean, you can get an attractive return while you wait and then possibly take out that project in a later date?

That's an interesting 2-part question. As it relates to providing capital financing or loans for projects that might not otherwise get build, we're not in the business to providing same capital. Would we be interested in providing some capital or something to project that we might be interested in owning upon completion and have some sort of option to buy, we'd certainly consider that, but have not seen much of that opportunity to date.

We'll take our next question from Daniel Santos with Sandler O'Neill.

Just one quick one from me. I want to go back to CapEx. It seems that's been ramping up year-to-date. And just wondering if you expect that trend to continue and whether you would say that's allowed you to boost rents? Or is it just keeping your units competitive?

Yes. Hi, it's Mark Parrell. So we feel like we're sort of on track to our guidance number for the year which is this $2,600 a unit number. So we typically do more CapEx in the third quarter. It takes a while to get all this things going. So no, we don't feel like we're off track on that, I think, at all. And in terms of boosting revenue, all I can tell you, as we took a look at the 30 or 40 projects that we have underway on the rehab side and took the rent results from those marked properties, isolated them and compared them to the rest of the same-store set and it really just again because of where the projects are located and what the momentum of those deals are, meaning how many units have already been improved and how many haven't, it made no difference to our reported number year-to-date.

We'll take our next question from Nick Joseph with Citigroup.

It's Michael Bilerman with Nick. David Neithercut, I'm curious if you can talk a little bit about sort of the stock price, and I recognize the stock is a little bit out of your control, but more so from the perspective of your shares are traded at a discount to its underlying asset value to NAV while your peers are effectively in line. So there's both an absolute discount, but more importantly, a relative discount to your peers. And understanding some of the challenges that happened last year that sort of exacerbated that discount and perhaps some of the weaker same-store NOI this year could be attributed to it. I'm curious when your Board asks you why the stock is trading where it is and what things you can do to help narrow that gap, what's your response? What are you doing to help drive the relative performance?

Yes, but we spend a lot of time with investors and the investment community explaining what's going on in our markets and what's going on in the transaction markets and the underlying value of our assets. We spend as much time as possible with limited success, but with some success having more of those conversations with generalist investors who I think are having more and more of an impact on valuations, relative valuations in the space. We've acknowledged that, we stubbed our toe last year, and we're working our way out of that. We've also acknowledged that, our strategy of having our assets primarily in the higher density locations of properties with high walk scores are experiencing elevated levels of new supply and on a relative basis. That's put us in a position this year and perhaps less than the same sort of revenue growth and NOI growth as others might be experiencing. But nothing has changed in our mind nor our Board's mind about the long-term (inaudible) strategy as demonstrated by a lot of the materials that we provided in our investor brochures and information about the performance of these higher density markets over extended time period. So we're having conversations where we can, explaining people what's going on. Happy to have this opportunity in this call to reiterate the depth of the demand we're seeing across our markets. And the way that our assets are performing and the job the teams are doing out there. But -- we are in a cyclical business and at the present time because of new supply, we're a little bit more challenged on the top line perhaps compared to others, but we remain convinced that we're in the right assets and the right markets as the nation continues to reurbanize and as more and more people look to live in these high-density urban markets. You have another question, Michael?

Can you hear me, okay?

I can now, yes.

As you think as you go into next year, you have more free cash flow available if the development pipeline winds down. How are you thinking strategically about potential stock buybacks as one way to, if you believe in the value of the asset base and where the stock's trading of creating NAV that way? Or two, selling additional assets either into partnerships with institutional investors who appear to still have a lot of interest in the multifamily space are taking a much more aggressive disposition program in being able to take advantage of the discount that your stock trades at both at an absolute and relative basis.

Well, the stock will continue to trade at a discount NAV as that gap is narrowed over the past 90 days or so. And we had said, either way, it was creating at a larger discount than we didn't think it was at a level that made stock buybacks make a great deal of sense for us. As we experienced in the sale of the portfolio to start with last year and as we talked a lot about joint venturing assets or selling assets, we got a significant amount of gain built into these assets that require a significant payout should we go down that path that does not provide a significant amount of free cash flow after the fact to make any meaningful impact on the stock price or the stock buyback. As it relates to free cash flow, I think we've mentioned on these calls in the past that, after having our free cash flow of $275-or-so million a year, after having that targeted to a very profitable development business over the past 5 or so years, that having brought those starts down beginning '15 and in '16 and in this year that by '18, to your point, we will have meaningful amount of free cash flow that will not be targeted for that development business anymore and will be available to do a handful of things. And we sat with our Board in June, continue to have that conversation with them and let them know of the various options that we might have with respect to use of that cash. We could pay down debt, we could buy stock back, we could increase the regular annual dividend, we could buy assets, we could start developments, and we do have a lot of flexibility and optionality with respect to that, particularly in light of the recent the balance sheet's in a terrific spot as Mark Parrell mentioned. So we got a lot of flexibility there and we've socialized that notion with our Board, and we'll continue to discuss with them that optionality as we go forward.

And for our final question in the queue, we'll go to Jim Sullivan with BTIG.

We've seen some material increases in commodity costs this year, but I don't think you've raised your estimated development costs. Are you not seeing some pressure this year? Or is it just that the costs were fixed before the recent increases in commodity costs?

Yes. It's just the fact that these prices were fixed. The development that we're now delivering those prices, those contracts were left a long time ago. Now I can tell you and I mentioned earlier, we recently approved the start-up construction of a project in Seattle, and we've seen those construction costs go up meaningfully, but we will lock that down at the present time. So -- and certainly, we've heard a lot lately about the flyers in Canada and the impact on lumber. And there is just a lot of pressure on costs, a lot of pressure on land, a lot of pressure on construction cost, as David Santee mentioned, pressure on labor which makes up a very big share of total cost, which -- all the reasons why among many that we've sort of taken our foot off the gas on the development side of our business beginning in 2016.

So given that the revenue projections in Seattle and San Francisco, which is where I think about 80% of your pipeline is located have -- are improving. Is it fair to conclude that the -- kind of the value creation spread on that development pipeline is, if anything, increasing?

We certainly increased from -- when we started those projects. We just have noted that we've stabilized our deal on Fremont and San Francisco at 4.57 or so number. There were some discussion earlier about how that played out relative to original expectations, but that deal would trade all day along with a 3 handle. So we certainly made money there. We certainly really made money on all of the developments, but we've seen those yields on new developments begin to compress considerably and put us in a position where we question the wisdom of continuing development going forward. But certainly, in Seattle, we've done very well, revenues have grown significantly, rents have grown significantly, so the yields that we are achieving there and have exceeded our expectation in San Francisco at or have modestly exceeded our expectations, but cap rates have stayed low and so value creation has been very impressive in all those transactions.

Okay. A quick question on Boston. You had mentioned in a prior call that the international student demand weakening is a potential negative area in Boston. Is there any sign of that here in the third quarter?

Yes. So we have been very aware of the potential for that, and we have been asking as many questions as possible. But based upon the level of new deliveries and -- that are in the financial district and Cambridge, which tend to be a little more student reliant, given our occupancy, given our exposure as we come out of the student churn, I think it's safe to say that, we haven't seen any impact at all from that.

Okay. Very good. Then the final question from me. Following on from Michael Bilerman's question about strategy. Apparently, we may see more details on the administration's proposed tax overall this week. I wonder, David, if you can give us your insights as to what the likely proposal maybe for Section 1031? And if 1031 were to be eliminated as proposed or has been talked about, what the impact might be on your recycling strategies?

Well, we have no idea what will come out of it and I'm not sure if the President knows what's going to come out of this proposal. Certainly, there's been a lot of discussion about 1031s. And we've been one of probably the biggest user of 1031s over the past tenures as anyone. And in fact, our transaction with Starwood was almost $2.5 billion of 1031 on our part. So much of the benefit of the 1031s we've already used and we could certainly go forward quite confidently even if there was a change there. I would suggest though that if something did happen to 1031, that the relative value in OP unit could become significantly more valuable in the world of the real estate. It's a security that I think has not been utilized to the extent that we would have hoped in the past, but I think if 1031s go away, I think it'd be very beneficial to reach that or able to issue OP units in an acquisition situation.

At this time, there's no further questions in the queue. I would like to turn the conference back to your speakers for any additional or closing remarks.

Well, thank you, everybody, for your time today. I hope you all have a wonderful summer and look forward to seeing many of you come September. Thank you so much.

Ladies and gentlemen, this concludes today's conference. We appreciate your participation.