住宅地產 (EQR) 2017 Q3 法說會逐字稿

Good day, and welcome to the Equity Residential 3Q 2017 Earnings Call. Today's conference is being recorded.

At this time, I'd like to turn the conference over to Marty McKenna.

Thanks, Dave. Good morning, and thank you for joining us to discuss Equity Residential's third 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 turn it over to David Neithercut.

Thank you, Marty. Good morning, everyone. Thank you for joining us for today's call. We're very pleased that across our markets, we continue to experience very deep and resilient demand for apartment living. As David Santee will explain in more detail in just a moment, despite elevated levels of new supply, our portfolio performed very well during the leasing season, driven by great property management and operational support teams that will now deliver results for the full year that will meet or exceed our original expectations for revenue growth in every market [since] day 1.

Across our portfolio, we see the benefits to our business of an expanding economy, producing jobs, low unemployment and rising incomes, which continue to drive strong and steady demand for rental housing in our core markets. As a result, we now expect to achieve year-over-year growth of same-store revenue and net operating income towards the upper end of our original expectations. And our year-over-year growth in normalized funds from operations will be in the upper end of the range we provided last February as well.

So I'll let David Santee go into more detail about how our markets performed during the extremely important third quarter, and then Mark Parrell will give some color on operating expenses and our guidance provisions.

Okay. Thank you, David. I'm extremely pleased with the performance of our property teams during our busiest quarter of the annual business cycle as they continue to deliver remarkable service and renewal results despite elevated deliveries across all of our markets.

In addition to the 4.7% renewal rate increases achieved for the quarter, our annualized year-to-date retention improved 230 basis points, which was up 80 basis points from Q2. In addition to renewing 54% of our expiring leases for the quarter, occupancy improved by 40 basis points sequentially and was 20 basis points better quarter-over-quarter.

And as I said on the previous call, if occupancy continue to hold, which it has, we would deliver full year results at the high end of our original guidance, which we will.

With 2017 deliveries peaking in the second half of the year across most of our markets, our results demonstrate that demand from quality urban apartments continues to be very good. And as I stated last quarter, we see no indications that demand will soften beyond the normal seasonal trends through the balance of the year.

Renewal rates, thus far, for October are 4.6%. With occupancy 20 bps higher than same week last year at 96.2% and available inventory flat, we are in a good position to end the year and deliver full year revenue growth of 2.2%.

Moving on to the markets. Again, no different than last quarter. Washington, D.C. is our only market that will fail to meet or exceed our original expectations. As peak deliveries from Q2 bled into Q3, rates at stabilized communities further deteriorated in the central district submarket. Federal job vacancies and weak government procurement further pressured this submarket as new development came online in the waterfront submarkets. However, the falloff in demand that we experienced late in Q2 did recover, allowing us to achieve a 40 basis point increase in sequential occupancy to 96.2%.

Renewal growth moderated to 3.8% for the quarter as D.C. is our only market to experience an increase in year-to-date turnover. New lease pricing was a minus 2.6%, driven mostly by the Central D.C. and the [indiscernible] to submarkets.

While all indicators signal an improving local economy, the pace of improvement is only sufficient to absorb new units at market rental rates that were below expectations. Better priority on federal initiatives and improving job growth will be necessary -- will be the necessary catalyst to absorb future deliveries with positive rate growth.

New York City was stable in the quarter and continues to outperform our relatively pessimistic expectations. Today, we enjoy a very strong occupancy of 96.9% and exposure that is 30 basis points better than same week last year. Renewal increases were 3% for the quarter and, combined with higher retention, mitigate the minus 4.1% new lease-over-lease results that, combined, achieved a positive 10 basis points revenue growth year-to-date.

Compared to Q2, these results are very good as New York had more units available in Q3 than any other quarter in 2017. Move-in concessions of 1 month or more are still mostly limited to new lease-ups. Concessions on stabilized assets across our portfolio, which, again, are very targeted to certain properties and unit types, ticked down slightly from $485 per move-in to $436 per move-in or from an average of 3.8 days to 3.5 days per move-in for the quarter.

Our net effective rents, which factor in concessions, are currently flat from the same time last year, which is an improvement from last quarter when they were down 2.3% compared with the same time the previous year. Additionally, we have not seen the need to use nonrevenue incentives, such as gift cards. And as a result, New York City leasing and advertising costs are down almost 39% for the quarter. These have been positive signs, thus far, but we acknowledge that the market still faces a significant amount of supply and slowing job growth.

For Boston, the summer student churn proved to be a little more challenging than previous years but recovered quickly to deliver a 30 basis point quarter-over-quarter improvement in occupancy. Renewal growth of 5.2% was very strong, in addition to 130 basis point improvement in retention. New lease pricing was positive 30 basis points for the quarter.

New deliveries in Downtown Cambridge continue to weigh on new lease rents. However, recent announcements of large office space leases by Facebook, Bristol-Myers Squibb in these submarkets are encouraging for demand and above average rent growth in the future.

Seattle remains on track to be our top-performing market and will exceed our most optimistic expectations. Renewal increases for the quarter were 7.8%. However, new lease pricing weakened either in quick reaction to the news of Amazon HQ2 or due to rate pressure as new deliveries peak in Q3.

New lease rate increases were 2.6% for the quarter, which was down from the 10.4% increase realized in Q2. Occupancy also dipped 50 basis points, but this reaction proved to be short-lived. Today, new lease rates are now back up to 6.9% versus same week last year, and renewal increases for October are 8%. They have averaged 8% going all the way back to May. Today, both occupancy at 95.7% and normal seasonal exposure are now back to the same levels that we experienced in 2016.

Estimates are that Amazon still has approximately 10,000 new jobs to fill before they begin to level off in 2018. The jury is still out on the full impact of the HQ2 decision. But given the city has not kept pace with infrastructure and transportation needs, perhaps a few years of moderation is the best interest of everyone for the long term. Recent announcement of large office space leases other than Amazon or related entities is welcome news in the interest of a more diversified economy.

Going down to San Francisco. San Francisco continued to be steady through the quarter as deliveries reached their lowest level in 7 quarters. While job growth was near the national average and the lease-up environment remained accommodating, there was little momentum to overcome the rental rate hangover we experienced in 2016.

New lease rents improved modestly, resulting in a lease-over-lease decline of 1.9%. Renewal rates continued to improve and increased to 4.6% for the quarter. This, combined with a 260 basis point increase in retention, drove revenue growth of 1.6%, that far exceeded our original expectations.

Southern California still remained the story of submarkets, and the story is playing out as we expected. For the L.A. region, Downtown and Pasadena were the weakest as new supply pressured new lease rents. West L.A., the Valley and Santa Clarita delivered exceptional results as new supply is nonexistent. Job growth remained healthy, and economy that relies heavily on the film industry is being bolstered by outsized demand for original content as cord cutters seek out alternative forms of entertainment. While lease-over-lease rates were up 80 basis points, renewal rates were up 5.9%. We also had 100 basis point improvement in retention and a 30 basis point lift in occupancy.

In both Orange County and San Diego, new deliveries fell off significantly in the back half of the year. This helped drive lease-over-lease growth of 2.3% and 2.5%, respectively, and renewals were second only to Seattle at 6% and 6.9%, respectively.

So all in all, we had a very strong quarter given the level of new deliveries across our markets. I'm extremely proud of our team's ability to achieve their renewal results in both rate and retention and know that all of our employees out there are the secret sauce that allows this to happen. So thank you all.

Mark?

Thank you, David, and good morning. I want to take a couple of minutes to talk today about our same-store expenses, our revised full year normalized FFO guidance and our capital markets activities.

Our same-store expenses were up 1.7% for the third quarter. This was driven by a relatively modest increase in payroll and utilities and an increase of 2.9% in property taxes. On the plus side, the third quarter property tax increase was considerably less than we had expected due to favorable results we obtained on several property tax appeals. Our annual property tax expense guidance included an estimate of appeals success based on the many years of experience of our in-house property tax team, but we had a few large appeals that were resolved sooner than we had anticipated in our guidance.

As we discussed on the July call, leasing and advertising expense growth has, as expected, turned negative for the quarter and year-to-date. Nearly nonexistent spending on resident gift cards, as David Santee mentioned, is driving the reduction.

Switching to the year-to-date numbers. Our same-store expenses are up 2.9% for the first 9 months of 2017. Again, increases in real estate taxes and on-site payroll continue to be the primary drivers of this growth. Same-store payroll expense was up 4.7% through the first 9 months of the year. As we have discussed on previous calls, we continue to be impacted in this category by 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 the support resident retention. These factors and higher estimate for certain employee medical insurance and workmen's comp claims had caused us to maintain our estimate that on-site payroll will grow about 6% for the full year.

We have revised our full year same-store property tax expense increased guidance to 3.4%, and that's down from our previous 4% to 4.5% growth expectation, all for the reasons I just mentioned. This improvement in our estimate of real estate tax expense growth, in turn, drove the reduction in our same-store expense growth guidance to 3.2%, which is slightly below the low end of our previous guidance range.

Moving on to normalized FFO. In our earnings release, we provided a full year same-store revenue increase guidance expectation of 2.2%. That's at the high end of our previous range driven by the factors that David Santee just discussed. This revenue number and our new expense growth guidance of 3.2% will lead to an increase in same-store NOI of 1.8%, which is slightly above the top end of our previous range.

For our annualized -- or excuse me, our annual normalized FFO guidance, we are picking up $0.02 per share from higher property NOI, with a contribution from both our better same-store performance and strong performance from our lease-up properties. We will see a $0.01 offset to this improvement due to slightly higher interest expense due to the size of our debt issuance as well as other items, including a slight increase in corporate overhead. Combining all of this, the result is a modest increase to our normalized FFO guidance midpoint to $3.12 per share from $3.11 per share.

Now going to the balance sheet. As we discussed in our earnings release, we issued $700 million of unsecured debt in August, and that consisted of $400 million of 10-year notes and $300 million of 30-year notes. Our July guidance included an assumption that we would issue about $500 million in 10-year notes this year. Recognizing the strength of the 30-year market, we decided to add a 30-year issuance while slightly pairing down the 10-year note issuance. And indeed, overall demand was exceptional for us. We were over 4x oversubscribed. Our 10-year was done at a coupon of 3.25% and an all-in rate of 3.32%, and the 30-year has a 4% coupon and all-in effective rate of 4.11%. The 30-year was our lowest cost 30-year issuance ever and one of the lowest 30-year unsecured bond coupons in the REIT industry history. We use the proceeds to pay down our outstanding commercial paper and revolver balance. We thank our many strong supporters in the fixed income community for this terrific result.

So all in all, better-than-expected revenue, expense and NOI results, a slight increase in our normalized FFO and a very good unsecured debt issuance.

I'll turn the call back over to David Neithercut.

All right. Thanks, Mark. Just a moment -- a quick comment on capital allocation. As we noted in last night's press release, our transaction activity picked up some in the third quarter with the acquisition of 3 assets. A stabilized 300 -- 301-unit property completed in 2016 in the Wilshire center submarket Los Angeles was acquired for $117 million at a cap rate of 4.5%. During the quarter, we also acquired 2 brand new assets that were both nearing completion of their initial lease-up: 1 in Boston, 160-unit property acquired for $116 million at a stabilized cap rate of 4.5%; we also acquired a 350-unit property in Bellevue, Washington for $178 million at a stabilized cap rate of 5.3%.

During the quarter, we disposed of 1 asset, 120-unit property at Encinitas, California built in 2002 for $53 million at a disposition yield of 4.3%, and we realized a 10.1% unleveraged IRR on that investment.

Now at the present time, we do not expect to acquire additional assets before the year is up. So as a result, the $468 million acquired through the end of the third quarter will most likely be our number for the full year, but that could change if the seller needs to complete a transaction by year-end, and we are incentivized to help make that happen.

We also continue to actively work on the disposition of a handful of assets that could close yet this year, so we have every expectation that we will get closer to the original guidance on dispositions of $500 million for the year.

On the development side, in the third quarter, we were very excited to essentially complete the construction on our new 398-unit high-rise tower in Seattle, just 2 blocks from Pike Place Market. Rents and absorption rates are well above our original pro forma, and we expect this asset to stabilize at a yield on cost of about 5.6%. You'll note that the budget for this development has been increased by about $11.5 million, and this represents changes in scope that have occurred since construction began in this asset in 2014.

As rents continued to increase across the Seattle market, we were compelled to increase the quality of the unit appliance packages and the overall finishes at the property, including the amenities in the common areas. We could not be more pleased with the job our team in Seattle did delivering in this asset, and the market reaction to it has been tremendous, thus far.

During the quarter, we also completed our 178th year development in Washington, D.C.'s Mt. Vernon Triangle submarket. This asset has also been very well received by the marketplace. Since occupancy began in June, we're already 69% occupied and 80% leased at rents that are very much in line with our original expectations. We expect to realize a stabilized yield on cost of this new development of 5.7%, and this was a job well done by our D.C. team.

During the third quarter, we started our first new development of the year, a small one, a 137 units in the Capitol Hill market in Seattle. This project has a $62 million development cost, and we project a high 5% stabilized yield on cost on this transaction. And it remains possible that we will start construction on one more development project before the year is out, also small, 84 units in Cambridge, Massachusetts. This is adjacent to an existing 186-unit asset we have in that market, and the construction budget on this deal would be about $50 million and a yield on cost currently projected in the mid-5s.

So before we open the call to Q&A, I just wanted to toot our horn 1 additional time on having been recently recognized by GRESB for the 4th consecutive year as a leader in environmental, social and governance performance. We take our responsibilities and our commitments on these matters quite seriously here, and everyone at Equity is honored that we are recognized as this year's Global Residential Listed Leader. My thanks to everyone at Equity for helping make that happen again this year.

So with that, James, we'll open the call to Q&A.

(Operator Instructions) And we'll take our first question today from Nick Yulico with UBS.

Wanted to start with the topic of supply. In your view, is this year, the peak supply impact for your markets overall? And then, I was hoping you could break down which cities you still are seeing supply ease versus get worse? I think in New York City, Seattle and San Francisco are couple of controversial markets that come to mind.

Okay. Nick, this is David. I'll just kind of give you higher, lower by market. Starting with Boston, 18 deliveries, slightly lower; New York, slightly higher, but -- or higher, but some of that is a push from '17 into '18; Washington, D.C., pretty much identical to '17; San Francisco, a little bit lower; Seattle, lower; Los Angeles, significantly higher, 8,000 up to 14,500; Orange County, about the same, 5,000; San Diego, just a little bit more at 3,500 units.

And just to be clear, Nick, this is the way that we look at the -- with our competitive set, those projects and these marketplaces that we look at that would compete with us. So this would not be a holistic amount across an entire marketplace, but only those that are within the sort of defined boundary that we look as competitive to us.

Okay. That's helpful. So I guess, David, putting all this together, look, it's been several years of slowing growth -- revenue growth in multi-family. You've gone to this year. You're seeing some stability in your markets. There are some supply pockets of pressure still next year. Hoping to just get any early thoughts you'd be willing to share on next year. And whether your same-store revenue growth could accelerate next year, and what would be a driver for that whether it's certain markets or not.

Well, I guess, I would say job with full employment, it's probably difficult to expect outsized job growth. And then when we go across the markets, we just look at where the supply is going to impact us. So as an example, Boston, 50% of the new deliveries will be in urban core, and 20% are going to be in Cambridge. But there's announcements of Facebook taking sizable office spaces in Cambridge, which I discussed previously, so even though there is elevated supply there, we expect it to be absorbed with minimal impact to rate. D.C. is really -- it's pretty much everywhere, but 45% of those deliveries are very concentrated in the Riverfront, D.C. Central and NoMa submarkets. So places like RBC Corridor where we have little -- where we have a lot of product, we'll see little deliveries. Kind of going on to New York, I mean, when you look at the deliveries or even the delayed deliveries, 57% of those numbers, both really this year and next year, are in Long Island City where we have no presence. And then Midtown West where we don't have a large presence, adding that and Jersey waterfront is 23%. So 70% -- 80% of the deliveries in New York are really not directly competing with our assets. So I mean, I can go on through the rest of the markets, but I think that's how we're kind of looking at next year and our ability to drive rates and retain our residents and drive good renewal rate growth.

Okay. That's helpful. I mean, so just a follow-up here. I mean, so is it -- when you look at everything, you look across your markets right now and everything you talked about, about supplies, is it just too early to get a read on 2018 showing better rent growth and revenue growth for your markets?

It's just too early. We're not prepared to give guidance at this juncture, Nick.

Next, we'll hear from Nick Joseph with Citi.

David, you talked about the acquisitions in the third quarter. But just more broadly, are you seeing more opportunities for acquisitions than you have over the past few years? And what do you think is driving that, if so?

Be careful with the use of the term opportunity, Nick. Are we seeing more product? No. I think the -- well, volume is, I guess, okay. It's still down from a year ago. I don't think we've seen the same amount of product that we have seen kind of in the past, and I wouldn't characterize any of it still as an opportunity. I think there's a lot of capital that's maybe backed away maybe from core product, but there's still enough out there that what is getting done is getting done at the same kind of cap rates and valuations that we've seen for some time. But I would not suggest that we've seen anything would represent as opportunities.

David, you had talked -- it's Michael Bilerman. It's probably going back 18 months that there was more merchant development or the potential for merchant development deals to start to crack, and that was going to serve potentially as an opportunity to you, put a lot of capital to work sort of within this time frame. Is that not coming to fruition at all?

No, I guess, I'm not sure. Our -- my comments, Michael, should have interpreted expecting something to crack, but more that they're just would be deals that one could acquire that have been recently built that might represent better sort of risk-adjusted opportunity to deploy capital rather than develop oneself, at least in the marketplace today. Now as I noted, of what we acquired in the third quarter, 2 of those were deals that have been recently completed that were in their final stages of lease-up. So we have executed a couple of those. I think we got decent going in yields, relative to what stabilized products might have traded for. So I wasn't -- I'm not sure we expected anything to sort of crack, but rather there might be a flow-up product. We've demonstrated by buying 2, and my guess is that there will be opportunities for us to look at more of that product come 2018.

And then just one more follow-up. In terms of the free cash flow for next year, I think we've talked about $275 million or so. Just curious what is the most attractive where we stand today for the use of that in terms of additional acquisitions, development, paying down debt, raising the dividend. Just your thoughts on that where we stand today.

Well, I guess, I'd say we will consider all of those, Nick. We had a Board Meeting in September, and Mark Parrell laid out that exact situation and the options we might have with that free cash flow now that our development spend is -- has decreased considerably over the past several years. So we'll consider when the time comes what we think is the best execution on behalf of our shareholders and won't be afraid to buy if it make sense, address the dividend if it makes sense or to think about development if it makes sense.

Next, we'll hear from Rich Hightower with Evercore.

I want to quickly follow up on Nick Yulico's question about New York. Just with respect to your outlook for submarkets supply next year, does your experience in 2016 where I think you sort of discovered that renters were submarket agnostic in many ways in New York, does that sort of tempered your view on what New York could be next year in terms of rent growth, despite the fact that you're fairly well protected from a submarket perspective currently?

Well, I think the biggest most obvious discussion for our portfolio would be Long Island City. And we just haven't seen -- our concern was would value hunters be willing to move out of the city into Long Island City for a better value, and we just really haven't seen that materialize. And then, when you look at a big portion of what's being delivered in Brooklyn is further east. Brooklyn is pretty much held up reasonably well for us. So we don't see a big chunk of these new deliveries next year really impacting us if the market continues to be disciplined the way it has this year.

Okay. That's helpful. And then back to third quarter results really quickly in Seattle. So pretty strong on the rent growth side, but there was a pretty significant delta between rent growth and then total revenue growth. Can you tell us what was going on in some of those other revenue categories during the third quarter in Seattle?

Hey, Rich, it's Mark Parrell. So just going over to the quarter-over-quarter numbers and giving you a little bit of background, average rental rate, physical occupancy and turnover are all numbers we compute solely with regards to the residential portfolio, which is 96-plus percent of our income. We do have, as you know, retail on the base of our buildings as tenant amenities, dry cleaners and the like. That number that we report, the revenue number for the quarter for Seattle, which was 4.9%, that number does include retail garage and anything else. So we had some retail vacancy in the third quarter in Seattle. We also had some stuff that was really a timing issue that'll correct itself in the fourth quarter. So if you would have looked at that number, 4.9%, it would have been a 6% number just on residential. But again, it's not anything particularly material, and a great deal of that will reverse itself in the fourth quarter.

We'll move on to Conor Wagner with Green Street Advisors.

David Santee, on the Bay Area, can you give us some color on the difference between the performance in Oakland, San Francisco and then San Jose?

Sure. So we don't have anything in Oakland...

The East -- I mean, the East Bay, in general.

Okay. So the downtown market continues to be under pressure. That is the least -- that is the bottom-performing submarket. The best performance is in the Peninsula. And then East Bay, South Bay, Berkeley kind of all in between but very similar.

Okay. And then -- and sorry, in South Bay, that's -- you're referring to San Jose there and Silicon Valley?

Yes.

Okay. And then on that transaction activity, David Neithercut, can you just remind me, the numbers you're quoting the cap rates, is that 1-year forward nominal? Or on the lease-up, what rent is that on? Is that on the assumption of stabilization?

The transactions that are stabilized, that would be our forward 12 acquisition. And on the lease-ups, it would be the second 12-month period of ownership.

And on that second 12-month, are you assuming some rent growth in that interim period? Or is that based on today's rents?

Well, depending on the marketplace. It would either be -- that could include some combination of burn off of perhaps what the development might have offered in concessions as well as some sort of rent growth. Yes, it would be some view as to what would be taking place on the rent side in that second 12-month period.

Our next question comes from Juan Sanabria with Bank of America.

I was just hoping you could talk to the concession environment for lease-ups across your major markets and whether you've seen any step-up in the amount of free rent or other forms of concessions into the fourth quarter to date.

Juan, this is David Santee. As far as concessions on lease-ups, I mean, it's been very stable and within expectations. Places like Seattle even our [Brannan] deal in Downtown San Francisco, we had very strong demand. So we didn't come out of the chute with the standard 1-month concession. And everywhere else, it's pretty consistent. I mean, there's no markets that are giving more than 1 month on lease-ups, at least for our portfolio. And we don't -- we haven't seen any change through the peak season.

Is it fair to say you aren't seeing the same panic that we saw in '16, at least to date, despite the peak supply at this point of '17?

No. No. Not even close, no. Very stable.

Okay. And then just on the new lease rent growth, could you give us a sense of the trend throughout the third quarter and kind of where you are fourth quarter to date for the portfolio as a whole?

Well, all I could give you today would be kind of a snapshot of our market rents, relative to our exposure. And today, across the portfolio, market rents versus kind of same week last year, are up about 2.5%, which bodes very well, considering we're in the -- entering the slower time of the year.

And did the trend on the new leases signed during the third quarter decelerate throughout the third quarter given seasonality?

Well, I guess that would be a-market-by-market discussion, but I gave you all of the Q3 lease-over-lease numbers in my prepared remarks.

Great. And one last quick one for me. Any reason for the -- we saw a couple of development delays in the expected delivery dates, any reason for that? It seemed to be more on the West Coast.

Well, there's several reasons. I can tell you that our property in San Francisco, our [Brandon] asset is just having some issues getting sufficient labor to close out the last 122-or-so units on that property. And then our property cascade in Seattle, we had some issues completing some of the exterior work because of some work that are being done across the street that was sort of closing down the -- some street or some sidewalks that caused delay. But very important to sort of note, with respect to these 2 deals: each of them have been pushed back maybe one a quarter, maybe one a couple of quarters. But that did not push back at all the date upon which those properties were first made available for lease. So I think it's a very important thing. We get asked a lot of questions about what's happening, what -- is your performance a result of properties being pushed back or completion being pushed back. And this is a perfect example of why we don't really pay a lot of attention to those being pushed back. These deals were pushed back, but did not affect when they open and available in the marketplace, and it will not affect the overall leasing velocity and overall performance of these assets despite that one being pushed back a quarter, and I think the other being pushed back a couple of quarters.

Dennis McGill with Zelman & Associates has our next question.

First one, just for the portfolio as a whole, do you have the new and the renewal rate increases in the third quarter? Sorry if I missed it.

The renewal for the portfolio was 4.7%, and the lease-over-lease was minus 90 basis points.

Okay. Great. And then just back to the supply conversation, when you noted the different increases across the markets or increases or decreases, you said it was on how you define the boundary as in what's competitive with you. Can you maybe just elaborate on how you do define those boundaries? Is it a distance from the property? Is it qualitative at the market level? Any thoughts there would be helpful.

Well, I think, so if you look at some of the data shops, they're using the statistical MSA, which, if you use New York as an example, goes all the way down to almost Philadelphia, far west into New Jersey, further up into outer New York, almost Connecticut. And our portfolio in New York is really Manhattan, a little bit on the Jersey waterfront and then a little bit in Brooklyn. So we just kind of draw a circle around all of that and focus on the deliveries within that boundary. This year or last year, we decided to include Long Island City, which really is a different price point, probably a different -- a little bit different demographic, knowing that, that new submarket could draw residents from the city. So I think we're very conservative in giving ourselves being intellectually honest with drawing these boundaries, plus we're going all the way down to kind of 5 level -- 5-unit communities. So we're including kind of everything, knowing that anything that's on the market for lease could impact demand in our footprint.

So the radius of that circle is defined at each level with the local teams? Or is there a uniform definition they use?

It is. Okay. Yes. Go ahead.

Okay. Yes, okay, so on New York, specifically, earlier you had said in New York that the supply in '18 would be slightly higher, I think, or higher versus '17. But then later, you said that about 80% of what's being delivered is not directly competing with your assets. So the increase encompassing some of those areas like Long Island City that you mentioned are not directly competing? Or is that slight increase versus '17 just in your competitive set?

Well, so the increase in New York for '18, some of that is a push -- going back to that delayed units, it's probably couple of thousand units that are being moved from 2017 into 2018. Now when you look at where all of these deliveries are, the largest concentration, and when I say, concentration, I mean, literally within a couple of blocks of each other, 57% of the number for '18 is 19,000 units. So 57% of those 19,000 units are predominantly in Long Island City and far East and North Brooklyn. Okay? So we have probably 4 smaller assets in Brooklyn. We have nothing in Long Island City, but we have incorporated that into our own customized competitive set, knowing that because of the value opportunity in Long Island City, that some folks could be willing to move from the city or Brooklyn to save on rent.

Okay. That makes sense. And then just last question. That 19,000 for the market as a whole, what's your estimate for '17 to compare against?

Well, we started out the year with, I think, a little above 15 and now we're down to 13-ish.

About 15. 15 for '17, and then 19 for '18.

And I just -- before the next question, I'll add one other little piece of information to you, Dennis, with respect to that lease-over-lease, the number that David gave you, 90 basis points, is our total lease-over-lease. 12-month lease expiring over a 12-month lease being written is half that amount. So it's about negative 40 basis points.

Next, we'll hear from Alexander Goldfarb with Sandler O'Neill.

Dave, just going back to the comments on the lack of opportunity from the merchant, you had to pick up deals from the merchant guys, is that -- do you think that's more just where your portfolio is in terms of timing of deliveries? And maybe those deals that you thought would crack this year are getting delayed until next year? Or is it something else going on? Because obviously from some of your peers, [Dave] said differently. So I'm trying to figure out if it's deals getting pushed that's causing the lack of opportunity versus literally in your markets, it's just you're not seeing it because of capital flows, et cetera.

I guess, just perhaps all of the above, Alex. And again, I'm not sure that I ever implied that there's going to be some tsunami wave of these deals coming, but if you all -- if any of these markets see them all going up and our expectations over some period of time, maybe some of them have been delayed because constructions have been delayed, some maybe want to get stabilized, maybe some have got some institutional capital that's willing to sit for several years. I mean, it's all of the above. But we certainly will expect to see some of those brought to market, [as I know, we brought] 2. So certainly, they -- some of them already are being brought to market. I'm sure we've underwritten scads more than just the 2 that we've acquired, and I'm sure that we will look at more yet this year and certainly into 2018. But I'm not so sure that there's any reason why there's fewer today that I may have led you to believe when we talked about this pool of potential investment of opportunities kind of on the horizon. They're -- we're looking at them. We bought a couple, and we'll certainly look at more. But I don't think there's been any change necessarily in the flow of that product.

Okay. And then, David Santee, when we look at Seattle, I mean, clearly, Amazon has been the 800 gorilla as far as job growth and expansion in all facets. But at the property level, are your teams seeing just predominantly Amazon employees or companies that are spawned because of Amazon? Or is the view that there is sufficient other tech growers and other companies that are going to Seattle that even if Amazon dials back, there's still sufficient demand? I'm just trying to get a sense from you guys from what you're hearing from your local teams, how much of an impact they think it's going to have.

Well, I mean, obviously, the closer you are to -- the closer a property is to South Lake Union, the more it's going to be influenced by Amazon. But -- I mean, we have a wide range of people living with -- that works for different employers, but again, I mean, we measure that every so often. But it's not necessarily concerning at any one community. But I guess that's all I could give you for now.

Okay. And then just final question. I just saw the news item on the litigation or the, I guess, class action, whatever, in California. Is there anything that you can provide some more color around this or perspective?

Well, I mean, 2014, a lawsuit was brought against us because of our late rate -- late payments and process and procedures. And I would just sort of tell you that things like this are sort of standard operating procedure for a company like us, and particularly in a place like California.

Next, we'll hear from John Kim with BMO Capital Markets.

In Seattle, David Santee, you referenced Amazon HQ2 and its impact on new leases. But I was wondering, was that announcement in combination with the approval of a new municipal income tax, if that's impacted your underwriting for Seattle investments going forward?

Well, we haven't -- we're not really underwriting anything new at this point in time, but I mean, we certainly -- there have been numerous city council initiatives, what have you, that involves fees and taxes. And we always update those items when we're underwriting either an acquisition or a new development.

Yes. David's comments about HQ2 weren't specifically citing that but just mentioning that we did see a little kind of wobble, if you will, of some of our pricing around that time. But as he also noted in his prepared remarks, the markets recovered, and it's now operating at the same levels that it had for most of the summer. But certainly, as we think about looking at Seattle, which represents maybe only 8% or 9% of our NOI, we take all of these things into consideration. The impact of gorillas like Amazon and Microsoft and issues with fees and regulations, all of those things will be part of the -- part of what we'll consider as we underwrite future cash flow streams of the assets we want to either build or acquire.

Okay. The next question maybe Amazon-related. But on the discussion of wage pressure, is -- can you just clarify, is this a direct result of new multi-family supply? And also, there was some commentary on additional staff needed to provide better service, and I was wondering if that was in relation to package delivery.

Hey, John, it's Mark. I mean, some of this is just the wage growth as we said because there are wage pressures in the field. But there also are, and we mentioned this on the prior earnings call as well, some adjustments there we're making that are very hard for us to predict. To workmen's comp and medical insurance reserves, we are self-insured. So as a result of that, when those items run through the numbers, they can impact on the margin a bit. So when you look at what's going on, and we talk about a 6% number for the year, a fair amount of that kind of part over 4% is probably driven by these workmen's comp and medical insurance reserve adjustments that we've made the last few quarters, and that we're making estimates of in the fourth quarter that could change a fair amount. I mean, we -- if we're wrong, that number could be a fair amount lower than 6% or a bit higher. I mean, it's just very hard for us to peg.

Mark, and any commentary on the additional staff needed?

Well, I think -- I mean, we targeted several of our larger buildings or buildings that were across the street from one another that we may have used 1 manager to run 2 or 3 buildings. And we felt that in this very competitive environment, we want to make sure that our residents were being serviced, that we had appropriate resources to administer our renewal programs, to ensure that sales were in tiptop shape. And when we discussed that at the beginning of the year, most of that was put in place. And we really haven't made any further adjustments since then. We don't see -- we have not really added staffing solely because of packages. We are more focused on 24/7 package rooms that we have been extremely focused on delivering to our employees this year. So I mean, when you look at the wage growth -- wage pressure with the retail slowdown, however you want to categorize what's going on with retail, office employees are not really that under pressure. It's more on the service side of the guys that know how to fix refrigerators and HVACs and what have you. So we feel good about the changes that we've made year-to-date, and for the most part, we're pretty stable right now.

Our next question comes from Drew Babin with Robert W. Baird.

Having heard anecdotally from a couple of your peers that the Bay Area has maybe benefited a little more than other markets from construction delays over a competitive supply this year. Just wanted to ask, a, is that accurate with what -- was that consistent with what you're seeing in the Bay Area? And b, what submarket can maybe benefiting the most from projects being pushed out in the next year?

Well, again, I mean, I know there was a large fire in the East Bay in a new development. That certainly would help the East Bay. David just discussed our experience at our [Brannan] property in downtown. But again, the fire certainly is taking something out of the mix and pushing it out another year or 2. But we have not seen anything that is categorized as delayed but has not begun to lease up. So the units coming to market are still coming to market as we expected when we began the year.

Yes. Again, just to reiterate what we said earlier, just because projects are being "delayed" from their final completion, does not mean their doors did not open for occupancy when originally expected. And certainly, they begin marketing those units 60, 90 days in advance. So just because something gets sort of "delayed", but when its completion gets pushed back does not mean it was not in the competitive set during the third quarter. Now it's possible, but it's just -- in our own experience, it's been on 2 deals that on this press release, we're notifying you for the first time, have been delayed. Their doors were opened as we expected, and first occupancies took place as we expected, and the delays did not impact any of that. So we'll just use that as an example of being careful about drawing too much out of the fact that things have -- completions have been pushed back.

That's helpful. And also, to the some merchant builders this year, there's been a lot more discipline in the market, obviously, with concessions and things like that with your competitive set. How much of that would you attribute to kind of -- earlier this year, maybe interest rate expectations being rained in a little bit, has anything changed? Or do you expect anything to change should the 10-year treasury creep up over the next couple of quarters? For short-term interest rate, I should say.

I guess, I'm not sure I understand about -- maybe you could rephrase that for me, Drew.

Sure. The question is really on the correlation between kind of the urgency of merchant builders to lease up their properties and interest -- short-term interest rates. So if their interest costs are going up...

Okay. I got it. So with respect to the urgency, I think what we saw a year ago, primarily in San Francisco, was people could cut rents from the marketplace and still exceed their original expectations above the rental levels. That's not the case now. I think that people that rent today are in the ballpark of what people underwrote, and they have to preserve trying at those levels. And so they have to be disciplined with respect to achieving those, and I think that may very well explain what we're seeing this year relative to what we saw in San Francisco a year ago. So it's less the financing market and more just where rents are today relative to their original pro formas.

Vincent Chao with Deutsche Bank has our next question.

I know this is probably more of a regional impact, but just curious, given that there's been labor shortage there already, some of the natural disasters we saw this fall, I was just curious if there's any noticeable change in that dynamic post some of the hurricanes.

We've had labor challenges, particularly on the construction site across all of our markets, and those continue. As I noted, our property in San Francisco, our [Brandon] property has been -- the last 127-odd units have been delayed because of just challenges getting people on site. I have not heard anyone attribute any marginal worsening of that problem because resources have been deployed in Texas or Florida. So I can't tell you that's the case, but we continue to just see labor shortages, and our contractors, our tradesmen are all kind of continuing to sing the blues in that regard. But I haven't heard anyone suggest that that's gotten worse because of the hurricanes.

Okay. And then just maybe some guidance for the same-store revenue. I mean, it does seem like there's an implied modest deceleration in the fourth quarter. Is that really just a reflection of timing of some of the supply that had already expected some are getting pushed out maybe into the fourth quarter from the third?

Hey, Vin, it's Mark Parrell. The -- no. Just the math here means that in the fourth quarter, our quarter-over-quarter number could be anywhere from 1.9% to 2.3% and still math out to the 2.2% number that we put out to you. And really, it's very small changes in occupancy. And as we said a moment ago, we're really not buyers in the thesis that there are delays that are meaningful in deliveries that are impacting our numbers. So there is a margin of error in these numbers, but we would generally expect the number in the fourth quarter that we report quarter-over-quarter to be reasonably consistent with third quarter number quarter-over-quarter that we just reported.

The next question comes from Richard Hill with Morgan Stanley.

Just a quick question on the tax appeals. I wanted to make sure, was that related to the L.A. market? And can we attribute that to the sharp declines in expenses that we saw this quarter?

There's 2 -- 2 markets were impacted by the appeals in the same-store set, New York and L.A.

Understood. And are there any other markets where you have ongoing appeals right now?

We have ongoing appeals in every market. We underwrite and try and guess, and it's really a very good educated guess as to how many of those appeals wind up getting recognized as income received or reduction of our taxes. But it's an estimate, and sometimes things happen a little faster, a little slower than we expected.

Got it. And then on your FFO guide increase, you noted that it was a combination of tax appeals and NOIs. Do you have a breakdown? Or can you provide any guidance of how we should be thinking about the benefit of tax appeal versus the NOI growth?

I think you can think about the tax appeal as worth, give or take, $2 million. And then the rest of it is a combination of revenue being better than we thought. In the same-store set and nonsame-store, predominantly, lease-up income being better than we thought.

Next, we'll hear from Tayo Okusanya with Jefferies.

Following up on Rich's question, how do we start -- I know, again, that you're not giving a lot of insight into '18 yet, but from an operating expense perspective, how do we kind of start thinking about kind of same-store OpEx growth kind of on an a regular run rate basis? Do you still kind of see an opportunity to kind of keep driving things down? Or this quarter was clearly unusual, and you expect a higher run rate going forward for same-store OpEx growth?

So this is David Santee. I think we've kind of talked previously that real estate taxes are a big driver. It's 40% of our total operating expense. And one of the key inputs to that are the increases or the step-ups in our 421-a program in New York, which will add probably, call it, 150 basis points to normalize real estate tax growth up through 2020. So for the past several quarters or year, we've talked about real estate tax growth of 4% to 5% up through 2020. And then everything else is -- payroll was obviously our second biggest expense group. Wage pressures this year, we probably would expect a little bleed into next year. And then utilities, we are trying to -- we're making investments into LED lighting, a lot of energy conservation. At the same time, we kind of try to lock in future natural gas prices at significant discounts year-over-year. So all in all, I mean, I think expenses going forward, we've kind of always said, 3-handle.

Got you. Okay, that's helpful. And I know this is not part of your normalized FFO per share number, but could you talk about the legal settlements during the quarter what that was about?

Sure. That was a construction defect lawsuit that our lawyers were able to resolve in a favorable way for us. So we received the money. And then, you can't capitalize it. It has to go through an income account, and so we do exclude it from normalized FFO even though it's a benefit.

Wes Golladay with RBC Capital Markets has our next question.

Did you guys give us the new rent growth for October yet?

No we did not. We do not have that number.

Okay. And then looking at the Seattle market, you mentioned the supply would be down next year. In particular, I see, looking at [close chart data], the CBD would be rising next year. Do you agree with that? And how do you view your trade area? Do you lump it together with Queen Anne, Lake Union? Or just give more color on how you see supply going down.

So almost all of the deliveries in '18 are going to be in downtown CBD. So that is -- compared to this year, it's a pretty meaningful reduction relative to what was delivered this year in North Seattle. Right here, yes, I mean, the bulk of it is really CBD.

And we do consider all those areas within our competitive sort of trade areas. So going back to the conversation about sort of the boundaries, Belltown, Queen Anne, downtown, South Lake Union, Capitol Hill, Bellevue, Redmond, I mean, those are all considered part of that trade area.

Okay. And...

(inaudible) Go ahead.

No, go ahead. You can go finish. Sorry about that.

No, no. It's just I should of sort of said 'trade area'. I just want to make it clear. Of that area that we consider new product being built to compete with us, so that would -- those -- all those markets would be included in that area.

Okay. And then, I was going to say that you guys walk all those areas, those sites, right? I believe you mentioned that on the last call?

Our local teams?

Yes.

Oh, yes. They do certainly. They're tracking all those things. They know -- I mean, we've got platforms. You can go online and see every potential site, who owns it, what's being contemplated to build, when our team is expected to start, when our team is expected to be not just completed but available for occupancy. And they track all that information, absolutely.

That will conclude the question-and-answer session. I will now turn the conference over to Mr. Neithercut for any additional or closing comments.

Thank you, everybody. We'll see a lot of you in Dallas next month. Thanks for your time this morning.

That does conclude today's conference call. Thank you for your participation. You may now disconnect.