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Edited Transcript of ACC earnings conference call or presentation 25-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 American Campus Communities Inc Earnings Call

AUSTIN May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of American Campus Communities Inc earnings conference call or presentation Tuesday, April 25, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Daniel B. Perry

American Campus Communities, Inc. - CFO, EVP, Secretary and Treasurer

* James C. Hopke

American Campus Communities, Inc. - President

* Ryan Dennison

American Campus Communities, Inc. - SVP of Capital Markets and IR

* William C. Bayless

American Campus Communities, Inc. - CEO and Executive Director

* William W. Talbot

American Campus Communities, Inc. - CIO and EVP

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Conference Call Participants

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* Alexander David Goldfarb

Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research and Senior REIT Analyst

* Austin Todd Wurschmidt

KeyBanc Capital Markets Inc., Research Division - VP

* David Steven Corak

FBR Capital Markets & Co., Research Division - VP and Research Analyst

* Jeffrey Robert Pehl

Goldman Sachs Group Inc., Research Division - Research Analyst

* Juan Carlos Sanabria

BofA Merrill Lynch, Research Division - VP

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - VP and Senior Analyst

* Ryan Cole Burke

Green Street Advisors, LLC, Research Division - Analyst

* Ryan Meliker

Canaccord Genuity Limited, Research Division - MD and Senior REIT Analyst

* Thomas James Lesnick

Capital One Securities, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the American Campus Communities First Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note this event is being recorded. I would now like to turn the conference over to Ryan Dennison, Senior Vice President of Corporate Finance and Investor Relations. Please go ahead.

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Ryan Dennison, American Campus Communities, Inc. - SVP of Capital Markets and IR [2]

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Good morning, and thank you for joining the American Campus Communities 2017 First Quarter Conference Call. The press release was furnished on Form 8-K to provide access to the widest possible audience. In the release, the company has reconciled the non-GAAP financial measures to those directly comparable GAAP measures in accordance with the Reg G requirements. If you do not have a copy of the release, it's available on the company's website at americancampus.com in the Investor Relations section under press releases.

Also posted on the company website in the Investor Relations section, you will find the supplemental financial package. We're hosting a live webcast for today's call, which you can access on the website with the replay available for 1 month. Our supplemental analyst package and our webcast presentation are one and the same. Webcast slides may be advanced by you to facilitate following along.

Management will be making forward-looking statements today as referenced in the disclosure in the press release the supplemental financial package and in SEC filings. Management would like to inform you that certain statements made during this conference call, which are not historical fact may be deemed forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. Although the company believes the expectations reflected in any forward-looking statements are based on reasonable assumptions, they are subject to economic risks and uncertainties. The company can provide no assurance that its expectations will be achieved and actual results may vary. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time in the company's periodic filings with the SEC. The company undertakes no obligation to advise or update any forward-looking statements to reflect events or circumstances after the date of this release.

Having said that, I would now like to introduce the members of senior management joining us for today's call. Bill Bayless, Chief Executive Officer; Jim Hopke, President; William Talbot, Chief Investment Officer; Daniel Perry, Chief Financial Officer; Jennifer Beese, Chief Operating Officer; and Kim Voss, Chief Accounting Officer. With that, I'll turn the call over to Bill for his opening remarks. Bill?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [3]

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Thank you, Ryan. Good morning, and thank you all for joining us as we discuss our first quarter 2017 financial and operating results. As you read in the release last night and we'll hear further details on the call today, we had a productive quarter related to our external growth initiatives with 5 new on-campus Public-Private Partnership awards, along with the acquisition of a core pedestrian property in an existing market. We're also pleased with the continued solid operational performance and internal net asset value creation having achieved a 55% margin on a trailing 12-month basis for our total portfolio along with strong preleasing velocity to date for our same-store portfolio with regard to the upcoming 2017, 2018 academic year.

With that, I'll turn it over to Jim Hopke to discuss our first quarter operational results in detail along with our areas of focus moving into Q2 and Q3.

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James C. Hopke, American Campus Communities, Inc. - President [4]

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Thanks, Bill. Our 2017 operating results were in line with our internal expectations. First quarter same-store property NOI increased by 3.3% over Q1 of 2016 on a 3.3% increase in revenue and an increase in operating expenses of 3.4%.

Also notable and highlighted on the seasonality page of the supplemental is that our operating margin eclipsed 55% for our total portfolio for the trailing 12 months ended March 31. The 3.4% year-over-year growth in same-store operating expenses was slightly better than our expectations for the first quarter as expense growth in our payroll, utilities, G&A, property taxes and insurance categories were all slightly better than or in line with our expectations.

While our property tax results for Q1 were in line, in the past few weeks, we received the initial 2017 assessments for our Austin properties, which were 24% above the final 2016 assessments. Taxes for our Austin properties represent approximately 15% of our total property tax expense, and we're working with our consultants to minimize these increases through appeal. It is early in the year, and we've not adjusted our annual tax forecast as we evaluate the ability to additionally offset these increases through savings and other markets.

In our repairs and maintenance category, expense growth was more than expected due to funding of repair costs for weather-related events up to our insurance deductibles at several properties and nonroutine work at 3 properties, which will be taken offline at various times later in the year to perform comprehensive repairs, and in one case, reconstruction of 41 beds destroyed by fire.

Loss revenue from taking these properties offline will put pressure on same-store revenues in Q2 and Q3. We are closely monitoring our vacancy backfill initiatives for spring semester leases, which have the ability to further pressure same-store rental revenue growth.

Turning to leasing. As of Friday, April 21, our 2018 same-store wholly owned portfolio is 78.7% leased, 10 basis points ahead of the 2016, 2017 lease-up. We are still projecting an overall rental rate increase of 2.9% for the 2018 same-store portfolio. Our new store properties are 55.3% preleased for academic year '17, '18. As we mentioned on our last call, our guidance assumes new store occupancy of 88% as we expect certain of our development projects will take 2 years to stabilize.

With that, I will turn the call over to William to discuss our investment activity.

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William W. Talbot, American Campus Communities, Inc. - CIO and EVP [5]

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Thanks, Jim. We are pleased to announced strong external growth this quarter with 5 new on-campus awards, including 2 new on-campus ACE projects and 3 third-party awards.

Turning first to the ACE awards. We executed an 80-year ground lease and commenced construction for a residential Honors College on the campus of Northern Arizona University in Flagstaff. This is our fifth ACE development on the campus of NAU and is targeted for delivery in 2018. Our fall 2018 owned developments and presales are now all under construction and total 7 projects encompassing 5,486 beds and $433 million in cost.

In addition, we have entered into a predevelopment agreement with the University of Arizona for a 1,000-bed residential honors college under our ACE structure. The transaction remains subject to final lease negotiations, feasibility and scope and is targeted for a fall 2019 delivery. With the 2 new ACE projects, our owned development and presale pipeline for 2017 through 2019 now totals 19 projects of 14,700 beds and represents an excess of $1.28 billion of development cost, consisting entirely of core Class A communities located either on-campus or pedestrian to Tier 1 universities. We are targeting between 6.5% and 7% stabilized nominal yield for lease developments.

We also announced 3 new third-party developments during the quarter. First, we executed a predevelopment agreement with the University of California at Irvine for 1,441 beds student housing development. This is our fourth development on the campus of the University of California at Irvine and our fifth with the University of California System. The development is expected to start construction in late 2017 for a fall 2019 delivery. We're also selected to develop a 525-bed project on the campus of the University of Illinois, Chicago after a competitive RFP process. The project is targeted for a fall 2019 delivery with start of construction expected to begin in late 2017 or early 2018.

Lastly, in conjunction with our ACE project at the University of Arizona, ACC will also provide third-party development services for an adjacent office building and student recreation center to be funded by the University. These 3 third-party awards and associated fees that will be earned over the development period are subject to final scope, feasibility and negotiations. These awards are an integral component of our guidance range of third-party fees of $6.2 million to $9.6 million. The P3 pipeline remains vibrant as colleges and universities look to modernize their Student Housing stock without impacting their balance sheet and debt capacity as evidenced by our 5 newly awarded projects this quarter.

Turning now to acquisitions. In April, we acquired the Arlie, a 598-bed core student housing community located adjacent to our Campus Edge property in a pedestrian location to the University of Texas at Arlington. The asset is currently 96% occupied in its first year of operation. After $1.7 million of upfront capital improvements and enhancements, the core pedestrian acquisition represents a 5.5% nominal and 5.3% economic cap rate on year 1 pro forma and offers the potential for 25 to 50 basis points of additional yield through multi-asset efficiencies of Campus Edge. We continue to evaluate core pedestrian acquisitions that can offer attractive returns through management upside, operating performance or existing market efficiencies.

Lastly, we are currently under contract on the sale of the province serving Wright State University in Dayton, Ohio for $25 million. The asset is 8 years old. And although located adjacent to University land, it is over 1.5-mile drive to the academic core. The buyer has waived their financial contingency and is expected to close in the next few weeks. The sale will represent a 6.1% economic cap on in-place revenue, escalated T12 operating expenses and historical capital expenditures.

With that, I'll now turn it over to Daniel to discuss our financial results.

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Daniel B. Perry, American Campus Communities, Inc. - CFO, EVP, Secretary and Treasurer [6]

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Thanks William. FFOM results met our internal expectations for the first quarter of 2017 as we reported total FFOM of $83.2 million or $0.62 per fully diluted share.

While FFOM per share was equal to the prior year quarter, total FFOM for the quarter increased $5 million or 6.4% even with the loss of $11.5 million of NOI from the 21 properties sold during 2016. The growth in total FFOM dollars was driven by $3.2 million or 3.3% increase in same-store NOI, the production of $5.4 million of NOI from developments and acquisitions completed throughout 2016, as well as a $7.9 million reduction in interest expense resulting from the equity and disposition capital raised last year.

It's important to remember that the company has raised over $2.1 billion in equity and disposition capital in the last 2 years to fund a very vibrant development pipeline that would currently total $1.8 billion in deliveries between 2015 and 2019 and is still continuing to grow. While the timing lag between capital being raised and development deliveries producing NOI has slowed the growth of our earnings per share over the last 2 years, it has created significant NAV for our shareholders and will ultimately translate into an attractive and sustainable earnings per share growth on a stronger asset base and a balance sheet positioned for continued external growth.

Moving to capital structure. As of March 31, 2017, the company's debt-to-enterprise value was 25.4%. Debt-to-total asset value was 31.7%, and the net debt to run rate EBITDA was 5.6x. As disclosed in the capital allocation and long-term funding plan on Page 15 of the supplemental, these future ratios are anticipated to range within our targeted levels of 30% to 35% debt-to-total asset value in the low 5x area for net debt to run rate EBITDA. In terms of capital activities since our last call, we raised approximately $30 million under our ATM program at an average issue price of $48 per share, match funding over 65% of the Arlie acquisition.

Remaining debt maturities for the next 3 years are $189 million or only 8.6% of total outstanding indebtedness. Our floating rate debt did increase slightly this quarter to 15.3% as the interest rate swap on our $150 million term loan expired. However, we intend to manage our floating rate debt exposure with the bond offering currently planned for the fourth quarter in our guidance.

With regards to our 2017 guidance, for the balance of the year, the most significant factors that will impact where we will end up within our FFOM guidance range are as follows: For property NOI, we've previously communicated total owned NOI of $405 to $412 million. Our ability to meet our NOI expectations is dependent on our success with backfilling any vacancies that occur in the remainder of the spring or summer months and the success of our fall 2017 lease-up. Management feels positive about the current preleasing status. But as we discussed, we are closely monitoring the leasing progress of a few -- of our upcoming fall development deliveries. Of course, the NOI produced for the year is always dependent on achieving our budgeted expense growth, including more controllable operating expenses, such as payroll, marketing and repairs and maintenance, as well as more noncontrollable operating expense items, such as property taxes and utilities.

In third-party services revenues, the fee range included in guidance for 2017 is primarily dependent upon successfully structuring and closing the 3 third-party development awards during the year that William discussed. Recognizing the fees associated with these awarded projects would put us at the midpoint of our third-party development revenue guidance with the potential to achieve the high-end through additional closings of awarded or to-be awarded transactions during the year.

In summary, we are maintaining our previously stated FFOM guidance range of $2.32 to $2.42 for fully diluted share. And we'll update you on future calls if we need to make any adjustments to this guidance range.

With that, I'll turn it back to Bill.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [7]

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Thank you, Daniel. In closing, as many of you know, the next 120 days is the most critical period in our annual operating cycle. As Jim noted, we're currently focused on backfilling vacancies for the spring and summer periods, as well as the successful completion of the 2017, '18 academic year lease-up for our same-store and new store portfolios. As always, I'd like to thank the American Campus team for their hard work and dedication and ask the team to stay focused on execution in the coming months.

With that, we'll open it up for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question will come from Nick Joseph of Citigroup.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - VP and Senior Analyst [2]

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I was just wondering if you can give more color on preleasing. In terms of the leases plus applications, you're slightly trailing last year. And that's why it contracted from the update you provided earlier in April. So just any additional color on that would be appreciated.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [3]

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Sure. Nicholas, let's go ahead and drill down into the overall velocity of the portfolio. And we'd love to take this opportunity because so often, we talk about where are we at the moment in time from the velocity perspective and what does that tell. And what we always talk about is what the goal is at the end of the day is to maximize the combination of rental rate and occupancy to get the greatest revenue. So when you look at the 65 markets that we're in, in 28 of the markets we are actually ahead of where we were in last year's velocity. And the other thing we look at is looking at any impacts on new supply in markets coming in. When you look at the 28 markets that we're in, in 12 of those markets we actually have new supply coming. And in those markets, we are averaging 4.5% rental rate growth and about 600 basis points ahead in velocity. And so it is actually the highest category that we have. There's been 16 markets where there isn't new supply coming in where we're ahead. And a lot of these properties just happen to be -- those that are in the category of below 95%. And in that arena, right now, we're at about 2.2% rental rate growth, but we're running 1,200 bps ahead demonstrating there the big focus is on increasing that occupancy. When you then look at the, in the 37 markets where we're currently trailing behind, in 19 of those markets, we are strategically slowing velocity. This is why we always try to caution the market on, don't read too much in the velocity. And in 37 of the markets that we're currently behind, 19 of those markets we are averaging over 4% rental rate increase and a slow velocity, 500 to 600 bps. Places we filled early where we feel very comfortable in terms of doing that. And then there's 18 markets that we are currently trailing behind in, where we're very strategically manipulating rates and spending marketing dollars to maximize the revenue in that. And so we really look at it on a very, very myopic basis property by property that rolls into those categories. So overall, we feel very good about where the lease-up is. It relates to the same-store properties and balancing that combination of rental rate and occupancy. And so I hope that level of detail gives you a little insight on to what you were asking.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - VP and Senior Analyst [4]

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Thanks. But just in terms of guidance, you have a 220 basis points range for occupancies for, I guess, the final lease-up. And the midpoint actually assumes about a 16 basis point increase over what you achieved last year. Clearly, you're still within the range. But do you still think the midpoint is achievable recognizing that preleasing update is just a snapshot in time?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [5]

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No, absolutely. And at the end of the day, I think -- Daniel, the implied rental rate at the midpoint is 2.8% or 2.9%?

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Daniel B. Perry, American Campus Communities, Inc. - CFO, EVP, Secretary and Treasurer [6]

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2.9%

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [7]

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And so we're still trailing down. And certainly from an occupancy perspective, we think we're right on track given the data that we just went through. Of course, as I mentioned in my comments, there's a theme. This is the most important 120 days in terms of filling every bed till the end of the season and focusing on it all the way through the process.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - VP and Senior Analyst [8]

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Thanks. But just, William, maybe in terms of cap rates, it seemed that in our Interface Conference earlier this month, there's a debate if cap rates have moved and if they've moved on core or more drive properties. Just wondering if you could give any color in terms of what you're seeing in terms of cap rates in the market today.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [9]

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Yes, sure, Nick. I mean we were constantly talking to the brokerage community and tracking cap rates. We've talked to [Seaberry]. We've talked to HFF. They've seen stability in the cap rate, certainly on the core pedestrian. We're still seeing it at that low 5s to sub-5%, have not seen a real expansion there. As you look, we're selling an asset that we just announced cap rate at the low 6s for a value-add asset, very consistent with what we've seen as well. So we are not seeing dramatic movements on cap rate.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - VP and Senior Analyst [10]

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Thanks. And just finally in terms of the deliveries for this academic year, are all of them still on time? Is there any risk of missing the deadline?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [11]

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No. We're in good shape from a delivery perspective. Although we will say -- we mentioned this a little bit on the last call. We are seeing a national trending in terms of end markets where in prior years, developers have missed openings. There's some apprehension in students as they look at properties under construction even when you're going to make it. We mentioned on the last call that at the midpoint of our guidance, Lubbock and Waco, we expected to be at 70%. And in the case of Waco, it is a direct correlation to the marketplace having apprehension regarding prior year misses. And so the other thing also that's kind of a dynamic change that we are keeping in mind as we look at all new development going forward and how we approach the marketing and the messaging. A lot of the development that is now taking place today is more the urban infill. We've always done that. But now you see that our competitors moving toward that. And unlike when 5, 10 years ago, when people were building 2, 3 miles from campus and you had more of a multifamily club house and the residential buildings rolling on, where front buildings all look 5 months ahead of where the buildings are in the back, and it alleviated the perception. When you're building more of the urban infill in the way those buildings come together and construction methodology being all 1 building and 1 configuration, it's harder for a drive-by student and parent to understand what is the level of construction completion. And so, for example, in Clemson, there was some concern over another property in the market not getting done, we actually -- where we have no fear, we started marketing a construction completion guarantee to just overcome students' misperceptions of that. So that's something we're looking at on a longer-term basis in terms of a potential change in how we have to message marketing relating to that. So we are not in jeopardy with something we are paying attention from that messaging perspective.

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Operator [12]

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The next question will come from David Corak of FBR.

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David Steven Corak, FBR Capital Markets & Co., Research Division - VP and Research Analyst [13]

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Could you just give us some color on the overall P3 environment? What you're seeing out there in terms of deal flow for '19 and maybe how that stacks up against what you guys saw for '17 and '18? And then maybe just an update on the California System if there is one?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [14]

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Yes, and David, as we -- Jamie on the last call gave an update. And at that moment of time, we had 40 active transactions we were tracking either through RFP, [ RRP ] development or direct conversation and negotiation. So we commented then you left the highest number we had ever seen at any point in time. And so I would say the general environment certainly is colleges and universities looking more and more to P3 structures, whether it's equity, whether it's third-party project-based financing or in some cases maybe even GEO for the efficiencies that the private sector brings. But it is becoming more and more the established mainstream delivery vehicle. And so we see that only the positive in all fronts of our on-campus P3 initiative, both for equity investments and for third party. Certainly, you saw that evidence in the release last night with 5 new announcements: 2 ACE deals, 3 third-party. As a relation to the University of California System, what we talked about there. UC Irvine, as we announced on this call, which is really where the P3 structure was pioneered within the University of California System. We're pleased there to be starting our fourth transaction. Those are very large projects. The remaining system projects that are coming out, they have prequalified. As we talked about earlier, 8 companies to partake in that process. We do have an inclination, although -- certainly don't want to say this as a definitive. The University of California System -- our work at Irvine -- has been more predisposed toward the third party project-based financing structure. And that's one that they know, It's been proven at UC Irvine, very successful. And so I think there maybe a predisposition that more of those transactions will be third party in the UC System than ACE, not that, that's the case certainly at Cal Berkeley. And what we've done there under the ACE structure, that may play into the thinking of some of the universities as they look at what's best for them. But certainly, what's happening there is just a little bit of a microcosm of what's really happening on a much broader scale nationally.

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David Steven Corak, FBR Capital Markets & Co., Research Division - VP and Research Analyst [15]

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Okay. That's helpful. And then switching the page a little bit here. You touched on this a bit in your prepared remarks, but can you just talk about your kind of summer leasing initiatives and the May ending leases if you're planning on doing anything differently this year? And then maybe kind of help us try to quantify the impact of that could have on NOI?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [16]

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Yes, and Jim mentioned this in his prepared remarks. On the last call, Daniel mentioned that we don't have the material increase in the percentage of on-campus leases in the portfolio. This year was right at about 2%, where I think last year, it was about 1.2%, 1.3%. then.

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James C. Hopke, American Campus Communities, Inc. - President [17]

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That's May ending leases.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [18]

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Yes, I'm sorry, that's May ending leases. And in that regard, that's about 500 to 600 more. So it's a little bit of an increase in the number we're focused on. We also look at where those May ending leases are. The top properties for the number of May-ending leases are at the 4 to 5 properties that we have continued target for sale in the portfolio. Some of the Tier 2 markets, the [ Valdoss ], the states, the Wright State universities, some of those that are probably long-term exit plans forced in that regard. The other thing that we're looking at within those May ending, this is a little unique in that our Drexel properties in Philadelphia, Drexel had a very large coop program where every quarter students go out for an internship and come back up. We now have 3,100 beds at Drexel and are now the majority of their on-campus housing. And so we're actually are working more in meeting the markets' needs in terms of the roll-off of those coops and releasing students from liability on those leases. That when you're an off-campus property or even a one-off property, you don't have to do, you can force the market to administer that and people to replace themselves. This is where we love ACE properties and all the benefits and stability of cash flows. Some of the things that we see in those ACE properties when you have 3,000 to 4,000 beds on-campus, you have to be more of a student friendly lease administration policy, more mirroring how the University handles that. And so at Drexel, we were backfilling those leases, but it's more open market backfilling with new leasing terms. So a little bit more of a challenge this year than in years' past that we're focused on and administrating that.

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Operator [19]

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And the next question will come from Alexander Goldfarb of Sandler O'Neill.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research and Senior REIT Analyst [20]

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Just 2 questions here. First on the development spill, you guys -- you talked about Waco. You talked about Lubbock. At the recent Interface Industry Conference, a number of the private developers spoke about just delays in getting projects open in time and how the private developers are holding deals longer before flipping them or some of them end up keeping them for their own account. So given your comments around the complexity and the appearance of delivering infill all-in-one apartment buildings versus a more suburban approach, was this something that we should more expect? And that going forward, we're going to see more sort of 2-year stabilizations of developments instead of the traditional, it stabilizes when it's delivered.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [21]

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Alex, I do think on a global and macro basis within the industry, yes, you are going to see that. We certainly always attempt to focus on the early stabilization possible. Some of the things that we've talked about based on what you did hear at Interface and some of the more national and again, what causes all this is developers knew the sectors that don't understand. You have to really get it done. And opening 2 to 3 months late in causing havoc for students and parents and being in hotels, it causes a market to be somewhat speculative of what comes in. Again, it doesn't affect long-term stabilization once you're up and running. All those properties that folks have missed that are good assets and good locations, have fully stabilized typically through their performance. Some of the things that we have talked about internally, one I mentioned is marketing a construction guarantee where you know you're not going to miss the open, do a financial incentive. If we do miss, we'll give you this and make it a big monetary number that you know don't have to pay. The other things that we talked about doing internally are actually targeting May openings instead of August openings. And that one, you'd be starting construction 3 months earlier. And therefore, you have more visibility of the type of structures coming to the market and eliminate any concern. And you also have a little potential about carrying summer occupancy with students moving out of the residence halls. So we're looking at things strategically on the long-term to always attempt to stabilize our assets in the first year. But we do think, yes, what you heard at interface, there has been more of a national trend at some properties or some developers are having more of a year 2 stabilization. So it doesn't impact certainly there is a little bit of a drag on first year yield. But it doesn't really impact long-term IRR yield requirements as it relates to what we're looking at from an investment thesis.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research and Senior REIT Analyst [22]

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And where those comments came from was from some of the dedicated student housing developers, who it didn't seem to be development delays as far as opening. It seemed to be more just dealing with whether it's competitive supply. But it seemed to be -- that it's just taking actually longer for the asset to stabilize versus construction delays.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [23]

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You know net year 2 stabilization though I would say is related to the others that have missed their openings of what creates the apprehension until the second year that allows it to fully stabilize in year 2.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research and Senior REIT Analyst [24]

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And then just coming back Jim, can you just go back through the NOI stuff that you spoke about earlier. I just want to get a sense that this is something new or this is something that you guys are just repeating fourth quarter earnings seems a while ago. But you mentioned some fires or things that are impacting NOI in the second and third quarter. So I just want to make sure that this is something that was already there versus this is new?

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James C. Hopke, American Campus Communities, Inc. - President [25]

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No Alex, some of it is new. And that there's 3 properties that Jim has mentioned that we're going to be taking out of service for occupancy during some of the summer months to do some repairs. One was a fire that occurred during the first quarter at The Province in Tampa. And so we lost 41 beds to a fire. Thank God, most importantly, no one was hurt. It was actually an international student smoking on the balcony where they should not have been smoking. And in that regard, we lost 41 beds. Ultimately, we have business interruption insurance, but we're not allowed to recognize that for GAAP as rental revenue. So that will certainly be a diminishment. We have 2 other properties, one is Barrett Honors College. We're going to be undertaking some plumbing repairs that are necessary. That's a normal residential vacancy period. But Barrett does do $300,000 to $400,000 in summer business in Camp Conference that we'll be foregoing in that. And that was a decision that we made post guidance as to when we're going to initiate those repairs. We've got one other property at the University of Illinois in Champaign where we have some roof and facade issues. It is one of our 2012 acquisitions. The amenities are on the roof. And we're going to have to go in and redo that roof and some water proofing on the facade. And we're going and we have structured the leases in the summer so that we can perform that work. So that will cause a little bit of pressure that was unforeseen that Jim wanted to telegraph there that we're focused on.

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Operator [26]

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And our next question will come from Ryan Meliker of Canaccord Genuity.

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Ryan Meliker, Canaccord Genuity Limited, Research Division - MD and Senior REIT Analyst [27]

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I just had a, kind of a big picture question tied to the ACE deals and owned campus Public-Private Partnerships. And that was, as I'm sure you're aware a few weeks ago, EdR announced that their University of Kentucky assets were going to be leasing up at a lower level this year then passed on the issue of getting upper classmen to live on the campus. I'm wondering if across your portfolio, as you think about ACE deals. And obviously, this is -- you know, you've got a bunch of different deals at University of Arizona now, along with other deals, several deals at other schools. Are you at a level where you might see a need for upperclassman to live on-campus in your facilities? Are you far from that anywhere and do you see that as being an issue that might be an impediment to continuing to expand ACE deals across some of the larger universities that you play in?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [28]

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No and -- let us talk. First of all, we actually pioneered ACE with upper classman development. And so let's talk about ACE though. And we always thought ACE as a great investment. And on-campus properties represent a wonderful stable cash flow stream. But you really have to dissect it as a real estate investment. And so many of the ACE transactions that you hear us announcing today have evolved more toward the replacement of the residence hall beds that colleges and universities need to replace that really have very, very low open market risk. About half of our universities have first year housing requirements where there's really no risk of vacancy occurring. And even in the markets where that housing requirement does not exist, universities are highly effective and encouraging in first access to students to capture basically 90% of the first year market, even when there is not a requirement. And so projects like we're doing at Residence Hall at the University of California, Barrett Honors College, all the residence halls at ASU, those at NAU, there's virtually no market risk. Now what you always have to be sensitive to, and this is the type of thing that we're mentioning at Drexel. When you are building a large prolific programs on-campus where you become 3,000 to 4,000 beds, the affordability of that housing to support the broader enrollment base of that mission is critical in to how you perform it and structure deals. And so even where you have a captive audience from a residence hall perspective, what we always refer to as build for the masses, not the classes and ensuring that you have a affordable range across a spectrum of products, that you can grow in a 2.5% to 3% rental rate increase over the long term, you have to build in. Now when you move into upperclassman housing, it's the exact opposite of what I just described. An upperclassman is making a consumer choice to live on campus. And when they're making that consumer choice, it comes down to exactly like any other off-campus decision in that they're going to factor location, product offering as compared to the open market choices they have and rate. You then have to look at what is the size of on-campus upperclassman housing that you're building. And is the number of beds that you're building in a large community enabling those beds to be absorbed and then have a sustainable long-term growth. And so when you look at Arizona State as the perfect example, how you approach upperclassman housing on an ACE transaction, especially of that large scale, at ASU, we have 2,200 beds of upperclassman housing. Our price points range from $563 a month to just at about $800 a month, $794 per month and averages in the low 700s. The 4 top off-campus properties, average rent is $875 and ranges all the way up to $1,079. And so our properties are the best located and incredibly competitive design and add an affordable price point and spread to the market where we can capture from the entire student enrollment population base in an open market choice and then grow rents. And so that the thing you have to always focus on in the ACE transactions when you're targeting upperclassman is the open market decision parameters of product, location and price. Now given that many of these structures permits you to not pay real estate taxes like we do at ASU and that you have the best location, you usually can structure those winning formulas from day 1. And so that the key to the upperclassman housing is taking the open market parameters that you approach off-campus development with into that superior location. And again, that behaves differently than the residence halls you develop for first-year students that are not subject to open market conditions.

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Ryan Meliker, Canaccord Genuity Limited, Research Division - MD and Senior REIT Analyst [29]

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That's really good color. Thanks, Bill. So it sounds to me like the first year, the first residence halls that you guys are developing on-campus offer very low risk. But some of the housing that you're being built for potentially upperclassman is much more open market conditions with the location benefit, is that a fair way to summarize?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [30]

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With a location benefit and usually an uncontrollable cost benefit. And that again, you look at the margins on those on-campus apartments, make no mistake, if you structure an ACE transaction properly and the university allows you to bring open market parameters into the transaction, upperclassman housing on-campus can be. We think our on-campus beds at ASU are the best apartment upper campus investment anyone could decide to make in that marketplace. And that proved itself out through the economic downturn when you saw vacancy off-campus and rental rate [ demunition ] and we had none. Because our price points were initiated at an appropriate level to the open market.

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Ryan Meliker, Canaccord Genuity Limited, Research Division - MD and Senior REIT Analyst [31]

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All right, that's really helpful. And then to take that one step further, so you guys still see ample opportunity for ACE developments going forward. The pipeline is pretty rich and the university that you've looked at in the past, you'd still continue to look at going forward?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [32]

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Yes. Again, the one evolution in ACE is that has been beyond what we ever expected -- and as I mentioned ACE began with upperclassman housing. The thing that has come to fruition that was beyond our initial expectation is surprise, surprise, the replacement of the on-campus residence hall that have a median age of 51 years in the market we serve. And so just the replacement of that first year housing is a significant market opportunity that colleges and universities are facing. The upperclassman housing has become more of a secondary byproduct that again we love when it makes sense to do. We've done the same thing at Northern Arizona University where we have both product types that have taken the same approach and done extremely well. The one thing we always focus on -- we always remind our university partners, when we're undertaking large-scale development, and in essence, becoming the majority of on-campus, we bring that same pricing strategy of build for the masses, not the classes to the University. That at the end of the day, when you control the university housing stock, the beds that you bring to their campus have got to allow the recruitment and retention of students by having a multitude of affordable price points.

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Operator [33]

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And next we have a question from Juan Sanabria of Bank of America.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [34]

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Just a question on the construction delays and being willing to have construction guarantees. Is there any color you can give as to -- I think, you mentioned one university, what percentage of the development pipeline you'd be willing to offer that on? And does that change your targeted yields with presumably some risk to the downside if, for whatever reason, you do miss how you underwrite developments?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [35]

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Yes. The short-term question is no, there's not a financial negative impact. And you would only do it in markets where there is a true concern from past misses that exist. And we would also candidly only offer where we knew we had no chance of missing the opening. And so you're basically creating a phantom messaging to reinforce what you know is your delivery. And so when you think about it -- and so what we did at Clemson, we offered $1,000 construction guaranty. If we don't have your unit ready on your lease begin date, we'll give you $1,000. And so, again, we don't believe we're at risk of paying that on a single unit. However, let's say, we had to. You have a total contract value to maybe $10,000, $11,000 that your worst case scenario is you got that student to sign that contract, of which you gave up 10% of that to secure it versus their concern of the unit not being done leading to 0 revenue. And so it is only an enhancer to versus a -- something that we actually think we have to do in a situation where we were going to miss. Candidly, the best decision that you make may. If you ever think you're in jeopardy of missing, you push your schedule a year and you move to the following period.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [36]

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Great. And just on a question on Jim's comments on the NOI and kind of the couple of things that have come up at Barrett Honors in Champaign. Is there a quantum you can give and has that contributed at anyway to the same-store rental growth not coming up from that midpoint of 2.9%?

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Daniel B. Perry, American Campus Communities, Inc. - CFO, EVP, Secretary and Treasurer [37]

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Juan, this is Daniel. So with regards to the properties that we're expecting to come offline, it's up around $400,00, $500,000 of potential risk we think we have related to that. It's really not an impact to the 2.9% rental rate increase if those properties come offline because they would come offline in the summer months and be back online for the fall.

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Juan Carlos Sanabria, BofA Merrill Lynch, Research Division - VP [38]

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Okay. And then just one last one from me. For the University of California, the potential RFPs sounding like it might go more third-party versus ACE. I mean would you guys be interested in owning Santa Cruz and Riverside assets ACE and ACE structure. Just how do you think about those versus your traditional -- those particular universities versus your traditional power 5 kind of focus?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [39]

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Yes. And I mean, certainly the fact that they're -- let me start with investments we've already made at the University of California, Irvine. We would have loved to have owned everything we did on the campus of University of California, Irvine under an ACE structure. And having managed the prior phases for the last 12 years, it would have been one of the best investments we have ever made. And so we are always open to analyzing on a case-by-case situation whether or not we will invest our equity now. Take the conversation we just had in terms of how you approach ACE from a business perspective. Ultimately, whether or not you're willing to invest your equity, it comes down to those individual negotiations and what is built and how it's intended to be priced. And so I would not say yes or no off the cuff versus getting in to see how the RFP is written, how they come about and what the parameters are. But certainly the University of California System, as a whole, is one of the more prominent clients that we believe when you look at the demographics of higher education in that state and the campuses that we're targeting are going to be long-term, vibrant institutions within the system and this is going to be the critical on-campus housing component. And so there are very attractive transactions across the board in that regard. Again, whether they end up equity or third party, will be RFP by RFP. And after the universities have gone through those processes and made those individual evaluations, then we'll approach each one independently.

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Operator [40]

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The next question comes from Austin Wurschmidt of KeyBanc Capital Markets.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [41]

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Just wanted to touch back on some of the pre-leasing detail that you provided Bill, particularly on the 16 markets that are tracking 1,200 basis points ahead. I think you said 2.2% rental run rate growth there. Any opportunity there to potentially push rate a little bit higher given how far you're tracking ahead? And then just separately on the 19 markets that you're strategically swelling, you said you're 500 to 600 basis points behind, was curious how those are tracking maybe relative to the market in general?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [42]

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Yes. First of all, your first question on the 16 that are currently tracking ahead with the 2.2% rate. The majority of those properties are actually in the current occupancy category of 95% and below. And so the modest rental rate pricing, it is what is driving a 1,200 basis points velocity outperformance. And so there, you have more upside in occupancy gains than you do rental rate. And so this is where you see that delicate balance and that decision of where you push rate in the occupancy. This is what we always talk about. It is unit type by unit type, property by property, really can't make a generalization in either of those categories. And so in every category that we broke down and gave in terms of the broader segment, those individual analysis of where to tweak the velocity and the rate are done unit type by unit type, asset by asset. And So it's hard to make a general statement in terms of the actions you'll take of the group, but it's rather the individual actions that then drive what that property group falls into.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [43]

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And then on the 19 that you strategically slowed, any sense how that velocity is tracking on the property...

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [44]

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No. I'm sorry. We're doing very well to the market in all those cases. And again, these are places where we filled up early last year and had plenty of market opportunity left so we're slowing it down as a strategic objective to maximize revenue.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [45]

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And then as far as you guys have mentioned in the last quarters on the pull back and construction lending, could you just give an update on what your guys appetite is and what the backlog looks like for potential mezzanine opportunities? And then how that balances, I guess, versus more straightforward acquisitions.

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William W. Talbot, American Campus Communities, Inc. - CIO and EVP [46]

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Sure, Austin. This is William. We have seen quite an increase and interest in our mezzanine program. As you would expect with the lending constrictions, our mezzanine program becomes very attractive. And so just like we evaluate core acquisitions, we look at the real estate first. And if the real estate is something that meets our investment criteria, then we're able to expand and offer the mezzanine financing and ultimate presale structure. So we are absolutely seeing an overall increase in those. As it relates to just overall acquisition environment, our pipeline remains vibrant. We see a number of opportunities, both one-off and portfolio that meet our investment criteria that we're currently underwriting and pursuing. And then as you look back in Q1, CBRE as they track first quarter transaction, you actually saw about $1.7 billion trade in the first quarter. That's up from $1.1 billion last quarter -- or last year first quarter if you take out the Campus Crest transaction. So you are continuing to see a very active transaction market, a lot of interest about 55% of the investment in first quarter was from institutional. So again as we thought you would see or continuing to see investment from the institutional group and our opportunities remain vibrant and our pipeline remains strong.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [47]

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So on the mezz deals, would you typically look for those to ultimately be more of a presale type transaction? And then how does that balance out versus how many of those are for potential 2018 deliveries?

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William W. Talbot, American Campus Communities, Inc. - CIO and EVP [48]

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Correct. Obviously, with the mezz program, it's just a means to get to the presale to acquire core real estate. So in every case it's going to have that acquisition component to it. We're looking at a number of opportunities right now. It's really too early to say how many we think will be added to '18, but that is really the limited opportunity we have to add '18 development is through the presale program.

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Operator [49]

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And our next question comes from Ryan Burke of Green Street Advisors.

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Ryan Cole Burke, Green Street Advisors, LLC, Research Division - Analyst [50]

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The 2 new ACE deals NAU and University of Arizona, were those widely marketed RFPs or did they come as the results of just your existing relationships with the universities and border regions?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [51]

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The University of Arizona is actually a -- there was an RFP about 6 years ago that was done by the university. At the time that RFP was done, and you may recall from some of the discussion we've had in the past, we have been land banking some very strategic off-campus sites at the University of Arizona. And when we first responded to that RFP 6 years ago, we brought to the table, at that point in time, that we would be willing to contribute and donate our land into an on-campus project type structure. And we've always been prepared to move forward with that -- those properties as off-campus stand-alone developments. Obviously, because the university owned contiguous sites next to ours, it made a lot more sense, you got much greater economies in pulling our land resources together. And so there's actually -- a lot of administrative changes that have taken place in the University of Arizona, heck, it may have been 8 years ago that that RFP took place. And so this transaction has been sitting there as a potential for the University for about 5 to 6 years. And so they -- about a year ago in wanting -- in having their vision for an Honors College, this transaction made perfect sense in terms of bringing to fruition what -- was an RFP many, many years ago. And certainly all of the work that we have done with ABOR, the Arizona Board of Regents that governs University of Arizona, Arizona State University and Northern Arizona University, it is very easy to facilitate a transaction within the system. And so it was very well teed up to move forward. And in the case of Northern Arizona University, that was part of the original selection with us as their partner years ago on the first transactions we did and additional adding to that. And so in both cases there was a competitive RFP at a point in time in which we've selected that have led to those 2 opportunities.

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Ryan Cole Burke, Green Street Advisors, LLC, Research Division - Analyst [52]

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Okay. Separately, you do continue to focus on development as oppose to acquisitions even though the acquisition is, well, you mentioned, is pretty vibrant. I think your logic, given so, has been well explained. Curious if you can provide some color on the various stabilized acquisition properties of trading versus the cap rates you guys would be willing to pay. So on the properties that you would like to own that you're not buying, are the winning bidder is paying cap rates that are 10 basis points below you or are they paying cap rates there 100 basis points below you?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [53]

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It varies, Ryan. And If you look at the CBRE report that a lot of folks were talking about at the interface conference, we did see trades. I think there were about a dozen trades, just under a dozen or in the 4s, low 4s to mid-4s. Typically, in university markets that were part of major metropolitan statistical areas, and so you had a little more institutional folks that like to play in those investment parameters. As we've always said, for us, cap rate is an inversion of what is the growth rate that we see in those assets. And so it really comes more down into the underwrite. And it certainly, you've heard us talk about 5 cap rates and sub-5 cap rates where we felt it's not a 3, 3 growth rate, but it's a 7, 5, 4 and then a 3 stabilization. So we're on an IRR basis, we know we can achieve the long-term yields that we are looking for. And so, for us, that cap rate comes down more to -- and this is where we do feel that we have a competitive advantage and that we typically have more market data, more revenue occupancy trending data than anybody else. That we're more better equipped to predict future growth in cash flows than other people and making that decision when you should pay up and be competitive or when it's okay to lose by 100 basis points. So it runs the full spectrum of whether we win or how much we lose by, based on that type of analysis.

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Ryan Cole Burke, Green Street Advisors, LLC, Research Division - Analyst [54]

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So it all depends?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [55]

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Yes, sir.

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Ryan Cole Burke, Green Street Advisors, LLC, Research Division - Analyst [56]

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Okay. Last question, a little bit more macro in nature. New York peers is headed in the direction to providing tuition-free education. What's your view on this. Would a broadening of this trend across the country would be a good thing or a bad thing for student housing owners? With the impact you get from the sort of your higher quality educational institution or versus your lower quality?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [57]

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Overall, I think it's a good thing. And free tuition to 1 degree equals more discretionary income for housing, and so that's not a bad thing. And it's really not new there's -- the Georgia, years ago, came up with the HOPE Scholarship. That was -- it's probably 10, 15 years old now. My home state of West Virginia has a program. And a lot of the states have focused on tuition assistance tied to maintaining academic performance. And so the thing we really like about these programs is they almost always have a hook in them that relates to better university retention of students and motivation for a lack of turnover in enrollment. And so in that regard, there -- we believe overall positive indicators. The broader macro that we see in the large public institutions that we serve where you're seeing some of these initiatives, is that the competition for the seats is so fierce, this is just another alternative for more people to have access to that. And again, given the fact that free tuition typically has a component of its first given toward those that have the actual need. Those students then also tend to qualify for Pell Grant and student loans and other forms of funding, which then can be used for housing. And so I certainly -- we can't think of anything that we would derive that is a negative from those things taking place.

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Operator [58]

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And the next question comes from Jeffrey Pehl of Goldman Sachs.

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Jeffrey Robert Pehl, Goldman Sachs Group Inc., Research Division - Research Analyst [59]

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Thanks for all the color on the third-party revenue earlier in the call. It kind of assumes about up to a 39% increase in third-party revenue in '17 with the large increase in third-party development fees. Does this basically imply that, in '18, you expect a ramp in third-party development fees from '17 with all the announced third-party developments?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [60]

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It is too early to call a new trend and a new growth curve on that. But I do think when you listen to our discussion about the build up of P3s across the country, as it relates to both equity and third-party opportunities, there's more transactions hitting the street. And so, certainly, this is a really good year for the potential for third-party income. Typically, based on the development cycle, we recognize 50% or more of those in the year in which they commence. And so there is a tail on anything that we start this year into '18. But really the biggest portion of contribution comes from additional awards that didn't hit in '18. So we don't want to call it a new trend as it relates to that income, but we're certainly pleased with where it is at this point in time and what the future horizon looks like based on the P3 environment on campus.

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Jeffrey Robert Pehl, Goldman Sachs Group Inc., Research Division - Research Analyst [61]

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Great. And just on development pipeline for '18, you have a few months to add , a few projects. How much larger do you think '18 could be? And could 2019 potentially be lower than '18 pipeline?

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [62]

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'18 has a little bit of a window certainly from -- and from Williams conversation, mezzanine is where you see the greater opportunity for things to come in at this point in the year that other folks have teed up well through the entitlement and they're in that final talking to construction lenders and making decisions as to what was the best route to go. And '19 has plenty of runway. Again, kind of the same comment as it related to how I just answered third party. When you look at '19 opportunities, certainly, in the on-campus environment there is many transactions that are out there that can still fit into the box for 2019 and also from an off-campus perspective, also still plenty of time. And so there's no reason for us to believe at this point in time that '19 should not have the opportunity potential that you see in '18.

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Operator [63]

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(Operator Instructions) And our next question comes from Tom Lesnick of Capital One.

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Thomas James Lesnick, Capital One Securities, Inc., Research Division - Analyst [64]

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Most of my questions have been answered at this point, but just wanted to circle back on expense growth for a minute. I think you mentioned that Austin perhaps drove a little bit of property tax pressure in the quarter. Just wondering if you could elaborate on that a little bit and then if there are any other markets across the country where you see the potential for pressure? If any of those jump out to you I would appreciate you pointing those out?

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Daniel B. Perry, American Campus Communities, Inc. - CFO, EVP, Secretary and Treasurer [65]

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Sure, Tom. This is Daniel. With regards to property tax, obviously, that's not flowing through the numbers yet. We're just starting to see initial assessments come in. We're hesitant to make any changes even with that large increase in the initial assessment we saw in Austin because we had a big initial assessment last year in Austin and saw a significant decrease after the appeal. But with it being in such a large increase, we wanted to note it. We're still waiting to see the rest of the markets come in and if those end up in for potential for savings that might have offset some increase we see in Austin. I don't know Jim if there is any other markets that we would point to as significant risk market for us, but...

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James C. Hopke, American Campus Communities, Inc. - President [66]

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None more so than any other year, Daniel. We're still waiting on assessments to come in and we'll have more color on this in the third and fourth quarters.

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Operator [67]

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And this concludes our question-and-answer session. I would like to turn the conference over to Bill Bayless for any closing remarks.

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William C. Bayless, American Campus Communities, Inc. - CEO and Executive Director [68]

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Again, we want to thank you all for joining us as we talk about the results for the first quarter. And again, thank the American Campus team for all their hard work and dedication. We look forward to talking with you all in June at NAREIT. I'm sure we'll issue a leasing update prior to the conference there to give a little more color on how things are going and in talking with you at the next call. Thank you much.

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Operator [69]

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The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.