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Edited Transcript of AVB earnings conference call or presentation 27-Apr-17 5:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 AvalonBay Communities Inc Earnings Call

ARLINGTON May 11, 2017 (Thomson StreetEvents) -- Edited Transcript of AvalonBay Communities Inc earnings conference call or presentation Thursday, April 27, 2017 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jason Reilley

AvalonBay Communities, Inc. - Senior Director of IR

* Kevin P. O'Shea

AvalonBay Communities, Inc. - CFO

* Matthew H. Birenbaum

AvalonBay Communities, Inc. - CIO

* Sean J. Breslin

AvalonBay Communities, Inc. - COO

* Timothy J. Naughton

AvalonBay Communities, Inc. - Chairman, CEO and President

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Conference Call Participants

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* Austin Todd Wurschmidt

KeyBanc Capital Markets Inc., Research Division - VP

* Conor Wagner

* Daniel Santos

* Dennis Patrick McGill

Zelman & Associates LLC - Director of Research and Principal

* Gaurav Mehta

Cantor Fitzgerald & Co., Research Division - VP and Analyst

* Jeffrey Alan Spector

BofA Merrill Lynch, Research Division - MD and Head of United States REITs

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - VP and Senior Analyst

* Omotayo Tejamude Okusanya

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Richard Allen Hightower

Evercore ISI, Research Division - MD and Fundamental Research Analyst

* Richard Charles Anderson

Mizuho Securities USA Inc., Research Division - MD

* Vincent Chao

Deutsche Bank AG, Research Division - VP

* Wes Golladay

RBC Capital Markets, LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to AvalonBay Communities First Quarter 2017 Earnings Conference Call. (Operator Instructions) Your host for today's conference call is Mr. Jason Reilley, Senior Director of Investor Relations. Mr. Reilley, you may begin your conference.

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Jason Reilley, AvalonBay Communities, Inc. - Senior Director of IR [2]

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Thank you, Cynthia, and welcome to AvalonBay Communities First Quarter 2017 Earnings Conference Call.

Before we begin, please note that forward-looking statements may be made during this discussion.

There are a variety of risks and uncertainties associated with forward-looking statements, and actual results may differ materially.

There is a discussion of these risks and uncertainties in yesterday afternoon's press release as well as in the company's Form 10-K and Form 10-Q filed with the SEC.

As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today's discussion.

The attachment is also available on our website at www.avalonbay.com/earnings, and we encourage you to refer to this information during the review of our operating results and financial performance.

And with that, I'll turn the call over to Tim Naughton, Chairman and CEO of AvalonBay Communities, for his remarks. Tim?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [3]

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Yes, thanks, Jason, and welcome to our Q1 call. With me today are Kevin O'Shea, Sean Breslin and Matt Birenbaum. I'll provide management commentary on the slides that we posted last night, and then all of us will be available for Q&A afterwards.

My comments will focus on providing a summary of Q1 results; review of important macro trends impacting our business; an overview of market and portfolio performance; and finally, some color on our approach to development at this point in the cycle.

Starting now on Slide 4, highlights for the quarter include core FFO growth of just over 6%. We saw same-store revenues grow at 3.2%, or 3.4% including redevelopment. This was a little better than expected, driven by higher-than-expected occupancy in January and February.

We had $650 million of development completions at an initial projected yield of 5.6% with about 70% of those attributable to the completion of Avalon Willoughby and the AVA DoBro combination community in Brooklyn. And lastly, we raised $460 million of capital, including dispositions, at an average initial cost of 3.7%.

Turning to Slide 5 and some of the key trends we've been following. Given that the economy is essentially at full employment, and we're now roughly 7 years into the current expansion, wage growth will be a key driver in sustaining apartment sector performance for the balance of this cycle.

Over the last several quarters, workers have made solid gains in wages as the labor market has tightened almost 100 basis points of improvement in hourly wages as we can see on the chart to the left. And the trend is even stronger for younger workers or those under 55 on the chart to the right. You're seeing gains closer to 150 basis points are now enjoying year-over-year gains in hourly wages of almost 4%.

Turning to Slide 6. Another trend we're tracking is the health and attitudes of the business sector, which can be a leading indicator of job and wage growth as well as new capital investment. As you can see on the chart to the left, corporate profits are now up in 3 of the last 4 quarters. And on the right, business confidence continues to rebound since the election late last year. So it looks like the business sector is positioned to support continued economic growth over the near term.

Slide 7. A third factor we're watching is the trend in the rate of homeownership as the for-sale recovery continues to take hold. Obviously, the apartment sector has benefited tremendously this cycle as homeownership rates drop roughly 500 basis points in the aftermath of the housing correction. But over the last 2 years or so, it appears that the homeownership rate has settled into the 63% to 64% range, consistent with the longer-term trend we saw before the housing market run-up [in] the 2000s.

As we stated last quarter for a variety of reasons, we do expect housing demand to be more balanced going forward between for-sale and rental as well as single and multifamily.

Moving to Slide 8. Given the outlook for balanced housing demand, we continue to keep an eye on the supply side of the equation. Based on recent trends in housing starts, the housing industry has responded in a very rational way to shifts in demand.

Single-family starts have risen significantly over the last 2 years on the order of 25% to 30% to roughly 800,000 units per year, while multifamily starts have essentially leveled off in the 400,000 unit range over that same period of time. This 2/3, 1/3 ratio is roughly consistent with homeownership rates over the last couple of years. And the 1.2 million in annual housing starts less units lost to obsolescence or destruction is roughly in line with net household formation. So overall at the macro level, the housing market appears to be in good shape, appear to have rough equilibrium. Of course, there are some imbalances in certain markets and submarkets, but for now, the market in total remains healthy.

[Now] turning to Slide 9 and taking a look, specifically, at our markets. Rent growth in AVB's market has been roughly stable over the last couple of quarters in the low single-digit range. As you can see on this chart, rent growth effectively peaked in mid-2015 in the 5% range, and it has decelerated to the 1% to 2% range since then. In our portfolio, we're seeing similar trends with blended like term rent change averaging 1.7% in Q1 and 2.3% so far in April. Rent growth in suburban submarkets continues to outperform urban by more than 300 basis points across our footprint, which is consistent with the trend over the last couple of years as urban supply has been roughly double that delivered in the suburbs.

Turning to Slide 10. The discrepancy between urban and suburban rent performance is evident in most of our markets, where we have a diversified presence across the region. This slide depicts rent growth performance for 3 of our larger regions: Northern California; Metro New York/New Jersey; and Boston. As you can see on this chart, in these regions, urban rent growth is underperforming by about 200 to 400 bps, a trend that is consistent with our portfolio for these regions, where roughly 40% of our portfolio by value is urban, and rent growth has been more than 200 basis points lower for communities in urban submarkets.

Turning to Slide 11. So given some of these macro and operating trends, how are we thinking about new development? Well, we continue to pursue new development although at a more risk measured way than early in the cycle.

The last few slides speak to some of the actions we're taking to manage risk in the development platform. First, as you see here, overall volume has peaked and is projected to decline by roughly 30% or so over the next year from Q4's level of 4 billion. In addition, the composition of what is underway is projected to change, skewing more toward infill midrise and away from downtown high-rise product, where market conditions, as we just discussed, have softened more significantly.

Turning to Slide 12. In addition, we remain disciplined about managing land inventory. We talked about this last quarter as well. We currently have about $100 million in land inventory, almost a record low as percentage of enterprise value. The 7 parcels that we own for new development represent only 1/4 of our development rights with the other 3/4 being controlled through purchase contracts. In addition, 5 of those 7 parcels are scheduled to start construction over the next couple of quarters. So we don't have much land exposure currently, and it's our intention to maintain this land-light posture for the balance of the cycle.

Now to Slide 13. We're also managing development risk with the right-hand side of the balance sheet through our funding strategy. At quarter end, we're almost 90% match-funded with only about $0.5 billion in additional permanent capital needed to fully fund the $4 billion in production.

And lastly, on Slide 14, spot liquidity remains very healthy. In fact, before considering the impact of any free cash flow, we have plenty of current liquidity to build out and complete the $4 billion pipeline under construction.

So in summary, Q1 played out more or less as expected. We believe that the apartment market has entered into a period of equilibrium, downshifting a bit from exceptionally strong performance we experienced in the first few years of this cycle to something closer to longer-term trend. Many key macro trends continue to support this thesis, but do bear watching as the cycle matures. And we continue to pursue growth, primarily through new developments. But given where we are in the current cycle with moderating rent growth and improving for-sale market and construction costs still on the rise, we are taking a more risk-measured approach than in recent years.

And with that, Cynthia, we'd be happy to open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We'll take our first question from Nick Joseph with Citi.

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

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When you provided the mid-quarter update in early March, you indicated that you're only about 25 basis points ahead of initial expectations in terms of same-store revenue growth. Is that still the case today, I guess, through almost the end of April?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [3]

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Yes, Nick, this is Sean. A fair statement as it relates to Q1. Q2, obviously, we're just getting into the leasing season now. So I'd say it's probably closer to par at this point when we look at what's happening in April and what we might anticipate through the balance of the quarter, but there's still a lot of transactions left to go here in the next 60 days. And occupancy is a little below where we were for the first quarter, about 10 basis points or so. So I call it probably closer to neutral than slightly up.

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

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And then just in terms of individual markets, are there any markets that are either materially outperforming or underperforming what you initially expected in guidance?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [5]

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Material being the key keyword there, Nick, I wouldn't say any of them are material at this point. Think about the volume of transactions in Q1, it's just not that heavy. The market that points to that maybe you're slightly below our expectations. Right now, first, probably is L.A., San Fernando Valley specifically. As you may recall, there was a sizable gas leak there last year, and we achieved some pretty nice rents in that market. We're not achieving as much growth on top of those slightly higher rents than we would have hoped for, and I'd say it's a little bit weaker operating environment in Northern California as well, a combination of job growth and the supply that we expected with more supply on the way. So those are probably the 2 that I'd point to that are maybe slightly below, and then on the other side slightly above. The Pacific Northwest continues to perform well quite well. Job growth has been healthy, and then job growth in Boston has also been pretty healthy, pretty consistent with last year at this point, at least through March. And supply is relatively level and starting to moderate a bit in the urban core. So those 2 are probably slightly ahead, and then the other 2 slightly behind.

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Operator [6]

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And we'll hear next from Rich Hightower with Evercore.

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Richard Allen Hightower, Evercore ISI, Research Division - MD and Fundamental Research Analyst [7]

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I want to go back to the Bay Area for a second there to follow up on Nick's question. When you look at [out on] performance versus a couple of peers that have reported already this quarter as well, there was just a little bit of underperformance in your Bay Area revenue growth numbers versus what those companies reported. I'm wondering if there's anything peculiar to your geographic setup there relative to peers or something else about the portfolio that we should be aware of for the first quarter?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [8]

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Yes, Rich, good question. Not necessarily. I mean, one thing to keep in mind as you compare across the peers is there are some, I'll call it, geographical differences in terms of how we account for different things. So you can think about rent change as an example, revenue growth, everything that we have in terms of discounts, concessions, et cetera, is in a contra revenue account. So it's really a net number. And if there's not anything flowing through the expense side of the house that creates some differences whether you include redev or not, that creates some differences, things of that sort. So you just have to sort of keep those things in mind. As it relates to the portfolio, there are some differences, probably too many to mention as it relates to this particular call, but I wouldn't say they're material enough at this point that you would point to, say, San Jose and say what's the mix there that's creating significant variation. It's not dramatic in a market like San Jose. Some of us are more urban concentrated versus suburban, but you really have to dissect it in pretty good detail to get down to where those differences are.

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Richard Allen Hightower, Evercore ISI, Research Division - MD and Fundamental Research Analyst [9]

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All right. That's helpful color. Second question here is on development. Appreciate the color in the presentation as to the composition of the pipeline in terms of midrise versus high-rise and so forth. Is that -- I just want to confirm that, that is more a function of where you're building that it's mostly suburban in the pipeline today? And could you confirm sort of the number or the portion of the pipeline that is suburban versus urban at this point?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [10]

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Sure, this is Matt. Yes, I think it is normally high-rise is in urban markets, and midrise and gardens are in suburban markets. There are some exceptions to that. But when you look at our Development Rights pipeline of the $3.4 billion, about 2/3 of it is midrise product and only about 25% of it is high-rise, and 8% garden. And when you look at it kind of on a location basis, about 35% of it's urban and 65% of it's suburban. And when you look at our starts this year, they're all suburban.

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Operator [11]

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(Operator Instructions) We'll take our next question from Dennis McGill with Zelman & Associates.

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Dennis Patrick McGill, Zelman & Associates LLC - Director of Research and Principal [12]

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Just carrying on that -- the last answer there. If you were to look at the market, and do your market intelligence around where you're developing or could develop, do you see a similar shift to the market toward suburban and midrise away from urban?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [13]

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This is Matt again. I guess, certainly in terms of the supply being delivered in the next couple of years, no, we're seeing supply in our markets over the next couple of years, roughly 2% of stock, and it's about 3% in the urban submarkets as compared to maybe 1.5% in the suburbs. If you look out beyond that, the stuff that might start this year, you might start to see a shift a little bit, but one of the reasons we like the suburbs -- the suburban submarkets, and why we think it really plays to our strength as a developer, is that they are more supply constrained. And generally speaking, the entitlements process is more challenging, it's a longer, more expensive process where in a lot of the urban submarkets the jurisdictions want the business, they want the growth, they want the tax revenues. And if it works economically -- the barriers in the urban submarkets tend to be more economic than regulatory. So I wouldn't be surprised to see the mix -- the composition of mix change a bit, but it is inherently a little more difficult to get those starts going in the suburbs.

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Dennis Patrick McGill, Zelman & Associates LLC - Director of Research and Principal [14]

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And then last quarter you had a slide sort of detailing your thoughts on how revenue growth would progress through the year and had a little bit of an uptick in the fourth quarter, and not sure if that was intended or not. But when you think about the outlook today, is that a similar way for us to think about how the year might phase?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [15]

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Dennis, this is Sean. We don't have any reason to believe it'd be any different than what we anticipated as part of our outlook when we talked about it on the last quarter call.

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Dennis Patrick McGill, Zelman & Associates LLC - Director of Research and Principal [16]

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Perfect. And then just last question. For 1Q, did you give the new and renewal numbers for the quarter?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [17]

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I think Tim gave it on a blended basis in his prepared remarks. But in terms of the Q1 detail, as Tim indicated, the blended rent change for the quarter was 1.7%. Renewals were 4.2%, and new move-ins were down 1%.

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Operator [18]

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And our next question will come from Jeff Spector with Bank of America.

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Jeffrey Alan Spector, BofA Merrill Lynch, Research Division - MD and Head of United States REITs [19]

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First question is just on supply. Can you just talk about what you saw happen in the first quarter if supply in your markets or any particular markets slipping into second, third quarter? And then, I guess, what are your latest thoughts on 2018?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [20]

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Yes, Jeff, this is Sean. I can comment, and then either Matt or Tim can jump in as well. But, I mean, in terms of the supply that's being delivered in our markets and throughout the different quarters of the year, from a portfolio perspective, it's pretty even throughout the year. If you look at it in terms of market-by-market performance, it's a little bit different. To give you some perspective as an example, the markets that we're project to see an increase in deliveries as we move through the year include San Francisco, the Pacific Northwest and Orange County. Those that are going to come down a little bit, as you might imagine given where we are in this cycle, are many, but it's a little bit San Jose, a little bit Northern Virginia. And then as you move into '18, it's pretty level until you get to the back half of the year where you start to see things falloff in markets like New York City and San Francisco in the back half of '18. But our experience would tell us, based on what we've seen the last several years and particularly given that the biggest concentration of supply is urban, which is product that's more challenging to get delivered. We've probably expect a relatively flat pipeline between the deliveries in '17 and '18 across the footprint with some minor deviations from market to market.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [21]

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Hey Jeff, it's Tim here. Just to put it in perspective, I think we've talked about somewhere between high 1% range to 2% range that we expect to be delivered in '17 and '18. And if you look -- and it's going to jump around quarter-to-quarter. But based upon our best estimate, it's somewhere between 40 bps a quarter to 55 bps a quarter. So it's pretty level. I know some of us out there are positive that they might expect to see it coming down more significantly later in the year. That's not our expectation.

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Jeffrey Alan Spector, BofA Merrill Lynch, Research Division - MD and Head of United States REITs [22]

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And is that even a change from your thoughts from, let's say, a month or 2 ago? For some reason I thought you guys (inaudible)...

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [23]

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No.

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Jeffrey Alan Spector, BofA Merrill Lynch, Research Division - MD and Head of United States REITs [24]

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No, okay. And then just specifically Columbus Circle. Can you just talk about that project and your comfort on expected returns?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [25]

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Jeff, I know we talked a lot about it last quarter so not really any update bit from last quarter in terms of expected returns and rents. I guess I just refer you back to the script there, but it's under construction. Retail, we are starting to gear up from a marketing standpoint, which I think Matt spoke to last quarter. And there's really no update in terms of how we're thinking about the economics from what we laid out last quarter where I think we gave a fair bit of detail between retail and residential and the implied cost in each of the product types.

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Operator [26]

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And we will next hear from Austin Wurschmidt with KeyBanc Capital Markets.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [27]

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You mentioned that you saw acceleration in like term rent change into April. I was just curious how the metrics for like term rent change in the first quarter and April stacked up relative to last year and whether or not that you would expect the current year to, I guess, turn positive relative to last year's like term rent change at any point this year.

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [28]

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Yes, sure Austin. Good question. If you look at it in Q1, rent change on a blended basis was down about 220 basis points compared to Q1 of '16. We certainly do expect to see some acceleration in rent change as we move through the leasing season here, particularly as you get into sort of the May through July portion of the year. But we're not expecting rent change to exceed what we achieved last year given the outlook for both the demand and supply in our markets. So I don't think -- it would be a positive surprise to the extent that occurred. And yes, we may see an uplift later this year to the extent we see a better job growth through the second quarter, but we're not expecting that as part of our original outlook. We do not expect that, and we don't expect that today.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [29]

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No, that's helpful color. And then just would love to hear your guys thoughts on the revised 421-a plan or the affordable New York plan I think, in terms of just the economics and what it could mean for pickup -- potential pickup in permitting activity.

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [30]

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Sure, Austin. This is Matt. I guess I can speak to that one. I think it's been expected for some time that there would be a new program. In fact, I think the betting was it would have happened a little sooner than it did happen. So it's not hugely different than the prior program. There are some subtle differences. So I think you may see some deals that we're waiting on the program to pull their permits so they could avail themselves of it. There's been very little rental product started in New York City, really, over the last 3, 4 quarters I think. So you might see a little bit of an uptick there. But we're certainly not expecting any dramatic surge because the economics of starting the rental deals are still pretty challenging there with where construction cost land values are.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [31]

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Great. That's helpful, and then just 1 last one. I was just curious in the release you guys mentioned that there was a change in the composition of your dispositions for the year. Could you just provide a little bit of additional detail as to what exactly that comment was related to?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [32]

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Sure, this is Matt again. And there are changes to that disposition pool typically throughout the year, basically based on kind of market dynamics and market sentiment. So in this particular case, we thought we were going to sell 1 asset that was going to have a very large GAAP gain. It was affecting EPS, which is why it's called out there. And basically we have replaced that asset in the plan with a different asset, which we believe will be met by a little bit deeper buyer pooled market, which has a different GAAP gain to it.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [33]

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Is there any change in the volume of dispositions that you expect in terms of dollar value?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [34]

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Not materially, no.

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Operator [35]

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And our next question will come from Wes Golladay with RBC Capital Markets.

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Wes Golladay, RBC Capital Markets, LLC, Research Division - Associate [36]

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You mentioned the supply for your portfolio starting to move to the suburban markets. Are you seeing demographic shifts favoring the suburban markets from the demand side, you know people looking for more space, looking to be next to the schools?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [37]

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Hey Wes, Tim here. I think you may have misheard us. Actually for '17 and '18, we're still expecting deliveries to be about twice as much in the urban submarkets than suburban submarkets. So we may have misstated it or we -- but just be clear. I think what Matt was talking about -- I think there was a question as to beyond 2018 in terms of land deals that people are starting to secure today that might start over '17, '18 and deliver '19 and '20 might we see bit of a shift in suburban. And then the answer is, yes, we might see a little bit of a shift there. But as Matt mentioned, we are seeing the entitlements are more challenging there. So we don't necessarily expect to see a dramatic pickup in suburban supply as a result.

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Wes Golladay, RBC Capital Markets, LLC, Research Division - Associate [38]

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Okay. What about from the demand side? I guess that's what I was trying to get on. So sorry if I misheard you earlier. But do you see demand shifting to the suburbs with the aging demographic, people saying, "Well, maybe it's now time to live in the suburbs. I want more space, want to be next to the schools." Any of that?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [39]

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Yes, no, it's a good question. I think you have 2 trends that are occurring that maybe take a little bit longer to play out. That's the leading edge of the millennials in the late 30s now, but the bulk of millenials are still 23 to 28. That's sort of the pig going through the python, if you will. And there's still a preference for that age cohort, we think, in the urban submarkets as we've seen in the last couple of years. But combined with that, you have kind of the potential of the downsizing boomers. And we think there's a good probability that that's going to create more demand in infill suburban locations. And they're both migrating to the same kind of geography, if you will, looking for the same kind of amenities, still kind of walkable lifestyle but maybe more space. In the case of an aging millennial, it may be a little less space and more walkability in the case of a downsizing boomer.

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Wes Golladay, RBC Capital Markets, LLC, Research Division - Associate [40]

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Okay. That makes sense. And then I guess if you would have to pinpoint when you -- I mean, it's a 300 basis point gap right now on effective rent growth between the suburban and urban, when do you see that, I guess, being close to each other? Will it be more of a late '18 event, maybe 2019 event when you look at all these trends?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [41]

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Yes, just speaking for myself. I mean it's again with supply being 2x in the urban markets compared to the suburban markets and demand is not 2x, something significantly less than that -- maybe it's higher in the urban submarkets, but it's not twice what we're seeing in the suburban markets. It's hard to see that those lines converge over the next couple of years.

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Operator [42]

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And our next question will come from Vincent Chao with Deutsche Bank.

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Vincent Chao, Deutsche Bank AG, Research Division - VP [43]

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Just wanted to go back to the discussion around the composition change. I thought I heard that one of the assets was switched -- switching to a different asset that has a deeper buyer pool. Can you maybe comment on what you're seeing in terms of investor trends across the different buckets of your portfolio? Which are the -- sort of seeing the weakest demand, and have you started to see cap rates expand in some of those weaker demand parts of the portfolio?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [44]

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Sure, Vince, this is Matt. You know there hasn't been a lot of transaction volume in the market, particularly in our markets in the first quarter, I think transaction volumes were down something like 35% or 40% year-over-year. So there's not a lot of data to go on yet. But it is an interesting market out there in the sense that some assets are meeting incredibly deep demand, multiple rounds of offers. We're selling an asset right now, that in the Pacific Northwest, where we had to go to 3 rounds, which we weren't expecting. If you have the right asset in the right location with the right story, there's still a lot of capital looking to be placed. Then there are other assets where if that story isn't there and doesn't line up with kind of the dry powder capital that's on the sidelines, it can be a little bit more challenging. So you know -- and we're just trying to respond that, to tell you the truth, it's a little unpredictable. We've been a little bit surprised sometimes that which assets draw that deep pool and which don't, and we have a very large portfolio, and so we have the opportunity to kind of trade on that.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [45]

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Yes, Vince, Tim here. I think one of the challenges is that probably a lot of market participants are behaving like we are to the extent we're seeing some softness in a particular kind of asset, they're just pulling the asset rather than accepting a lower price. So just -- it's just not visibility to whether on a composite basis, cap rates are really moved or valuations have moved at least at this point in the cycle.

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Vincent Chao, Deutsche Bank AG, Research Division - VP [46]

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Okay. But is there geographic trends that you can draw to? It sounds like it's maybe more asset specific, but are there any regions that are seeing weakness?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [47]

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Certainly, New York City is -- because of all the stuff that's been discussed on this in prior calls. There's probably some of that kind of trophy money is a little bit sidelined right now.

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Vincent Chao, Deutsche Bank AG, Research Division - VP [48]

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Got it. Okay. And then just maybe moving back to some comments in terms of markets that you expect to supply to accelerate or decelerate. I didn't hear you comment on L.A., and I think EQR said that they sell some peak deliveries here in the first quarter. Would you agree with that assessment? Or do you think it's more ratable in L.A. from your perspective?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [49]

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Yes, this Sean. You're talking about 2017 specifically?

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Vincent Chao, Deutsche Bank AG, Research Division - VP [50]

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Yes, 2017.

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [51]

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Yes, no based on the data that we have in terms of how we track it, which as you may now is a little bit of bottoms-up from the field teams that we have there working deals every day as well as top down from our market research group, it's relatively flat in L.A. It actual increases a little bit according to the data that we have around 20, 25 basis points of inventory in Q1 up to around 35, 40 basis points of inventory by the time you get to Q4 in terms of L.A. proper. A little bit lower than that when you get into Ventura County, but we don't see it leveling off per se, based on the data that we have.

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Vincent Chao, Deutsche Bank AG, Research Division - VP [52]

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Got it. And do you think just looking at the leasing progress at Hollywood, only 15% leased mix stabilizations 2Q of '18. I mean, you think that, that stabilization period's at risk given the supply that doesn't really come down in from your data's perspective and then obviously, job growth there has been a little bit soft?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [53]

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Yes, in terms of our West Hollywood deal, as opposed to AVA Hollywood which just started construction not too long ago, we delivered the first building. We're getting ready to deliver the second building. Demand has been very healthy for that community. Rents are coming in substantially above what we expected. So it's a pretty unique building, a great location. We're not expecting any weakness for that specific asset whatsoever.

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Operator [54]

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And our next question will come from Gaurav Mehta with Cantor Fitzgerald.

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Gaurav Mehta, Cantor Fitzgerald & Co., Research Division - VP and Analyst [55]

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So I want to go back to your prepared remarks about taking a risk-measured approach on development, and one of the reasons you mentioned was improving -- improvement in for-sale markets. I was wondering if it's your view that you may actually start seeing an uptick in resident moving to buy homes, especially in the suburban markets where you are developing?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [56]

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Hey, Gaurav, this is Sean. I'm happy to answer that, and Tim can comment if he'd like. But we've not seen that happen in the portfolio at this point. Still well below long-term averages are running around 11% of move outs, which is, call it 700 basis points below, sort of long-term trends. I think it's a fair expectation that over a period of time, we'll start to see that tick up some. Very different in terms of the market composition of that when you think about places like San Francisco and New York in terms of what that housing looks like, price point, et cetera, as compared to, say, suburban towns and outside Boston or in the Mid-Atlantic as an example. So you probably start to see it move some, but we're not expecting it to accelerate dramatically just given the very high cost nature of the housing in our markets combined with what's happening in the financial markets in terms of mortgage availability and qualifying.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [57]

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Yes, Gaurav, just to add to that. Right now, for-sale housing is appreciating faster than rents, and then when you layer on top of that, I think as Sean was applying at the end, just higher potential interest cost, I mean, the cost of housing is going up at a faster rate than rental housing. I think it'll be interesting to see whether that for-sale demand, first-time buyer really materializes this cycle, much like we've been talking about young adults have been living with their parents, and we expected that to be a pretty big source of pent-up demand, and that really has not materialized this cycle for the (inaudible) housing sector. So we're still seeing kind of record level on a percentage basis of kind of that millenial segment that haven't formed households yet have and haven't decoupled with roommates. And you kind of wonder whether you might see some of the same behaviors and as it relates to that first-time homebuyer, but it's an open question for sure.

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Gaurav Mehta, Cantor Fitzgerald & Co., Research Division - VP and Analyst [58]

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Great. And I guess as a follow-up, I was wondering if you could comment on the state of land parcel in 1Q that was not included in previous outlook.

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [59]

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I think that was -- this is Matt. I think you're referring to a land parcel that was impaired. I don't think it's been sold yet. But that was a -- that's actually a property in Tysons Corner that we've owned for a long time that was bought in the last cycle. There's an existing warehouse on it, and we thought that, that was a long-term play on that submarket with metro coming and new master plan coming in. And after holding it for a long time, we concluded that the costs to develop it, the proffers that were going to be required and thus, the market environment there wasn't as attractive as we had hoped it might have been. So we're going to move forward in selling that parcel and basically recognize the current market value.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [60]

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Just on that -- just maybe as a follow-up. Beyond that -- that was a piece of property that we held for investment and not for development. Beyond that parcel, we have, I think, $13 million of sort of 7 or 8 smaller parcels that we're still holding for investment in addition to the $100 million of land inventory that we're holding for development. So there's not much more -- there's not much left beyond that. We really were trying to sort of get that clear before the end of the cycle. And honestly, it sort of a bit of a stark reminder as to why we don't want to be holding land going into the next downturn.

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Operator [61]

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And our next question will come from Tayo Okusanya from Jefferies.

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Omotayo Tejamude Okusanya, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [62]

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Yes. I just wanted to talk about guidance for a little bit. So first quarter, you were at $2.09. Second quarter, midpoint of $2.10 so you're kind of around $4.20 for the first half of the year and guidance was $8.44 to $8.84. So it seems like you are trending towards the low end as of this point. How do we kind of think about where you could end up at the end of the year given you're kind of tracking towards the lower end currently?

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Kevin P. O'Shea, AvalonBay Communities, Inc. - CFO [63]

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Hi, Tayo, this is Kevin. I guess just a couple of points. First, as you may be aware, we don't update guidance on our first quarter of calls just kind of as a matter of practice for a number of reasons, including the fact that as Sean mentioned there's just not a lot of transaction activity that's occurred year-to-date that allows us a very reliable basis on which to sort of reforecast for the year and come up with guidance. So what we do instead is we give a midyear reforecast in connection with our second quarter call. So that's when we'll be able to speak in a more detailed way about how we see the year laying out from a quarterly core FFO perspective, if you will. The second comment I'd say is just when you think about our business model and how development contributes to year-over-year growth and how the lease-up activity from development plays out across the quarters, it's typically the case that our core FFO growth is typically back-end weighted, and when we gave guidance at the beginning of this year for development NOIs, you may recall in the attachment that we're -- we had in the fourth quarter release, where we did provide our outlook for the year. I think we had development NOI of around $65 million. So -- and if you look at sort of how that paces out over the years, that's sort of tends to sort of double each quarter. So a lot of our sequential quarterly core FFO growth tends to come from lease-up NOI. And you'll typically see a pattern where a lot of our growth is the back-end weighed. So that the mechanic of simply taking the first quarter and then the guidance for the second quarter and doubling it will never really work for us because you'll always kind of come up with a much lower number than what we typically have for the year.

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Operator [64]

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And our next question will come from Rich Anderson with Mizuho Securities.

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Richard Charles Anderson, Mizuho Securities USA Inc., Research Division - MD [65]

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A quick -- just quick first question. You have $0.08 of a debt gain in the second quarter. I know you're not talking about the full year guidance, but has there been a change to the capital program because that compares to the $0.04 full year number that you had in February? Just wanted to make sure I had my model right.

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Kevin P. O'Shea, AvalonBay Communities, Inc. - CFO [66]

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Yes, Rich, this is Kevin again. No, that number you see for the second quarter was part of our original budget. It relates to essentially a contemplated pay off of Fannie Mae Pool 2, which is something we picked up in the Archstone transaction. It's a November maturity. It opens for partial repayment on April 30. It's about $700 million in size, and so that's an event that we expect to happen in the second quarter, and so there's been no change in that respect. Overall, in terms of our capital plan, don't have an awful lot to say. We're still early in the year. At the outlook -- at the beginning of the year, we contemplated about just under $1.7 billion of external capital. That's probably roughly where we're at, maybe we're a little bit tacking a bit low, but we raised $460 million in the first quarter. And kind of our overall plan is still -- while we don't announce with specificity what we expect to raise in the capital markets in advance, generally speaking, what we said then is probably in terms of our current plan still true today, which is we expect most of that external capital to come in the form of debt with the preference for unsecured debt. We may do some piece of our debt activity in the form of secured debt to support an ongoing tax protection that we picked up in the Archstone transaction, but mostly most of our overall net capital we expect will still be debt, and of that, most of that, hopefully, will be unsecured debt. So nothing changed there.

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Richard Charles Anderson, Mizuho Securities USA Inc., Research Division - MD [67]

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So then there could be some debt extinguishment losses later in the year to get to the $0.04 net number?

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Kevin P. O'Shea, AvalonBay Communities, Inc. - CFO [68]

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Well, there's a number of different moving pieces in the adjustments between NAREIT FFO and core FFO. Obviously, in the first quarter, you saw a couple here, we had the promote from Fund II of about $7 million. That is within our NAREIT FFO, but it's carved out from core FFO. Then we had the impairment that was added back to NAREIT FFO. If you look out through the balance of the year, we have additional promote from Fund II. So we're wrapping that up. Our intention is to sell the remaining 2 assets, and I think we probably have, in total, a fair bit of promote activity coming through the transom over the balance of the year that will be items that we carve out of NAREIT FFO. So I think for the full year, we have something on the order of about $23 million of promote income that is for the full year in our budget for NAREIT FFO that will be carved out for core FFO purposes, and then we have some deferred financing costs write-offs for pool 2.

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Richard Charles Anderson, Mizuho Securities USA Inc., Research Division - MD [69]

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Okay. I'll wait on that then for next quarter. Question more on the portfolio on this kind of suburban shift that you guys have been undertaking for a little while now. I mean, how much are you -- is that a permanent condition? Are you willing to muscle your way through what will inevitably be a relatively negative environment for that strategy? Or is there some means by which you can alter the portfolio at some level of velocity kind of to move with the punches? I'm just curious how committed you are long term to suburban real estate.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [70]

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Well, Rich, I think as we said, we're actually agnostic. We're believers in our markets. And if you look over a longer period of time, the reality is that suburban and urban rent growth have more or less have been pretty equal, but there are differences at different parts of the cycle and across cycles at time. So currently our portfolio is probably 30% urban by market value and 70% suburban. But of that suburban, I'd say at least half of it we think of is really kind of infill, more kind of midrise suburban. And we're -- as a developer and someone that leads with the development investment platform, we're looking for value. And so our focus, from a development perspective, is where this greater value that's been clear, from a land standpoint, over the last, probably, 4 years has been greater value on the suburban side, and that will inevitably change and at that point we'll look more at urban opportunities. And, I guess, lastly it sort of plays maybe at the margin, how you're thinking about dispositions, where you think maybe some assets are out of sync with underlying intrinsic value, and you got to be willing to pull the trigger on some of those opportunistic plays as well.

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Richard Charles Anderson, Mizuho Securities USA Inc., Research Division - MD [71]

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Same question on "land-light strategy". Also, even though it might go up in time, and it's kind of you said near record lows right now, but is that also kind of a permanent condition in the sense that maybe there was just as a vestige of some sort of lessons learned from the past down cycle and when some impairments were taken and the like?

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [72]

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Well, I think our bias is always try to tie things up with an option contract, purchase contract and try to close on the land as close to the time, which is gets put into production as possible. But now there'd be probably times in the cycle if there's distress or dislocation that we can potentially take land down and put on the balance sheet. We've got plenty of capacity to do that if we think that makes sense. We'll consider that. We're not at that point though, anywhere near that point at this point in the cycle. So really the combo is really about how we intend to behave through the balance of cycle until we do see some dislocation and disruption.

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Operator [73]

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(Operator Instructions) We'll take our next question from Daniel Santos with Sandler O'Neill.

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Daniel Santos, [74]

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Just a quick one from me. Just following up on developments. Just given -- and apologies if you cover this earlier. Just given the rising cost of developments have driven a lot of development at the high end, I'm wondering if you could talk a little bit more about ways that you might be able to value engineer new development to develop at a lower price point for a broader audience.

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [75]

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This is Matt. I guess I can take that one. It's an interesting question and one that we constantly are looking at, are there opportunities to push building technologies that might create opportunities to develop at a lower price point. I will say, as long as I've been in this business when I was -- my background is in development for a long time, the development always comes in at the top of the price pyramid. I mean, that's just kind of the way the housing stock gets refreshed, and it's the existing stock that tends to age into the more affordable price point. This cycle, given how much high-rise construction has been given and how expensive high-rise is to build, maybe that's a little bit more so than in past cycles. So some of it is location. There's people talking about in the future with autonomous vehicles and Uber and everything else as there's need for less parking. That will tend to bring cost down some, and we have looked at cases where can we push the envelope a little bit on parking and maybe not build as much as we would have built 10 years ago. So that's a way, particularly if the parking's underground, where in a structure you can start to bring the cost down. And we're looking at -- we're looking at pushing, whether it's modular or tall timber or other building technologies. We haven't tried anything really out of the box yet, but I think as an industry it's something that there's a lot of talk about.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [76]

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Yes, maybe to just add to that, Daniel. I think location and product is probably the biggest impactful thing that you can do. And if you look on attachment 7, and now that we've broken out between high-rise, midrise and garden, if you take kind of a the circle out of it, the high-rise rents are kind of in that $3,000 to $3,500 range, midrise are roughly kind of in the $2,500 to $3,000 range, and the garden is more in the $2,000 to $2,500 range. And you look at the midrise and the garden piece, that's pretty close to what our same-store basket is running for today. I mean, the average rent, I think, is around $2,450. And so that's probably the most impactful thing that we can do and then always looking to take advantage of new technologies as Matt had mentioned as well.

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Daniel Santos, [77]

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That's helpful. Just 1 quick follow-up on the land. Just wanted to clarify you guys said the strategy as we understand is to take options on the land versus buying it. And just clarifying, that was not the case with this land that you took a impairment on.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [78]

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Correct. We own the land in that case, and as Matt had mentioned, we bought it back in the 2000s, and it was in existing use. It was basically industrial light R&D, and it was in it a part of Tysons Corner that was going to be going through a master plan change that would allow for an upzone to residential. And ultimately we just decided that it didn't make as much economic sense as we have hoped when we bought that back in the 2000s.

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Operator [79]

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And our next question will come from Conor Wagner with Green Street Advisors.

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Conor Wagner, [80]

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Sean, where are renewals achieved for April? And where are there any going out for May?

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [81]

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Yes. For April renewals achieved basically are still in the low 4s as consistent with Q1, which is at 4.2. And then in terms of what's going out for May and June, they're in the high 5s, which are up about -- that's up about 40 basis points from where we initially sent out offer letters for April.

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Conor Wagner, [82]

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And then you typically see 100 basis point bleed, 100, 150 between what you're sending out and what you're achieving.

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Sean J. Breslin, AvalonBay Communities, Inc. - COO [83]

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Typically, yes. It was a little wider in the first quarter, it was a little bit weaker. It's closer to 200 basis points, but that would be more average as you described, yes.

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Conor Wagner, [84]

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Okay. And then, Tim or Matt, on the development pipeline that you lay out as far as for '18, longer term, how does that fit in? How do we think about that with the East 96th Street deal? I know there's been increased media on it lately and then seen it listed as potentially $1 billion development. What's the expected start time on that then how does that fit in in terms of the commentary of the development pipeline coming down and doing less high-rise?

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Matthew H. Birenbaum, AvalonBay Communities, Inc. - CIO [85]

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Yes, Conor, this is Matt. We have been making progress. There's still a lot of entitlement work in front of us as well as design work there. So we think that's likely a '19 start. And when I mentioned that 25% of our $3.4 billion in development rights is high-rise, that's the vast majority of that is 1 deal right there. So we do think, as we talked about a couple of quarters ago, that the public-private partnership, the time and amount might actually be pretty good when you think about kind of the macroeconomics if we might have started that in '19, delivering it in '21 and '22, and it really plays to our strengths. So we still think that's a great deal. It's not $1 billion deal. There's a ground lease involved. So there is an implied land value. I think our investment in that deal is roughly in the $600 million to $650 million range.

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Operator [86]

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And that concludes today's question-and-answer session. Mr. Naughton, at this time, I will turn the conference back to you for any additional or closing remarks.

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Timothy J. Naughton, AvalonBay Communities, Inc. - Chairman, CEO and President [87]

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Okay, well thank you, Cynthia, and thanks all for being on. I know it's a busy season right now for earnings, and we look forward to seeing you all in June at NAREIT in New York. Have a good day.

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Operator [88]

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That concludes today's conference. Thank you for your participation. You may now disconnect.