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Edited Transcript of EQR earnings conference call or presentation 23-Oct-19 3:00pm GMT

Q3 2019 Equity Residential Earnings Call

CHICAGO Oct 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Equity Residential earnings conference call or presentation Wednesday, October 23, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mark J. Parrell

Equity Residential - President, CEO & Trustee

* Martin J. McKenna

Equity Residential - First VP of Investor & Public Relations

* Michael L. Manelis

Equity Residential - COO & Executive VP

* Robert A. Garechana

Equity Residential - Executive VP & CFO

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Conference Call Participants

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* Aaron Brett Wolf

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

* Alexander David Goldfarb

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

* Andrew T. Babin

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Derek Charles Johnston

Deutsche Bank AG, Research Division - Research Analyst

* Haendel Emmanuel St. Juste

Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst

* Hardik Goel

Zelman & Associates LLC - VP of Research

* John Joseph Pawlowski

Green Street Advisors, LLC, Research Division - Analyst

* Michael Bilerman

Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - Director & Senior Analyst

* Nicholas Philip Yulico

Scotiabank Global Banking and Markets, Research Division - Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Richard Hill

Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS

* Richard Allen Hightower

Evercore ISI Institutional Equities, Research Division - MD & Research Analyst

* Richard Charles Anderson

SMBC Nikko Securities Inc., Research Division - Research Analyst

* Shirley Wu

BofA Merrill Lynch, Research Division - Research Analyst

* Wesley Keith Golladay

RBC Capital Markets, LLC, Research Division - VP & Equity Research Analyst

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Presentation

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Operator [1]

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Good day and welcome to the Equity Residential Third Quarter 2019 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Marty McKenna. Please go ahead, sir.

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Martin J. McKenna, Equity Residential - First VP of Investor & Public Relations [2]

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Thanks, Nick. Good morning, and thanks for joining us to discuss Equity Residential's third quarter 2019 results. Our featured speakers today are Mark Parrell, our President and CEO; and Michael Manelis, our Chief Operating Officer; Bob Garechana, our CFO, is also with us for the Q&A.

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

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [3]

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Thanks, Marty. Good morning, and thank you for joining us today. Continued solid demand for our product is driving absorption of new supply, and our excellent people and properties have produced record-high resident retention. And this all resulted in same-store revenue growth that is in line with the expectations we shared with you on our July call.

While we are not giving precise guidance at this time, we do want to share the basic building blocks and thought process that we are undertaking to determine next year's same-store revenue guidance. Important inputs to our process include expected supply; our embedded growth, which for us that means the growth inherent in our rent roll headed into 2020; and most importantly and most difficult for us to handicap, our perspective on demand, which influences both our occupancy and rate growth estimates. A new factor this year is a negative impact that regulatory changes in California and New York will have on our same-store revenue numbers. In a moment, Michael Manelis, our COO, will give you color on our third quarter operating performance and revised full year same-store operating guidance and discuss our 2020 building blocks. And then we'll open the call up to your questions.

So moving on to investments. With the exception of New York, our activity since the new rent control law in June is too limited to draw any conclusions on the product we own. We have seen cap rates modestly decline across our markets, pushing up values. Bidding tents are more crowded and competition among buyers is fierce. This is especially true for B and C quality assets where a value-add claim may exist. As we have stated previously, this has compressed cap rates between new and older product. Our response to this has been to accelerate the sale of older or less strategic assets and to purchase assets that better fit our long-term strategy and minimal to no dilution. During the third quarter, we were busy acquiring 4 new properties consistent with this strategy and selling 7 older assets. Three properties we acquired are in California. These are new properties, so they will not be subject to the new rent control law for almost 15 years. The first property is a 237-unit property in the Little Tokyo submarket of Downtown Los Angeles. This asset was built in 2017, and we bought it for a purchase price of approximately $105.2 million and at a cap rate of 4.4%. With a Walk Score of 96, the asset is a short walk to multiple transit hubs and is proximate to both extensive employment concentrations and interesting entertainment options.

The second is a 398-unit property built in 2017, in the Koreatown submarket of Los Angeles at a purchase price of approximately $189 million and at a cap rate of 4.3%. The property, which is a retail component, has excellent access to both public transit and freeways with abundant nearby entertainment options and sports a 97 Walk Score. The third asset we acquired is 137-unit property on the Peninsula in the San Francisco Bay Area, which was acquired for approximately $108 million at a 4.3% cap rate. This property is very near a Caltrain station and is in close proximity to many large technology employers. Our last acquisition was the purchase of a 312-unit property in the Denver suburbs. This asset was built in 2016. We bought it for a purchase price of approximately $88 million and at a cap rate of 4.7%. This property is an example of the kind of well-located suburban elevator building that is likely to make up about 30% of our portfolio in Denver.

During the third quarter, we also sold 7 assets. One was Park at Pentagon Row, a 30-year asset near Amazon's HQ2 that we discussed on last quarter's call. The other 6 sales were the vast majority of our portfolio in Berkeley, California. These were 6 smaller buildings that totaled 343 units and were sold for an aggregate price of approximately $187 million. These buildings are about 20 years old and have significant student populations making them operationally intensive to operate. The 7 properties sold during the quarter had an average disposition yield of 4.7% and generated an unlevered IRR of approximately 7.6%.

We also completed 2 developments during the third quarter. We'll offset Kendall Square too in Cambridge, Massachusetts. This is an 84-unit property, built at a total development cost of approximately $51.4 million that we expect will generate a stabilized yield of 5.4%. This property was developed as a second phase of our existing Kendall Square loft asset and is an excellent addition to our portfolio in the booming Cambridge Life Sciences area. We are particularly pleased with the speed of our lease-up at this property.

We also just completed our 137-unit Chloe on Madison project in Seattle. The total cost of this project was approximately $65.3 million, and we expect that we will generate a stabilized yield of 5.4%. This asset was built adjacent to our Chloe on Union asset in the Pine/Pike Corridor of Seattle.

Switching to new development, the capital availability story is somewhat different than for existing assets. We continue to hear from reputable local and regional developers with good projects unable to put their equity stack together in light of escalating construction costs and shrinking build to yields. We have been pursuing a few of these opportunities as joint ventures and believe that investing our capital in shovel-ready deals and sound deal structures that provide some protection to our capital is a good way to source new properties while managing some of the risk inherent in development. We started 2 developments during the quarter. Aero Apartments is a 200-unit mid-rise property that we're developing in a joint venture with a prominent regional developer. This property is part of a master-planned community, on the site of a former Naval Air station, and we'll have dedicated ferry service to San Francisco. We expect to build our 200 units for a total development cost of approximately $117.8 million, and we expect to produce a stabilized yield of 5.3%.

Our other new development is 4885 Edgemoor Lane. This is a 154-unit property in Downtown Bethesda, adjacent to an existing EQR asset, which is a ground lease deal where we have the right to acquire the fee interest in about 20 years. We'll develop this 15 story high-rise for a total cost of approximately $75.3 million, and expect to produce a stabilize yield of 5.9%. We think the recent increase in office space in Bethesda will create more demand for rental housing, and that this well located property will capture new office workers who want to live conveniently to work while having excellent access to the metro and entertainment amenities.

On the capital markets front, as you saw on the release, we took advantage of the very favorable environment and issued $600 million in unsecured debt with a yield of 2.56%. There was tremendous demand for the issuance, and we couldn't be more pleased with the execution and I congratulate the team for it.

Finally, before I hand it over to Michael, I want to make a comment on rent control. With California recently passing AB-1482, both that state and New York have introduced new regulations on rents. The new laws are complex and will create compliance challenges for all landlords while also acting as a powerful disincentive to building the new affordable apartments needed in these 2 states.

We agree that there is a shortage of workforce in affordable housing in many places in our country, but believe the actions taken in New York and California will not help solve these problems. These housing laws will discourage the production of new housing and do not materially address the root causes of housing production shortages like zoning regulations that prohibit construction of multiunit housing and other excessive governmental regulation. We also think that over time, it will lead to the deterioration of the existing affordable housing stock. Through our trade associations, we'll continue to encourage policymakers to embrace actions like zoning reform and the removal of regulatory barriers to new housing construction as well as programs that create incentives for private market developers to build the affordable housing units our cities so badly need. I'll now turn the call over to Michael Manelis.

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Michael L. Manelis, Equity Residential - COO & Executive VP [4]

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Thanks, Mark. I'd like to begin with a shout-out to all of the employees at Equity Residential. The third quarter represents our busiest leasing period of the year with just over 1/3 of the entire year's transactions taking place. The team's focus on delivering remarkable experiences to our new customers and current resident continues to pay off and allowed us to achieve our highest recorded resident satisfaction scores while increasing our all-time high online reputation scores. Favorable operating fundamentals continued through the quarter with strong occupancy of 96.5%, which is 20 basis points above Q3 of 2018, record low resident turnover, delivering a 5% achieved renewal increase for the quarter and strong demand to close out the peak leasing season. While we reported strong occupancy this quarter, we anticipate that the balance of the year will moderate in line with normal seasonal declines, a process that has already begun and should result in our full year same-store occupancy ending up at 96.4%, which supports our 3.3% same-store revenue guidance.

Today, our portfolio is 96.2% occupied, which is exactly where it was this time last year. Base rents are up 2.7% year-over-year, renewal performance continues to be very stable with expected achieved renewal rate increases around 5% for the balance of the year.

Heading into 2020, the following represents a few top-level inputs that will serve as building blocks for our guidance process. Most markets will deliver relatively the same amount of new supply with the exceptions being New York, which will have considerably less; and Boston, which will have more. We expect demand for our high-quality and well-located assets to be relatively the same as 2019, which should equate to similar occupancy next year.

Revenue growth in both our California markets and New York will be negatively impacted by about 20 basis points each due to recently enacted rent-control rules. For the entire company, this equates to about a 15 to 20 basis point impact to our 2020 same-store revenue growth.

We also anticipate starting the year with better embedded growth than we had entering into 2019. So overall, assuming these inputs hold, we would expect New York, D.C., Seattle and San Diego to deliver equal or better revenue growth next year and Boston, San Francisco, L.A. and Orange County to be less. We are in the early stages of our budget process, and we will be updating our models throughout the balance of this year, and we will issue specific guidance on our January call.

So on to the markets. Let's start with Boston. Full year revenue growth expectations have been raised to 3.9% from 3.5% as the results for the quarter were better than expected. The reprieve from head-to-head supply delivered strong rate growth and most notably, an occupancy of 96.4% that was 70 basis points better than the third quarter of 2018.

On the supply front, after a quiet 2019, we're starting to see new competitive supply return to the city of Boston. We are tracking about 5,800 units being delivered in 2020 with roughly 60% of those units in the city of Boston heavily concentrated in the Seaport. Demand remains strong, bolstered by large corporate expansions and relocations. It also helps with strong demand and increasing rents for office and lab space seems to be tilting the highest and best use for development parcels away from multifamily in the Seaport district. While we've only seen a few of these deals shift, this could create more renters and less supply in future years.

The New York market continues to demonstrate strength in overall operating fundamentals and its performance during the quarter was in line with expectations. There is no change to our full year same-store revenue growth projection for New York of 2.5%. Overall, we continue to see good economic activity and strong demand for our product in this market. The impact from changes associated with the rent regulations that went into effect in the middle of June are playing out exactly as expected with approximately a 50 basis point reduction to achieved renewal increases in the second half of the year and about a $400,000 reduction in applications and late fees. Combining these changes to the regulations will reduce our expected New York metro market revenue performance by approximately 20 basis points in 2019. A similar impact from rent regulations is expected next year.

On the supply front, next year we'll deliver just over 4,300 units in our competitive footprint, a 50% decline from 2019. While we still see some pressure, the overall competitive nature of this supply will be much less, which should allow us to absorb the impact from rent regulation changes.

Washington, D.C. continues to demonstrate strength despite the elevated deliveries with our full year revenue growth projected to be 2.5%, results for the quarter were in line with expectations. The market unemployment rate of 3.3% remains below the national average and job growth remains healthy with gains being driven in a large part by the professional and business service sector concentrated in northern Virginia.

Deliveries of 10,000 units per year or more seems to be the new norm for the Washington region. The continued strength in demand is fueling robust class A absorption, which delivered strong occupancy and improved pricing power for the third quarter.

In 2020, we are tracking just over 12,000 units with a notable increase to the Capitol Riverfront area where we have no direct exposure.

Heading over to the West Coast. Seattle outperformed our expectations for the quarter. We have increased our full year revenue growth projection by 20 basis points to 3.4%. Job growth remains robust, the market is creating jobs at its fastest pace in 2016, and Seattle's office absorption is the highest it has been in a decade. Gains in job growth were widespread not just in the technology sector. Overall, demand for our product remains strong, which has allowed us to maintain high occupancies while pushing rate. On the supply front, the concentration shifted to the east side in 2019, which has allowed pricing power to return to the CBD where we have several assets. Suburban submarkets have yield greater rental income growth over the last several years, but that trend reversed for us over the summer as the downtown submarket rent growth led the pack for the third quarter.

Overall deliveries in 2020 will be similar to 2019 with just over 8,000 new units coming online. The concentration will continue to be weighted to the east side in the first half of the year and will then shift back to the CBD downtown submarket in the second half of the year.

As I move to the California markets, let me start by providing color on the impact of the new rent control laws. These new regulations go into effect on January 1, 2020, and we have 97 properties or about 70% of our California portfolio subject to the new restrictions next year. The most pronounced impact will be on renewals as there will be a cap on increases equivalent to CPI plus 5% on all properties that are 15 years or older. The law allows vacancy be controlled, meaning upon move out, rent can increase the market pricing without a cap. If these regulations have been in place for 2019, they would have reduced our renewal growth rate by about 50 basis points and our same-store revenue growth in these markets by about 20 basis points.

So moving to San Francisco, we now expect full year same-store revenue growth to be 3.8%, which is 20 basis points lower than our July guidance.

During the third quarter, we were unable to maintain both occupancy and rate at the levels -- high levels we anticipated. We had continued strength in July and August, but September traffic was a little lighter than expected. Today, our San Francisco portfolio is 95.5% occupied, which is 10 basis points lower than the same week last year.

While reduction in occupancy at this time of the year is consistent with normal seasonal declines, this is something that we will continue to watch. Strongest results continue to be posted downtown and the East Bay continues to face pressure. On the job front, the Bay Area topped 4.1 million jobs with 10 straight months of employment gains. It's possible that the rate of job growth is slowing but these gains are still strong. Heading into 2020, we're tracking 9,800 units being delivered, which is similar to 2019. The East Bay will deliver less units and the concentration will shift to the South Bay.

Moving down to Los Angeles. Full year same-store revenue growth projection is 3.8%, which is 10 basis points lower than our July guidance. As we stated last quarter, we anticipated deceleration due to pressure from new supplies that was back-half loaded and had a difficult occupancy comp for the second half of 2018. Occupancy remained strong at 96.3%, but we didn't quite get as much pricing power as expected, resulting in softening rate growth to maintain the needed leasing velocity. Continuing the trend on supply, roughly 2,800 units of deliveries were pushed from 2019 into 2020. These units were originally scheduled to deliver towards the end of 2019, but the story remains the same with labor shortages and construction delays. This shift results in both 2019 and 2020 having approximately 9,700 units being delivered.

Downtown L.A., West L.A. and the San Fernando Valley are the highest supplied submarkets in 2019. There are still about 3,900 competitive units under construction scheduled to complete by the end of the year, which will continue to put pressure on rates.

Moving into 2020, the supply will be concentrated in West L.A., Hollywood and the San Fernando Valley. Downtown L.A. is expected to see a reduction to only 1,200 units being delivered, which should benefit our pricing power and performance in the back half of the year at a submarket that is close to 20% of our L.A. revenue.

Orange County delivered third quarter results, which were better than we expected, primarily driven by 40 basis points of strong new occupancy than this time last year. Our full year revenue growth guidance has been increased by 20 basis points to 3.8%. As I've stated before, we have a diverse set of properties in Orange County and not all bid competes head-to-head with the 2019 supply.

2020 is expected to be similar with just over 2,700 units being delivered. San Diego performed as expected in the third quarter and there is no change to our full year revenue growth guidance at 3.4%. Overall, the newer product downtown continues to pressure our pricing power as we think about next year's supply will be lower with just over 2,100 units being delivered.

On the initiative's front, we continue to make great progress towards the sales and service roadmap that was shared in our June investor update. On the sales front, we will have just over 1/3 of our communities on our artificial intelligence E-Lead platform by the end of the year. We'll have deployed self-guided tours at over 25% of our communities.

On the service side of the business, our new mobility platform for our service teams will be fully deployed by the end of the year. We also have approximately 2,500 units enabled with smart home technology. During the quarter, we launched our new resident portal and app. Our app adoption has grown to 55% of households. As with our original portal, residents will continue to pay rent and service request online but now have many additional features that will allow them to engage with each other. We can already see them taking advantage of self-service functionality in the portal to reserve amenities, register guest and leverage the social platform to facilitate gatherings and post items for sale. We hope that this continues to increase resident satisfaction and stickiness.

The evolution of our operating platform is underway. The new technology will enable continued centralization and digitization to further enhance the resident and employee experience. Over the next few quarters, we expect to provide more detailed updates on the financial and customer impact from these and other initiatives. At this time, I will turn the call over to the operator to begin the Q&A session.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Nick Joseph with Citi.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [2]

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Maybe just starting with guidance. Historically for the fourth quarter, you have seen an acceleration, both in terms of core FFO and also same-store NOI growth and this year seems to be an exception. So I'm wondering if you can walk through what's the variance of that versus historical years.

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Robert A. Garechana, Equity Residential - Executive VP & CFO [3]

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Thanks, Nick, it's Bob Garechana. It's really three-fold items, overall, as it relates to the NFFO guidance, the $0.03 identified in the press release. The first of which is really timing of transaction activity. During the fourth quarter, our guidance incorporates about $300 million in dispositions. And in the third quarter, we had a similar amount of dispositions, but actually had $500 million roughly of acquisitions that Mark went through, front-end loaded. So that's about a penny of the delta. It's also timing of other items, predominantly corporate overhead and some other expense items as well, and then that's another penny, and then the last penny is related to same store. So you're you right, as you look at sequential same-store revenue, it specifically does decelerate between the third and the fourth quarter, which is what we have embedded in our guidance today. That mod is kind of traditional deceleration that you'd see from seasonal activity. You usually also see some expense seasonality and you see expenses actually decline from the third quarter to the fourth quarter in a pretty material amount historically, and we don't expect to see that as much this year and that's largely driven by the timing of some tax real estate tax appeals and some other items. And so that's really driving that last penny that we identified in the release.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [4]

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So then Mark, you're active with California acquisitions, and I know the recent law doesn't impact those assets. But is your underwriting standards changed at all either quantitatively or qualitatively given the more broad-regulatory environment in California?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [5]

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Thanks for that question, Nick. Yes, we talked I think more than ever before, and we've always had a regulatory component to our underwriting but it has been a bigger discussion. We've done things like sensitized exit cap rates. We generally think about asset hold periods and our performance is 10 years. So 10 years from now these assets will be closer to the end of their protected period. So we have sensitized those cap rates at the end -- those exit cap rates a little and thought about them in a few different ways. So that we would be more thoughtful about maybe how those assets might trade 10 years from now. Again, mostly we do generally hold assets longer than 10 years. But we need to be a little bit more mindful. So we did that analysis and we were still happy to hold the assets. So generally changed our IRRs from mid-7% IRRs is to high 6% IRRs by doing that, Nick.

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Operator [6]

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Our next question comes from Nick Yulico with Scotiabank.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [7]

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So you had this unusual dynamic this quarter for new lease growth where strengthened on the East Coast and it weakened in California. You talked about some of the California issues. But -- yes, it also looks like your new leased growth stats were weaker in some of the industry stats we're looking at in California. So just hoping to get a little bit more info on how new lease growth turned negative in the third quarter for the California markets?

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Michael L. Manelis, Equity Residential - COO & Executive VP [8]

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Yes. So this Michael. So I guess first I would just want to call out that I think we've talked about before that looking at any of these stats for the standalone quarter on new lease change is probably not the best way to think about it, it's probably more indicative to think over long term of the year. But specific to the quarter, I guess, I want to call out what we report on Page 15 in that release is really the impact from all lease terms, meaning regardless of what lease was in place when the resident moved out to the replacement rent. When we isolate the leases that were just like term or just 12-month lease to 12-month lease, we see about 100 basis point improvement in the results for the quarter. So I would say that we started, we understood that we were going to see deceleration, I think I mentioned it on the previous call, but if you look specifically like at L.A., L.A., instead of reporting the negative 20 basis points would have reported 80 basis points if I just isolated out to the like term or the 12 to 12 and that would've been a positive. The quarter actually performed pretty consistent with what we expected. We knew we were going to face back-half pressure on supply, and you can see that in San Diego and you can see that in L.A. in the areas that we have supply had the most pronounced kind of pressure on that new lease change. As I said in my prepared remarks, I mean, Downtown L.A. actually is going to see a reduction in supply next year. So we would expect some pricing power to return to us there.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [9]

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Okay. That's helpful. So it sounds like the read through here is that you're not expecting these -- the new lease growth numbers in the California market to stay negative going forward?

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Michael L. Manelis, Equity Residential - COO & Executive VP [10]

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Yes. I guess I'll you tell this. As we hit the fourth quarter, they will most likely be negative. They typically are negative. And I've talked about that before that there's a seasonality component to these stats, which is why when you isolate any one quarter, it's not always indicative of the full year.

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Nicholas Philip Yulico, Scotiabank Global Banking and Markets, Research Division - Analyst [11]

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Okay. Just last question, Mark, I guess, how are you thinking about doing more acquisitions, right? EQR hasn't been a net acquirer in a while and your stock price is looking more attractive. Would you issue equity to do that? What is kind of the size of the opportunities that you're are looking at? Is this something that you would be considering at all?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [12]

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Thanks, Nick. No, we're certainly open to getting larger. I think the market is giving us a growth signal. I would start by saying, as I said in my prepared remarks, the transaction market for the kind of quality assets we want is extremely competitive. So it's not like we have a whole bunch of things that have piled up that we'd love to acquire. I mean we're buying pretty well everything again that fits into the window that we're comfortable with on price. So I would start by saying there isn't a lot left that we haven't done to begin with. And I'll also point out that if you were to use, for example, the ATM, the implied cap rate on the stock as compared to the kind of asset cap rates we have, it's not going to create a great deal of accretion, at least, immediately, for the company. I would say, we're more interested potentially in issuing debt than buying assets. I mean I think we have a pretty modest leverage profile. We're not suggesting we're going to pile the debt on, but I think we're in a position where we could certainly spend a considerable amount of money and fund it with debt to buy assets if we could find enough good assets to buy. So definitely, that's top of mind for us, Nick, but it's probably more of a debt play at this point than it is use of the ATM or some discrete secondary.

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Operator [13]

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Our next question comes from Shirley Wu with Bank of America.

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Shirley Wu, BofA Merrill Lynch, Research Division - Research Analyst [14]

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So this is a follow-up to Nick's earlier question on the rent regulation AB-1482. So what's your most recent (inaudible), did you guys see any impact to the transaction's market or in terms of let's say hesitation to jump into those markets? Just given that new regulation has been in place?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [15]

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Shirley, it's Mark. Thanks for the question. We have not. California has really just kept going. I mean cap rates have generally kind of been steady. They're declining for our kind of assets. So we have not seen. I think that's because California was so well discussed to the credit of the policymakers, the activist representing the tenant groups, the companies like ours and the owners, everyone was involved in this conversation about rent control and rent reform. And so when this all came to pass, everyone understood it and the regulations made sense and the market digested it. I'd contrast that to New York where it was done, as I've said before, sort of in the dark of night, probably wasn't as well thought through, and I think the implications are harder to understand of the transaction market in New York. But in California, everything feels about the same to us.

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Shirley Wu, BofA Merrill Lynch, Research Division - Research Analyst [16]

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That's great to hear. But there is talks of a new bold initiative that kind of brings back this -- the previous conversation about repealing Costa-Hawkins in 2020. Have you heard anything in terms of updated news on that front?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [17]

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Sure. So this is what the industry's been calling prop can 2.0. And the proponent put out a press release recently saying as we expected that they have enough signatures to put this on the ballot. Again, that's what the industry anticipated. I'll tell you, we're very well organized in the industry meetings about this. We beat this by about 20 percentage points back in November, educated the public, educated policymakers, it's just a bad idea. And we think the same approach is justified here again. We intend to be very much aggressive and out there having these conversations in the public space about how this sort of repeal of Costa-Hawkins is going to do the exact opposite of what people want. There will be less supply, there will be less investment in existing stock of housing, both single family and multifamily, by the way. And we're going to have that conversation and be very forthright about it. So at this point I feel pretty good about our organization in the industry to oppose that measure.

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Operator [18]

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And our next question comes from Rich Hightower with Evercore.

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Richard Allen Hightower, Evercore ISI Institutional Equities, Research Division - MD & Research Analyst [19]

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So Mark, I want to go back to a couple of your comments in the prepared remarks around developer equity appetite and just in the sense of the portion of the cap stack required from the equity or the cost of capital. And maybe, wondering if there's something of a disconnect there between public and private in the sense that the apartment REITs are, obviously, trading very well and have opportunity that comes from that versus what you're seeing on the private side and how does that lead to opportunities for EQR? I know, obviously, at least one of the developments that you guys started in the quarter was a joint venture and just wondering what the opportunities set might be that emanates from some of this phenomenon?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [20]

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Yes. We have a few other -- thank you for the question, Rich, we have a few other of these sort of opportunities we're talking to. We've just seen and we telegraphed this on a prior call, it's just more in-bound call volume. Developers we know, regional folks, reputable local folks that have had no problem getting equity and now do. And we think some of that is just, again, bill to yields have gotten low, a lot folks have made a lot of money on development, maybe they're a little anxious about where they are in the cycle. A lot of people that are building, they build for a window. So these developers are building, needing to deliver as merchant builders in a window and things need to be great in 2022 or 2023 or they don't make money. That is not the way we think about development. We want to like our unit cost and our per square foot cost and our location in the long run. So I think we do have an advantage right now at the moment where we're able to take a longer view, where we do have ample capital and these opportunities, again, you can put in front of you the capital of the developer. They're out there, taking the completion risk initially. Now again, these developers have capitalization, not as significant as ours, and they have experience and we watch over their shareholders. So we think we get a little risk mitigation and there is a little bit of an opportunity right now to kind of jump into deals that are ready to go. So I do think there's a little bit of a window here for us.

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Richard Allen Hightower, Evercore ISI Institutional Equities, Research Division - MD & Research Analyst [21]

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Okay. That's great color. And then maybe a second question here quickly. You know what, I lost where I was. Oh, no, 2020 supplies. Sorry about that. So obviously the numbers we look at coming from Axio or other sources seem to change every single quarter, and it's very hard to get a grip on what's really in the pipeline, what's really likely to open by a certain date. So how much flex do you guys put into your forecast in that regard?

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Michael L. Manelis, Equity Residential - COO & Executive VP [22]

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Yes. I mean -- so we have a process, right, where we have boots on the ground kind of validating this stuff. I mean it's pretty hard right now to think that in most of these markers that anything can get delivered in 2020 that we're not aware of. As you start to get to these shoulder periods, especially like the Q3, Q4, you could see things shift from what we thought was going to be a completion in '19, shifting to 2020. We have seen that now in L.A. consistently occurring. So I think as you get to these shoulder periods, it's normal to see some of this stuff shift. And I think on average, we see about this 10% to 15% shift. In L.A, we started seeing it to be a little bit more pronounced like 20% 25% of the unit shifts. But as far the total quantity, the process that we go through with our local investment team in the market trying to understand the competitive nature of supply in our competitive marketplace, the deals don't kind of come and go.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [23]

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Yes. And I'll just -- I want to add one thing, Rich, this stuff becomes competitive even earlier. So before the CFO comes, they're out there preleasing that pressures operators and people like us who have properties in the area. So sometimes moving from December to January looks like something to all of us form a distance, but from the operator perspective, it's meaningless. And I'll also point out when you have 20% of L.A. move from '18 to '19 and 20% move from '19 to '20, nothing really happened. I mean all that happened is, we have done some interesting analytical work where we see the pattern and really, this is the point where the numbers, for example, for 2020 are their highest and from here they'll just decline because deals will keep getting pushed or moved or changed in some regards. So there is a bit of a pattern here where I think we all start looking at numbers that end up being much lower in the long run because stuff just naturally pushes.

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Operator [24]

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And our next question comes from John Pawlowski with Green Street Advisors.

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [25]

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Mark, apologies if I missed this. Could you just give us, on the development opportunities, what you expect a reasonable development pipeline size to look like for EQR next year?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [26]

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Thanks, John. So I would probably put it in terms of spend if that's helpful. So the way we've talked about it with the Board is, we feel like we can spend $500 million a year on development, which would consist of the $300 million of excess cash flow that we have every year after all our CapEx needs are met as well as call it $200 million of additional leverage from the growth in EBITDA. We do that, we don't need to sell assets, we don't need to access the capital, we don't need to do anything, we can just sort of self-fund and in that case then we think that's the best, safest way to do it. So I would expect our goal is to get close to opening, starting, say, $500 million in 2020. We have one large deal in the West Coast we are working hard on that would be half of that. So and there's a number of other plays that are really interesting that are density plays where we're knocking down say 40 or so garden units and replacing them with 200 to 250 mid-rise units. And we have a number of projects like that going on in the West Coast that we hope to start next year, and a few going on in the east that may take a little longer. So I mean that's where you should see in terms of a range probably a spend $300 million, $400 million, $500 million a year and us looking at these bolt JV developments. Some of this legacy land bank, we still have a lower-priced land and these density plays that we think are interesting.

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [27]

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And Michael, can you give us more specifics about your opening remarks about weakness in traffic, foot traffic in San Francisco and not able to maintain occupancy or rate and just what are you seeing on the ground in terms of leading demand indicators for your San Fran portfolio?

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Michael L. Manelis, Equity Residential - COO & Executive VP [28]

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So -- I mean it's really -- it's submarket specific. So even if I just think about the results in the quarter, like the downtown portfolio produced like 6% revenue growth compared to the East Bay at 2.5%. When you start looking at the traffic patterns, our traffic is down. But I like I said, it was strong July and August and then in September, we started to see that shift. We went back and we kind of just looked against all of our available units. The volume of traffic we're getting just as a ratio and compared it. And when you look at it, it really seems to be following more of like a 2017 pattern versus the 2018 to really defy kind of the seasonal decline. So I think right now the demand is really just kind of overall. It's mixed, it's definitely kind of following a normal seasonal decline, but I haven't seen anything that suggests it's not -- it's going to be anything greater than normal. Did that help?

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [29]

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Is it -- is Oakland supply starting to suck out demand or...

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Michael L. Manelis, Equity Residential - COO & Executive VP [30]

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Yes. So it's interesting. So at the back door, meaning people leaving us and giving us forwarding addresses to Oakland, we see very little of that activity, less than 2% of our kind of move-outs give us that forwarding address. But you can look at the Oakland assets that are coming online right now. And they are performing well. Their concessions are reasonable, they're what you would expect from a lease-up. So they are probably siphoning off some demand on the front door right now.

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Operator [31]

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And our next question comes from Richard Hill with Morgan Stanley.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [32]

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A quick question on the leasing spreads. I thought your comments about like-for-like leasing spreads were around 100 basis points higher, was pretty interesting. Hopefully, I got that number right. I'm curious, are you seeing tenants ask for longer leases? Because it seems like your commentary would suggest so. And the reason I ask is one of the consequences of rent regulation was maybe tenants would stay in their leases for longer. So I'm curious, are you seeing leases longer? And is that intentional on your part? And how are you thinking about it?

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Michael L. Manelis, Equity Residential - COO & Executive VP [33]

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So you are correct, first of all, that the spread is about 100 basis points improvement in new lease change when you isolate to the 12 to 12. Haven't really seen much from a demand standpoint changing in the willingness to take long-term leases. We've done some stuff in L.A. We do some stuff strategically in front of some of the supply to try to get some longer leases in place. But we haven't seen anything, whether that be New York or California yet, that would suggest consumers are looking for longer-term leases.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [34]

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Or that turnover has changed. I mean New York turnover, for example -- one of my questions was just whether we'd see a difference between our market rate and our rent-stabilized portfolio in terms of turnover, and they both are moving in the similar way. So maybe, again, it's just one quarter of data and we'll see, but my expectation was that the rent-stabilized portfolio would start to have even lower turnover than the market rate portfolio. But that has not yet proven to be true.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [35]

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Got it. Got it. And look, I mean everyone focuses on the negatives of rent regulation, but I think there are some foreign investors that would argue that there's -- understand the consequences of restricting supply and accelerating rents. Could you comment about how you think about that maybe over the medium to long term in either California or New York?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [36]

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Yes. It's Mark. We certainly have talked on several occasions to the fact that these rent control rules, in the long run, are going to reduce supply. And even though the affordable New York program, for example, wasn't specifically changed, these sort of rules have a chilling effect on capital going into development. And so for an owner like us of properties that already have a relatively low basis because we've owned them a long time, in a lot of regards, the government has now been our partner in reducing supply and increasing the competitive moat.

But -- and we also have opportunities on expenses that we've talked about, whether it's leasing and advertising because, again, we're more highly occupied, turn costs and the like. But I have to be fair about this, and I've said this before, rent regulation, when it reduces the amount of supply of housing, ultimately reduces the dynamism and vibrancy of a city. And that's not good for us. We'd rather see and take a little bit of pain in the short run but see these neighborhoods continue to build out and our existing assets become even more popular and there be even more entertainment options and more of everything.

So I would suggest that rent control is a thing we can manage through. And to this point, it's been not as significant as maybe some folks have thought it would be. But it's hard for me to say that it's a positive in the long run to these cities because I think it's very damaging to the cities.

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Richard Hill, Morgan Stanley, Research Division - Head of U.S. REIT Equity & Commercial Real Estate Debt Research and Head of U.S. CMBS [37]

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Got it. And just one follow-up question. The 4.4% cap rate that you cited, I think some would say that that's pretty compelling against the global macro backdrop, where we stand right now. Is 4.5% cap just sort of steady state for where you see cap rates right now? I guess I'm not asking you to tell me where they're going forward but is 4.5% cap representative of where you think you could buy in, let's just say, the L.A. market for instance?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [38]

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Yes. I think that's probably fair or maybe a little bit lower. I mean I think the range we're operating in is 4.3% to 4.7% with markets like Boston near the low end of that cap rate range where it's just super competitive and a market like Denver more towards the higher end of that range.

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Operator [39]

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And our next question comes from John Kim with BMO Capital Markets.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [40]

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This quarter, your dispositions were very targeted in Berkeley and as we get Prop 10 2.0, as you call it, coming back, are you looking at repositioning out of certain markets within California? Or is age really the primary factor of the asset sales?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [41]

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Certainly, the regulatory scheme, the pressure we feel, the welcome, frankly, that the city puts out for us is a factor. The Berkeley assets had both asset characteristics and city characteristics that made them worth selling. So I'd say we're aware of places where it's more difficult to do business. And we factor that into our decisions to sell.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [42]

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Okay. And sticking to the market, do you have any commentary on Google and Facebook and potentially other tech companies investing billions of capital into the housing markets in San Francisco? Is there any potential for you to partner with these companies on the development or to participate in their incentive program?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [43]

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Sure. While we welcome those sorts of conversations, certainly, and I know we try and engage in those sort of dialogues, I think this is great. I think Facebook's announcement, I think it was $1 billion and I think that equated to about $50,000 a unit. So clearly, there's something else going on here in terms of the government matching or contributing land or doing some other things. I think it's great to alleviate some of these housing shortages. I think it's very thoughtful for big office users to also be thinking about housing, and I think this is just another ingredient in the solution that the government can utilize if it sees fit.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [44]

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But can EQR partner with them? Or is it not really?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [45]

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Sure. Sure. We're open to that. We're absolutely open to that. In a lot of cases, they're making -- if they're building a project that's employee-specific, the tech company is building what amounts to a dormitory for their employees, that's probably a little less interesting for us. If they're building properties where -- and along with maybe the city contributing land and they're contributing capital and we're in a partnership and we're building it, that's all, that's very interesting. Those kind of opportunities would be very worthwhile for us.

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Operator [46]

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And our next question comes from Derek Johnston of Deutsche Bank.

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Derek Charles Johnston, Deutsche Bank AG, Research Division - Research Analyst [47]

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With cap rates currently low and development yield targets hard to justify, we expect continued and possibly accelerated capital recycling going forward. I think you guys have mentioned that. Will you be focusing on Denver? I think that's certainly a key market but currently a pretty small earnings contributor. So what is the target NOI contribution you'd like to see from that market?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [48]

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Yes. Great question. So our goal, as we mentioned, in Denver is to get it up to, call it, 5% of our NOI. Right now, it's about 1.5%. That's probably funded with some incremental capital but probably some recycling out of places like Washington, D.C. where we like the market but we have a significant concentration and where there's been some serious supply issues over the years as well as maybe some money from some of the other markets here and there. So I think you can expect us to continue to acquire in Denver. We acquired one asset the past quarter. We have almost $600 million invested in that market, and I'd like to see that number close to the $2 billion and our concentration closer to 5%.

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Derek Charles Johnston, Deutsche Bank AG, Research Division - Research Analyst [49]

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Excellent. Helpful. And then what is the new low-end requirement on development yields from your perspective just given the environment today? I think you mentioned a projected 5.2% on an asset, I think was in San Francisco during the opening remarks. So what would the low end be?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [50]

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Well, the way you just spoke to that is really the merchant builder thought process. And that's fine, but that's not our thought process. The fact that we can build something in a place, for example, that's very hard to build like Boston, the fact that we can build a tower there and maybe -- and we've said this, we have a slightly lower than 5% current yield on that property mark-to-market, if you mark the land to market on that deal, that doesn't bother us in the least because we really like our basis in the asset. It's hard to buy. It's a location we really like. We like everything about the demand and supply dynamics.

So I don't have a number. If it was a 4.5% cap rate on current rents, we're done. I don't feel that way. I think as we talk about it, as a group, as a management team and with the Board, it's about how protected is that market, what are the demand dynamics, how do we feel about our basis on a per square foot and unit basis. So for us, it isn't just I've got to deliver it at 5.5% cap rate 2 years from now because I got 1 year to sell it or else my equity will wipe me out as a developer. That's just not the kind of deals we do. So for us, I think it's a little bit different of a thought process, and it isn't a minimum. It's just part of the ingredient to the thought process.

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Operator [51]

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And our next question comes from Rich Anderson with SMBC.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [52]

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So on the cap rates, can you just -- those are economic cap rates that you cite in the acquisitions and dispositions?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [53]

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Yes. They're after our normal thought process on CapEx for these types of assets.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [54]

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Okay. So is it -- what do you assume on the buy side and what do you assume on the sell side from a CapEx perspective?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [55]

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Well, it depends. I mean some of the older assets we sell, it's got a higher CapEx load to them. I'm not -- I have some of this stuff in front of me, but I'm not sure I'm in a position to give you exact numbers. We talk about it in our disclosure materials on -- go ahead, Bob.

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Robert A. Garechana, Equity Residential - Executive VP & CFO [56]

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So on Page 27, I think we define for you acquisition capitalization rate or cap rate and gives you a sense of kind of what the underwriting looks like from an in-unit replacement CapEx, et cetera, and how that's kind of conditioned. That might give you some color, Rich.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [57]

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All right. So I guess my point is very little if any, dilution from these trades. But if you were to go to the FFO line, I'm not saying that's more important, but if you were, what would the spread be? Or do you have that number available to you, if it's 30 basis points on an economic basis?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [58]

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So do you mean FFO or AFFO, kind of after the replacement reserves and everything else, for example, yes, like Park at Pentagon Row, that's a good thing to talk about for a second. I mean we looked at the buyer's numbers as best we can. And again, that's not where we disclose, and we put in $200 a unit for that per year. I can tell you that number is way low. We also put $200 a unit in some of the 2017, 2018 product we bought in California. And I think that number is just fine, on stuff that was built a year to 18 months ago. So I think when you start to get to where the rubber meets the road on what your replacements really are, a lot of the stuff we're doing isn't accretive in the long run. It's accretive right then and now.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [59]

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Yes. Okay. All right. And then shifting to California, 48% of your portfolio, housing shortage, regulation, business unfriendly, wildfires, earthquakes, school funding issues, out-migration of population, there's a lot of things going on in California and yet you're showing signs of continuing to grow there. Would it be fair to say that you're not going to get smaller in California but younger? Is that the basic game plan? Or do you see yourself sort of whittling down your exposure to rent control, inclusive of New York City, which brings you up to about 63% exposed to rent control situations?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [60]

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Well, I mean there's so much to unbundle in that. I mean I just want to start by saying you do have the plague of horrible, as you mentioned, in California. But there's a lot of positives, we would know and I know as a -- you're a veteran guy, you know that. I mean the job creation machine in California, the company creation machine, the whole employment picture in the United States is to some extent driven by what's going on in California in terms of technology and going on in the West Coast. And now it's spread everywhere throughout the country.

So I would say we like a lot of the dynamics there, and things that would scare us about California are mostly about those job dynamics changing. That sort of demand stuff would be most concerning to us. And we don't -- as Michael said in his remarks on San Francisco, we just don't see that yet. I also say that Prop 13 -- and remember the split roll initiative doesn't affect us in the apartment business. Having your largest single expense significantly lower, I mean we have a lot of markets where -- outside of New York where property taxes are going up 5%, 7% a year. And in California, they're considerably lower. That's a huge advantage and a -- to us in terms of what our return is.

So I'd say there's still plenty of positive things about California, notwithstanding some of the elements of the plague that you mentioned earlier. And I think you hit it on the head in terms of the California strategy. We do not want to have more NOI in California than we have now. I think we're about right, maybe a little lower would be okay too. But I think we do want to be younger. I think we have some older assets that even withstanding -- notwithstanding rent control, we want to sell. And I think we'll continue along that play. And you'll see us sell some of the stuff that's a little bit older in the portfolio and try and keep our portfolio in California particularly young.

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Operator [61]

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Our next question comes from Drew Babin with Baird.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [62]

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I wanted to expand on Rich's question. Demand growth in California, obviously, there's a bit of a north-heavy element to that. And with L.A., with the revenue growth expectations coming down a shade despite some supply being pushed down into next year, I guess has the demand picture in L.A. and, I guess, Southern California generally been somewhat disappointing? I know it had kind of a slow start to the year, kind of came back. Can you talk a little more about that trajectory as it applies to Southern California and what we might expect for next year?

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Michael L. Manelis, Equity Residential - COO & Executive VP [63]

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Yes. So I don't say that Southern Cal is disappointing at all on the demand side. I think what you're seeing right now in our numbers and what we've talked about even in the previous quarter is we knew deceleration was going to be coming just based on the supply coming right on top of us. So even though while there was that shift of supply kind of moving, the supply is on top of us in downtown L.A. right now, and we feel that. But the demand is still strong for our type of product. It's just we're not having as much pricing power. And as I think -- as you go into 2020, just in my prepared remarks, we recognize that we're still going to have that pressure sitting on us in the first part of the year in L.A. So I think it's clear to say that it's not that the demand is shifting, it's really more just the pressure that we're feeling from the supply on that.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [64]

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Okay. Appreciate the color. And then one more, shifting to the East Coast. New leasing spreads, if you kind of average that over the full year of going from negative, in some cases, or flat kind of to what I'll call maybe inflationary levels, given the current national employment backdrop, wage growth trends, homeownership trends, demographic trends, all those things you look at, I guess how do you feel about the potential for those leasing spreads to maybe exceed -- to maybe go to like a CPI plus type of territory in the near term based on everything we know right now, kind of the steady state economy?

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Michael L. Manelis, Equity Residential - COO & Executive VP [65]

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Well, I guess I would tell you, I kind of opened it up, which is what we thought about kind of next year at the high level for some of those markets. But I would say, the momentum for the East Coast markets has been strong. But you've got to factor in, just like I said, for next year, with Boston, we're starting to see the supply come back on us in Boston, which means just like the conversation we had in L.A., we will experience some pricing pressure that we haven't had to deal with this year. But the overall demand picture and the overall momentum that we feel on new lease growth and renewal growth is really good on the East Coast markets.

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Operator [66]

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And our next question comes from Alexander Goldfarb with Sandler O'Neill.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [67]

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Two questions. You gave some color on revenue, the other element, obviously is -- are expenses, which have outpaced revenue this year. So as you think about next year on what you're seeing on the different elements that fall into OpEx, do you think that this year sort of outpacing revenue, that's going to continue next year? Or are there some initiatives or abilities for you guys to contain such that OpEx will grow inside of revenue next year?

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Robert A. Garechana, Equity Residential - Executive VP & CFO [68]

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Alex, it's Bob. Obviously, we're very focused on reducing that number overall. I think if you look at our 10-year history, we've generated something that's well under 3% on expenses, and we'd like to get to that arena again. One of the things that we've talked about on these calls many times that is a challenge for us is the 421a assets. We've made a lot of progress in the sales that we've had, in reducing that rate of growth. But it does to overall same-store expenses on average contribute 60 basis points of incremental growth. So nipping away at that could obviously present some opportunities.

Michael talked about in the past initiatives and opportunities that we will focus on there. But it's hard to get over that real estate tax piece, although we've done a lot to make that better.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [69]

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Right. Right. Right. But I mean looking across, all your items are sort of 3% plus. So it's not just the real estate tax, it's the overall...

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Robert A. Garechana, Equity Residential - Executive VP & CFO [70]

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Yes. So it's not just real estate taxes, right? There are some things, and I think we gave you some color on page...

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [71]

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16.

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Robert A. Garechana, Equity Residential - Executive VP & CFO [72]

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16. On expenses, on certain things that are onetime in nature, for instance, that are in '19 or might be onetime or less frequent, like the ground lease revaluation, that's another expenses; and the HOA kind of holiday, that was another expenses that you wouldn't expect necessarily to recur.

We're not giving you 2020 guidance. So I've got to say that in 2020, there might be some things that pop up that aren't -- that could go the other way. You heard us and others talk about the benefit in real estate taxes that we saw in Seattle this year. That may not repeat itself. But we're very focused on making sure that we can manage those expense line items to the lowest possible growth rate overall.

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Alexander David Goldfarb, Sandler O'Neill + Partners, L.P., Research Division - MD of Equity Research & Senior REIT Analyst [73]

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Okay. And then the second thing is -- and Mark, appreciate your upfront comments on the California rent control and New York. As you look to next year, it seems like Albany is taking that CPI plus rent cap to try and have a market rate rent control, so -- which would not have -- as best as we can see from the press reports, would not have all the flexibility that California has. What do you guys see differently and how you and the industry would approach Albany in the upcoming legislative year versus what happened the prior year?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [74]

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I'll start by saying, I don't think anyone on this call, myself included, is in any position to predict what a politician will do or what the political system will do in Albany or elsewhere. So it's hard to say. I've read the same things you've read Alex, and we're working with our advocates in New York.

So what I'd say is I think there needs to be more dialogue than maybe there's been so far, and we're working to do that. I know that the people we have on the ground talk a lot to policymakers, but I'm not sure those channels couldn't be open even wider. I do know that there's been some conversations, even from the mayor's office, about whether that first stage of rent control is working very well in New York. I think there's already things that make you wonder about whether this is such a great idea. And I would hope the policymakers would take that into account before considering or passing new rules on top of the already owners regulations passed back in June.

So what I hope for the most is to have the industry have a seat at the table for that dialogue. And that's what, as a member of the industry and as a big owner in New York, we'll push for.

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Operator [75]

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And our next question comes from Hardik Goel from Zelman & Associates.

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Hardik Goel, Zelman & Associates LLC - VP of Research [76]

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We've heard a lot about cost controls in terms of -- on the personnel side, where you essentially have less employees, maybe you pay the remaining ones more and you essentially are leveraging technology to achieve that. Can you talk a little bit about how much of that you're doing and what you see the future of that over the next 2 years? How does that play out?

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Michael L. Manelis, Equity Residential - COO & Executive VP [77]

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Yes. So I think as I said, over the course of the next couple of quarters, I think you'll see us talk more specifically around some of the financial kind of impact from some of these initiatives. I would say sitting here right now, it's pretty clear that several of these initiatives combined are ultimately going to create some operating efficiencies in the portfolio.

For us, the goal of doing all these initiatives has really been around better experiences for our employees and residents. And we expect that the efficiencies that we gain on the operations staff that will impact staffing level will really just happen through attrition in the workplace. The initiatives on the sales side of the business are already starting to show times saved, definitely offering our customers flexibility and convenience. And on the service side of the business, right now, our expectation is that our dependency and reliance on contractors and overtime that we pay out should start to be reduced over time.

So I think it's clear, in the next couple of quarters, we'll start putting some more financial numbers in front of you guys. But over the course of the next couple of years, the operating efficiencies will start to manifest themselves through leveraging this technology.

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Hardik Goel, Zelman & Associates LLC - VP of Research [78]

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And just a quick one on utilities as well, which line items will this affect overall, I guess? And then a little bit on utilities, are you guys doing anything to cut...

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Robert A. Garechana, Equity Residential - Executive VP & CFO [79]

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Yes. So just to make sure I understood the question, kind of what's driving the utility cost in the quarter and year-to-date. And that's mostly -- it's been pretty self-contained in the gas and electric component. Most of the increase we were slightly higher in the third quarter was coming from some garbage and trash-related expenses, which is predominantly from the West Coast, from a couple of markets in the West Coast.

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Hardik Goel, Zelman & Associates LLC - VP of Research [80]

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Got it. And then I meant to ask, which line items are most affected by the efficiency savings over the next 2 years that you mentioned?

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Robert A. Garechana, Equity Residential - Executive VP & CFO [81]

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Yes. The -- so what -- the payroll obviously, which Michael alluded to, but also repairs and maintenance is where you tend to see most of that contract labor flow through. And oftentimes, that's a line item where you might see some of that as we -- on the service side. I don't know, Michael, if you have anything else?

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Michael L. Manelis, Equity Residential - COO & Executive VP [82]

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Yes. I think look, some of the initiatives around the smart home technology or even smart thermostats being put in the unit can help reduce some of the vacant electric costs associated with it, but those aren't significant dollars for us that are going to really equate to anything meaningful for us to be talking about.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [83]

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Yes. On the utility side, because you did call that out specifically, we've done almost every LED-type lighting project we can do. So some of the low hanging -- really all of the low-hanging fruit is gone. We have a lot of solar installs and some of which are actually going to be pushed into the beginning of next year that we're going to do in this quarter and the fourth quarter. That stuff will benefit us too. But on the utility side, it's this sort of the sustainability thought process we have that we just put a new report out on our ESG efforts. There's a lot in there about it. That's going to help us on the utility items, but it takes some time to kind of get through the numbers. But again, I think we've done all the easy stuff, and now we're on to things like solar and cogen and other things that will save us money and be good for the environment but take a little time to manifest.

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Operator [84]

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And our next question comes from Wes Golladay with RBC Capital.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - VP & Equity Research Analyst [85]

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.

So you sold about $1 billion this year, that's the plan. And in fact, you still have some noncore assets to sell. But you did mention potentially using leverage to buy assets. I'm trying to get the magnitude if you will be a net acquirer next year. Is it fair to assume that you've done the heavy lifting of selling the noncore assets this year?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [86]

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Yes. I mean we -- when you have a $40 billion portfolio, there's always an asset or 2 that is becoming obsolete for whatever reason, whether the neighborhoods changed, the dynamics changed. There will always be an asset here or there that needs selling, but it isn't significant. It isn't like we have this incredible burden where we're carrying a whole market we don't want to own or anything like that. That's just not the case anymore.

And you can evidence that most by seeing how little dilution, in this case, in this year none that we have because we're basically buying and selling in the same markets and just buying newer product versus the older. So next year, will we buy more than we sell? We'll see. And that mostly depends on the competition. It isn't that we've been hesitant to start raising debt and buy assets. It's just that we haven't been able to find enough good product at prices we're willing to pay in order to fire up that acquisition machine. So it's really more about us spending the next 2 or 3 months seeing if there's enough in the pipeline for us to really buy in order to kind of have a net acquisition year in 2020.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - VP & Equity Research Analyst [87]

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Okay. And then looking at the turnover. That just continues to trend lower. It kind of surprises a lot of people. And when I look to next year, I'm thinking, well, the smart home technology is going to be more robust next year, more people are going to adopt it, does that actually drive turnover lower? Or is that too aggressive of an assumption on my part?

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Michael L. Manelis, Equity Residential - COO & Executive VP [88]

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I don't think the correlation is there. I think lifestyle changes of our resident base is really the probably most significant catalyst to the reduction in turnover. And we've proven time and time again that turnover is correlated to resident satisfaction. So as we keep focused on increasing our overall resident satisfaction, we should still continue to see reductions in turnover. How much lower it can go? I don't know. I would think that it stabilizes here at some point. But like I said, every quarter, we've continued to inch that down a little bit.

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Operator [89]

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And our next question comes from Nick Joseph again with Citi.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [90]

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It's Michael Bilerman here with Nick. Mark, you mentioned Prop 10 2.0. You had, I think it was, $4.5 million last year that you spent on that campaign. You added that back to normalized FFO, even though I would argue you're in the business and when you spend money to advocate for your business, that is a business cost. Putting that part aside because that's in the past, I would assume your costs are going to continue as rent control initiative is going to go happen next year in California and it's going to go across the U.S. How should we think about the money you're spending, how much it could be and how you're going to treat it?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [91]

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Yes. Good question. Thank you for that Michael. So you can see on Page 25 that the amount we've spent this year on advocacy is $200,000 versus the number last year that I think approached $500,000, actually, at the end of the day, mostly California related. So there's great variability. It's like a lawsuit. We sometimes settle a lawsuit and get money. We sometimes settle a lawsuit and pay money. They're not important to the cooperation of the business. They're not...

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [92]

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I don't think you're going to get any money back on this one.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [93]

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Yes. Yes. They're not -- you're right there. So what I'd tell you is what we'll do and we'll promise to do is be very clear like we are on Page 25. We'll tell you what we're spending, whether it's in or out of norm FFO, we'll convene our Chief Accounting Officer, our very capable CFO and our Audit Committee, and we'll decide what we're going to do next year.

But I agree with you that at some point, if you have large recurring every year costs, then they are just part of your business. For us, this has been unusual. Last year was -- I don't remember any year like that, and I've been at the company for 20-plus years. So that's when we call out something is when it's unusual and was not affecting the run rate of our cash flows.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [94]

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And then as we think about the acquisitions, and you've been fortunate that you've been able to match them perfectly with dispose and not have any dilution, which you had in years past where you've been calling higher cap rate assets, you mentioned early on about IRRs and thinking about rent control and how the deals that you've bought are going to pencil in the high-6s versus in the 7s. How -- what is in that IRR now for the next, let's call it, 5 years from a fundamental standpoint? They're -- we're obviously extraordinarily long in this economic cycle. There's a significant amount of caution flags that are out there right now from an economic and a global perspective. Are you modeling any sort of slowdown in that IRR? And when are you doing it?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [95]

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So the way we think about, and I'm going to use rent growth as revenue growth as the kind of biggest thing you're thinking about, biggest variable. We have a good sense of what will happen in the next year. We know the markets we're going into. We know if there's a bunch of supply. We know if the prior owners run the asset well and whether rents are too low, maybe they've been -- they have nominally high rents but high concessions. So we understand the existing rent roll in the market, and then you'll get a number that's very specific as a result of that.

So I'm looking, for example, at our underwriting for Denver, and our number for rent growth in year 1 is slightly negative. And it's slightly negative because we understand what's going on in that submarket, and we have priced the deal to that. Over the long haul, we pick a number that we think is appropriate. We don't pro forma a year that it's going to be negative even though we know there's one there, just like we don't pro forma a year when it's 6% even though we know there's going to be one of those.

So in the near term, what we do, Michael, is we really think hard about what's going on. And for the first year or 2, we feel pretty good about that on revenue growth. After that, we're putting an average out there that's usually somewhere around 3, saying to ourselves, there'll be years we'll be way low on that number, there'll be years we'll be way high and this will be a good average. And then we spend a whole bunch of time thinking about the cap rate at the end of the deal, and that's kind of the thought process that the team has.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [96]

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And then I want to just come back on your financing comment about maybe using some additional leverage. Do you think the debt markets not only availability of capital, but the cost of that capital being so low both on the secured and the unsecured side is perhaps driving uneconomic decisions that could come back and bite us from a basis perspective?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [97]

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So if you're talking about us specifically being EQR, I'd say no with the thought being that we're talking about relatively small amounts of money relative to the size of the company. Do I think there's excesses in the sovereign debt market or in what the central banks are doing? I think -- there's a lot of people that think that's true. I mean there's a lot of interesting and unusual things going on in those markets, in the short-term funding market, things like that. But I don't feel like we're putting the company at any risk adding several hundred million dollars of debt to the balance sheet and adding hundreds of millions of dollars of high-quality assets. That feels fine to me.

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Michael Bilerman, Citigroup Inc, Research Division - MD and Head of the US Real Estate and Lodging Research [98]

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Yes. I just didn't know whether there was exodus that you see in the apartment acquisition market given the amount of cheap financing available where you're seeing efforts trade at levels that perhaps you would want to own them long term.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [99]

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I wonder if some of that isn't the equity. I mean I hear you on the debt. Now the debt's been cheap for a while. This isn't like a new factor, really. I think what really is going on is you've got a hard asset class with stable to good operating performance, good demographics that's easy to understand. And we are, to some extent, a safe haven. We're also a substitute for fixed income. And I think a lot of people look at apartments, and the private side is all over it because they feel all those things. So I think a lot of the positive you see -- that may be why development capital is a little less available equity because that is perceived correctly. It's considerably more risky, whereas buying a stabilized asset in a great market at a 4.5% cap rate feels like good trade, not going to turn out bad.

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Operator [100]

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And our next question comes from Haendel Juste with Mizuho.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [101]

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So I had a few questions. First I guess given the low cap rates you cited and challenge of putting capital to work for new acquisitions here in your core markets, what's your current view today or more recently with the Board on expanding the portfolio here to perhaps some vibrant secondary markets that offer higher returns, not too dissimilar from, say, a Denver, maybe Austin, Portland, Salt Lake? And then what type of yield or IRR premium would you require to go into those markets versus, say, your more established core markets?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [102]

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Great question. Thank you for that. We had our regularly scheduled Board meeting a few weeks ago. And at that meeting, we talked about market allocations. And I think you've been around awhile, so you know in our book, we have a page, usually, it's page 16 of our investor book, where we talk about other markets -- our markets and other markets and their relative attractiveness. And the example you gave of Austin, Austin screens particularly well.

The issue to date has been that Austin trades as good or better at the moment as some of our other primary markets do, and we're not sure that makes a lot of sense that, that IRR is defensible. So would we go into another market? Is that possible? Sure, that's possible. But in the near term, what we're trying to do is do things that make sense both on the real estate side but are good on the FFO side. And the buy -- there's an asset that traded recently in Austin. It was a good asset that's a sub-4 cap rate. I don't know why that's a good idea from our perspective. So for us, it's both having these great demand and good supply statistics like Austin has, especially on the demand side.

But it's also just a matter of price. There may be markets we'd like to be in, they're just not priced for our entry yet, they're just too expensive.

So I can't give you an exact premium, but there is a cost to us going into a new market. Until we have a good enough size, we don't have as good a coverage, we don't have the same number of people in that market doing maintenance items, for example, an oversight. We have people on site doing their jobs but just we don't have an on-site human resources manager for Denver, those sorts of things. There's travel costs and stuff. And then as you build it out, you have those people on site. So I would tell you that you don't need to just get to be a market with a little higher cap rate for it to be more compelling.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [103]

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Got it. That's helpful. And then I guess the perceptual potential risk of going maybe back into some market that you exited in 2015, I believe, I know that you had a largely suburban older portfolio and I think you're a bit more concentrated -- or focused on more urban location, but just curious how that weighs into the consideration as well.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [104]

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Well, I mean the good news is this team has been here a long time. Some of us are newer to our jobs, but none of us are new to the company. So we know that thought process, we understand it. Some of the markets we exited, many of them were delighted to have exited. We were in Austin many, many years ago with a very different suburban portfolio. And to me, that's an argument like Denver. We didn't leave the Denver market. We left the specific Denver assets we owned.

So I feel like if the markets changed, circumstances have changed and we can explain it to ourselves, to the Board and to you, then we go back into that market. And if we can't, we wouldn't, and nothing would change our minds on that.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [105]

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Okay. Okay. And one last one. I think you mentioned $500 million of potential new development starts on an annual basis at least near term. I guess I'm curious, should we assume these will be all within the existing core markets? And then given the development challenges, the rising cost, yield compression you outlined earlier, how confident are you of meeting that figure? And then should we be expecting similar low 5 stabilized yield on that?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [106]

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Right. Well, next year, we'll see whether we get to $500 million. It was more of a spend number. So we have existing assets under construction, especially the Alcott deal in Boston that are going to be a significant amount of cash next year as we get closer to completing it. So whether we start exactly $500 million or not, I'm not sure. But we expect to start modestly more development than we have, say, this year and last year. But I can't tell you. It won't be outside our markets.

It's not a great idea from our point of view to have our first asset in a new market be a development deal. We'd rather buy some stabilized assets and make sure we understand what's going on. And then there's a development opportunity like Denver. We're open for business to do development for sure in that market. But I don't expect us to enter a new market by doing development.

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Operator [107]

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And our next question comes from John Guinee with Stifel.

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Aaron Brett Wolf, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [108]

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This is Aaron Wolf on for John Guinee. I just had one -- you provided a great amount of commentary on your development pipeline and your project list, and you may have covered this and I apologize if you have, does the $489,000 a unit for the Edgemoor project, does that include a capitalized ground lease?

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [109]

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So it does include a ground lease, but let me give you some statistics. Just bear with me as I find the correct pile here. But I gave you a cap rate, I believe, was about a 5.9% cap rate. And that cap rate would go down to 5.1% if we had bought the land.

So I'm going to take that question a different way. Imagine we had bought the land, the per unit cost of the land would have been about $100,000 a unit in our estimation, and that would have driven down the yield from 5.9% to 5.1%. So that gives you an idea. We always think about ground leases as financing tools. So the answer is yes, it's in our numbers, and it's correctly accounted for as a GAAP matter. But when we think about it at the investment side, we're thinking about it as a financing and making sure we're comfortable that if we had bought the land in fee, it's still a good transaction.

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Operator [110]

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And we have no additional questions at this time.

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Mark J. Parrell, Equity Residential - President, CEO & Trustee [111]

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Thank you very much. We appreciate everyone's sticking with us on the call, and we'll see you around the conference circuit.

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Operator [112]

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Thank you all for your attention. This concludes today's conference. All participants may now disconnect.