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Edited Transcript of MAA earnings conference call or presentation 1-Aug-19 2:00pm GMT

Q2 2019 Mid-America Apartment Communities Inc Earnings Call

Memphis Sep 2, 2019 (Thomson StreetEvents) -- Edited Transcript of Mid-America Apartment Communities Inc earnings conference call or presentation Thursday, August 1, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Albert M. Campbell

Mid-America Apartment Communities, Inc. - Executive VP & CFO

* H. Eric Bolton

Mid-America Apartment Communities, Inc. - Chairman, President & CEO

* Thomas L. Grimes

Mid-America Apartment Communities, Inc. - Executive VP & COO

* Tim Argo

Mid-America Apartment Communities, Inc. - Senior VP & Director of Finance

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Conference Call Participants

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* Andrew T. Babin

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

* Austin Todd Wurschmidt

KeyBanc Capital Markets Inc., Research Division - VP

* Buck Horne

Raymond James & Associates, Inc., Research Division - SVP of Equity Research

* 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

* John William Guinee

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

* Nicholas Gregory Joseph

Citigroup Inc, Research Division - Director & Senior Analyst

* Piljung Kim

BMO Capital Markets Equity Research - Senior Real Estate Analyst

* Richard Charles Anderson

SMBC Nikko Securities Inc., Research Division - Research Analyst

* Robert Chapman Stevenson

Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst

* Trent Nathan Trujillo

Scotiabank Global Banking and Markets, Research Division - Analyst

* Wesley Keith Golladay

RBC Capital Markets, LLC, Research Division - Associate

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen. Welcome to the MAA Second Quarter 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded today, August 1, 2019.

I will now turn the conference over to Tim Argo, Senior Vice President, Finance, for MAA.

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Tim Argo, Mid-America Apartment Communities, Inc. - Senior VP & Director of Finance [2]

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Thank you, Aaron, and good morning, everyone. This is Tim Argo, Senior Vice President, Finance, for MAA. With me are Eric Bolton, our CEO; Al Campbell, our CFO; and Tom Grimes, our COO.

Before we begin with our prepared comments this morning, I want to point out that as part of the discussion, company management will be making forward-looking statements. Actual results may differ materially from our projections. We encourage you to refer to the forward-looking statements section in yesterday's earnings release and our '34 Act filings with SEC, which describe risk factors that may impact future results. These reports, along with a copy of today's prepared comments and an audio copy of this morning's call, will be available on our website.

During this call, we will also discuss certain non-GAAP financial measures. A presentation of the most directly comparable GAAP financial measures as well as reconciliations of the differences between non-GAAP and comparable GAAP measures can be found in our earnings release and supplemental financial data, which are available on the For Investors page of our website at www.maac.com.

I'll now turn the call over to Eric.

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [3]

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Thanks, Tim, and good morning. Second quarter results were ahead of our expectation. Strong job growth and resulting demand for apartment housing are driving higher trends in rent growth across our Sunbelt markets. We believe our portfolio, which is diversified across this region in terms of both submarkets and price point, is particularly well positioned to capture the benefits of these positive trends.

The strong demand, coupled with the benefits from our merger and the retooling of our operating platform, is really starting to bear fruit as our combined lease-over-lease pricing in Q2 was a strong 5%, higher than what we've seen in several years. We're encouraged with the trends as effective rent growth continues to climb.

As anticipated and in line with our expectations, same-store expense growth in Q2 was higher than what we've seen over the past couple of years as we harvested expense synergies from our merger transaction, setting up a more challenging comparison for us this year. However, as has been our custom, we maintained rigorous focus on driving efficiencies into our operation. And as you will note from yesterday's earnings release, we did revise down slightly our full year expectation for expense growth.

Overall, the 3% growth in same-store NOI captured in the second quarter is well ahead of our original expectations and we're encouraged with the overall trends. Given the strong year-to-date performance in that we are well into the busy summer leasing season, we are raising our full year expectations for same-store revenues, net operating income and overall FFO growth.

On the transaction front, we've not seen much change from the past few quarters with stable cap rates and a high level of buyer appetite. We continue to see good deal flow, but the product equity buyer remains aggressive in their efforts to deploy capital. We remain committed to our investment disciplines and as noted in our earnings guidance update, we have pulled back on the level of acquisitions we expect to complete this year while increasing the level of funding we plan to allocate to new development starts. You will note that we also increased our planned dispositions volume.

Earlier this month, we initiated marketing efforts with plans to sell 5 properties in the Little Rock, Arkansas, market and we expect to exit this market by year-end.

During the quarter, we completed lease-up in 2 of our new properties in Denver. Our remaining 2 properties in initial lease-up located in Charleston and Atlanta remain on track and should stabilize late this year. Our 5 new development projects currently under construction also remain on track. At a total investment of just over $354 million, we continue to forecast stabilized NOI yields north of 6% from these 2 pipelines.

We also continue to work on predevelopment activities at our existing owned land sites in Denver, Houston and Orlando.

In addition, we're close to finalizing a new JV development project located in Orlando. We expect to have construction underway at all 4 of these new projects by year-end.

Before turning the call over to Tom, I want to send a big thank you to our team of associates here at the home office, in our regional offices and those associates serving at each of our properties. Our folks have done a tremendous job over the last couple of years working through the challenging process of merging and transforming 2 long-established companies, systems and operating programs. The hard work is starting to show in our results and we look forward to capturing additional opportunity over the coming quarters. Tom?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [4]

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Thank you, Eric. Good morning, everyone. Our operating performance for the second quarter was strong and better than our original expectation. Driven by strong demand and the improved platform, we have continued momentum in rent growth, strong average daily occupancy and improving trends.

Same-store effective rent growth per unit was 3.2% for the quarter. This was the fifth straight quarter of improving ERU growth. As a result, our year-over-year revenue growth rate was the highest it's been since 2016 and revenues increased 130 basis points sequentially. The acceleration in revenues was widespread.

The year-over-year revenue growth rate for the second quarter exceeded the growth rate of the first quarter in 19 of our 21 largest markets. It's signaled by our guidance raise. We expect this acceleration to continue. This is led by steady momentum in new and renewal blended lease-over-lease pricing. Blended lease-over-lease rents for the quarter were up 5%, which is 170 basis points better than this time last year. The improvement in blended prices from Austin, Atlanta, Charlotte and Dallas were particularly impactful.

Even with the great traction on blended pricing during the quarter, average daily occupancy remained strong at 96%.

Operating expenses were in line with our guidance, but higher than they have been recently. As we have mentioned on prior calls, we have captured the benefits of the improved expense management platform on the Post portfolio and the comparisons are now more difficult.

Year-to-date expense growth is now 2.8%. As a reminder, our annual operating expense growth since 2012 has been just 2.4%, well below the sector average.

The favorable same-store trends continued into July. We're on track for another month of strong blended lease-over-lease pricing. July blended lease-over-lease rents were up 5.3%, which is well ahead of the 3.2% posted July of last year. Average daily occupancy for the month continued at a strong 95.9%, which was 20 basis points higher than July of last year. Our 60-day exposure, which represents all vacant units and move-outs notices for a 60-day period, is just 7.3%, which is 50 basis points better than this time last year.

On the redevelopment front. Through the second quarter, we completed about 3,800 units, which keeps us on track to redevelop around 8,000 units in 2019. This is one of our best uses of capital. Through the second quarter, on average, we spent approximately $5,800 per unit and achieved an additional 10% in rent, which generates a year 1 cash-on-cash return in excess of 20%. Our total redevelopment pipeline now stands in the neighborhood of 14,000 to 15,000 units.

Our technology platform continues to expand. Our overhauled operating system and new website [abated] our ability to attract, engage and create value for our residents. The results are evident in our blended pricing traction.

Our tests on smart homes are going well. The technology has been installed with minimum disruption and received well by our customers. We're also exploring a range of AI chat, customer resource management and prospect engagement tools. We're excited about the innovations in the apartment space and look forward to continuing to incorporate new technology into our operating platform.

Our teams are pleased to have the work of 2017 and 2018 in the rearview mirror. We're encouraged with the momentum in rent growth and excited to have our transformed platform fully operational. Al?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [5]

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Thank you, Tom, and good morning, everyone. I'll provide some additional commentary on the company's second quarter earnings performance, balance sheet activity and then finally on our updated guidance for the remainder of the year.

FFO per share of $1.57 for the second quarter included $0.04 per share of noncash income related to the embedded derivatives in our preferred shares. Excluding this item, FFO was $1.53 per share for the quarter, which was $0.02 above the midpoint of our guidance. The outperformance was a result of favorable operating performance and as Tom mentioned, primarily related to the continued strong lease-over-lease pricing achieved during the quarter and year-to-date. And pricing performance combined with the continued strong occupancy drove 90 basis points acceleration in total same-store revenues for the quarter to 2.3% growth. This revenue performance combined with the 3.6% growth in operating expenses for the quarter produced NOI growth of 3%, which is the highest in 9 quarters and is projected to continue growing over the remainder of the year. Additional information gained during the second quarter confirmed real estate tax pressure in Georgia, primarily Atlanta, and Texas, as we continue to work through significant valuation increases over the last couple of years.

We now expect real estate tax expense growth to range from 4.25 to 5.25 for the full year. And despite this increase, strong performance in overall same-store expenses in the first half of the year allowed us to slightly lower the midpoint of our expense guidance for the full year.

We continue to make progress on our development lease-up portfolio during the quarter. We funded an additional $26 million toward the completion of our current development pipeline. We now have $148 million remaining to fund on the 5 projects currently under construction, and we expect to fully complete 2 of these communities this year. And as Eric mentioned, we expect to begin 4 new projects later this year with a total estimated cost of around $300 million.

We continue to expect stabilized yields between 6% and 6.5% on our development projects once completed and fully leased up.

During the second quarter, we were fairly active on the financing front. We had paid off the $300 million 6-month term loan, which is due in June, and completed the renewal of our $1 billion unsecured credit facility, extending maturity until 2023.

We also established a commercial paper program during the quarter to capture lower financing costs on our routine working capital borrowings. Our commercial paper borrowings will be capped at $500 million and are fully backed by our credit facility.

Our balance sheet remains strong. Leverage remains low with debt to total assets at 32% and total debt-to-EBITDA below 5x. And we proactively used the low rate environment in the last few years to further protect our balance sheet. At quarter end, we had 85% of our debt fixed or hedged against rising interest rates and average maturity of almost 8 years, which is historical high for our company.

We also had over $670 million of cash and funding capacity under our line of credit, and our current forecast is leverage neutral for the year.

Finally, we are revising our FFO and same-store guidance for the full year to reflect the strong first half performance as well as our updated projections for the remainder of the year.

We're now projecting FFO per share for the full year to be in a range of $6.20 to $6.36 per share or $6.28 at the midpoint which is a $0.05 per share increase of our previous guidance based entirely on increased operating performance.

Given the volatility of interest rates, which is the primary driver of valuation changes related to our preferred shares, we're projecting the favorable for valuation to reverse later in the year, bringing the full year impact on earnings to 0.

With the continued strong pricing performance in the first half of the year, we are revising our full year guidance for same-store revenue to a range of 2.75% to 3.25%, or 3% at the midpoint, which is a 70 basis points increase from our midpoint of our previous guidance.

And as mentioned earlier, though we expect continued pressure from real estate taxes, we project total operating expenses for the full year to now be in the range of 2.5% to 3.5% or 3% at the midpoint. This performance will produce same-store NOI in the range of 2.5% to 3.5% or 3% at the midpoint for the full year, which is 120 basis points above our initial expectation for the year.

That's all that we have in the way of prepared comments. So Aaron, we'll now turn the call back over to you for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We can take our first question from Austin Wurschmidt with KeyBanc Capital.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [2]

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Tom or Tim, maybe -- I'm sorry, Tom or Al, you discussed that you expect continued acceleration in your markets. You highlighted July lease rates remain well above last year, occupancy is up on a year-over-year basis, but the revised guidance assumes same-store revenue growth stabilizes at a consistent level with what you achieved in the second quarter. So can you just give us the moving pieces? Or what it is you see that could drive stabilization in your same-store revenue growth in the back half of the year?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [3]

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This is Al, Austin. I'll start with that and Tom can add some if he wants to. But I think what we really think about is we're proud to see the trends that we've seen through the first half. We expect to continue to have good pricing trends, but remember we have dialed in about 20 basis points of occupancy that we expect to give up in remaining of the back half of the year to continue to be aggressive on the pricing, and so I think given all that put together, and obviously, we have the slower leasing season ahead of us. I think traffic will decline as we get on fourth quarter, late third, fourth quarter. So I think all that together tell us that we thought we had a good expectation in place and we feel good about that. I don't know if you have any more.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [4]

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Yes. I'll just say, I think we'll continue to make progress on the ERU growth with another month of blended pricing in it, 5.3% above that.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [5]

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In what month do you typically peak from a seasonality perspective?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [6]

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Last year, we peaked in May. This year, right now we -- the peak would be July. Too early to say where August will be.

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Austin Todd Wurschmidt, KeyBanc Capital Markets Inc., Research Division - VP [7]

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Okay. And then just last one for me. Based on kind of the refined supply analysis, you guys have done a lot of work on that front, but curious how the supply compares in the back half of the year versus the first half?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [8]

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Austin, this is Eric. I would tell you that we think that the supply levels over the back half of the year probably are a little bit higher than what we saw the first half. We continue to see a lot of evidence of delays occurring in the construction processes; a combination of construction labor shortage coupled with a lot of the regulatory or oversight processes at these cities and others and inspections that have to get done. A lot of these cities are really backlogged right now. So we have seen supply over the first half of this year come in a little less than we expected. And really, that's just delayed. So I think that we're in a period right now where just supply is going to continue to be fairly high. I think it's moving around a little bit, usually delayed a little bit for the reasons I just mentioned. Having said all that, I am comforted by the fact that I think we're also at a point where it's unlikely we see material increase in supply levels given the challenges that are continuing to mount on getting deals to pencil. So as a consequence of that, I just think that over the back half of this year, if I had to guess right now, I would tell you that it will be a little bit higher than what we saw in the first half this year. We'll have a lot more to say about 2020 later this year as we complete our more detailed analysis.

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Operator [9]

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And we can take our next question from Trent Trujillo with Scotia Bank.

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Trent Nathan Trujillo, Scotiabank Global Banking and Markets, Research Division - Analyst [10]

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Just following up really quickly on Austin's question there about supply. In your previous disclosures, you mentioned about 48% of your NOI would have lower supply 48 -- excuse me, 44% higher and aid about the same roughly. That was earlier in the year. With the shift of supply going into the second half, does that dynamic change? Do you happen to have updated figures to think about how supply is impacting your NOI?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [11]

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Yes. What I would tell you Trent is that I don't have the specifics here in front of me. And as I mentioned, we'll be doing a lot more detailed analysis on this as part of our budgeting process that gets underway later in the fall. But I would tell you that those numbers are -- the percentage is going to get better, is going to be a little lower, the percentage is going to get worse, it's going to be a little bit higher, and it's just shifting around a little bit over the course of this year. But as I say, a lot of the delays that we've seen take place have just pushed some of the stuff more towards the back half of the year.

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Trent Nathan Trujillo, Scotiabank Global Banking and Markets, Research Division - Analyst [12]

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Okay. I appreciate that context and look forward to the next update.

As it relates to your updated dispositions guidance, it sounded like you're exiting Arkansas completely. Why are you making that decision? And are there any other markets you're considering exiting given the pricing strength that you cited in terms of market deals?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [13]

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Well, our strategy surrounding dispositions is really built around almost really starting at an asset level and considering age of asset, CapEx requirements that may or may not be growing and sort of what the long-term value growth prospect is, comparing that to alternatives that we might be able to find with that capital. As we began to -- Little Rock's market we've been in since our days of our IPO, the 5 properties that we have there have an average age of roughly about 25 years old. So these are assets that we just felt like have reached a point in their life cycle that we need to rotate out of. And we think better to exit the market altogether versus just pulling out 2 to 3 assets out of the market given the size of that market. So that's what really drove us on that.

Going forward, as has been our approach, I mean, we will look at this every year. I think it's important that we strive to cycle capital out of some of our older assets every year. And we will look at that going forward into next year. There will be -- as it turns out, a lot of our older assets tend to be in some of the smaller markets that we have. But we also have, frankly, a little bit of inefficiency from an overhead perspective. So I think you'll see us continuing to work to clean that up over the next couple of years.

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Operator [14]

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And we can take our next question from Nicholas Joseph with Citi.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [15]

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Just going back to lease-over-lease pricing. It's obviously strong on an absolute year-over-year basis. But how does that spread versus last year trend within your expectations for the back half of this year?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [16]

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Nick, this is Al. I think as we look at the back half of the year, we certainly have seen a great spread and a lot of momentum over the last couple of quarters for a lot of reasons that Tom can talk about the reasons. I think when we look at the back half of the year, we're expecting that year-over-year spread to tighten a bit, primarily related as we talked about maybe moving into the softer leasing season or the more challenging leasing season. And you got to remember in total revenue, when you look at that, we still had a 20-basis-point occupancy. So I think, in summary, we expect to continue timing. We hope to outperform that, but that's what we outlined our plans on.

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [17]

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I would just add to that. I think that to some degree some of the lift that's occurring right now is coming out of some the legacy Post locations, and it's a combination of just market dynamics coupled with frankly just a little bit more stability now on the operating side of the platform as it pertains to those properties. And we really began to see some early trends of that emerging late last year. And so as a consequence of now going a full year, I think that, that will further support what Al is suggesting that we'll see a little compression of that on a year-over-year basis.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [18]

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If it was 170 basis points in the second quarter, where could that spread go to in the back half?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [19]

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I think we expect in the fourth quarter, which is your most challenging, to be a pretty tight spread over the prior year is kind of what we are expecting. So that's it.

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [20]

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But again, what's important to remember is that's lease over lease that we're talking about here. Now the momentum that ultimately, frankly, really matters is what's happening with effective rent per unit, which really drives revenue. And we think that, that momentum in the ERU will continue as a consequence of what has been happening with lease over lease, over the last 5 or 6 months.

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [21]

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And certainly contemplated that in the guidance, as you see, you can do the math on that, Nick, but expected revenue is with 2.8% year-to-date and 3% for the year during the quarter range average in the back half. So that -- so we still have the trends playing into strength of our portfolio. But this gap over the prior year in terms of that just improvement of the trend and we expect that to narrow a bit as we get to the end of the year.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [22]

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Makes sense. Then from a short-term funding perspective, how do you think about and expect to balance the use of the CP program versus using the line?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [23]

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We got into a little discussion on that to put that in, and we're happy to put that program in. And first of all, maybe think that as sort of one of the final ways we can use the strength of our balance sheet to lower our borrowing cost. And we're using it -- the way we're going use it, to just tell you, is to essentially do the same borrowings we would've done under our line of credit, but just do it cheaper. I mean at the end of the day, it's working capital borrowings that we're targeting. And so you'll see the borrowings on our commercial paper go up, you'll see it come down. Just like you would've seen our line of credit, and our line of credit will stay closer to 0. And so we're doing that because there are some pretty significant savings in that. Just using our balance sheet, we think we've gotten to a strong level now. And so we're not increasing, we're not taking on marginal debt and we're actually, we talked about in comments, we're improving the average maturity of our debt, extending it out. So we feel like we are getting cost savings, we're not adding risk to our balance sheet and that's how we expect to use the program. If that's -- it probably answers your question.

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Nicholas Gregory Joseph, Citigroup Inc, Research Division - Director & Senior Analyst [24]

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It does. So you'll use the line essentially as a backstop to the CP program in case there is ever any issues on the CP side?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [25]

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Exactly right. And the program, we're going to cap -- we're capping our commercial type of borrowings at $500 million, have $1 billion line and to your point fully stopping that, so we see no risk to that program or little risk.

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Operator [26]

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And we will take our next question from John Kim with BMO Capital Markets.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [27]

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On your blended lease growth rate assumption for the year, how realistic is even the midpoint of this because you got 3.9% in the first quarter, 5% second quarter. It looks like third quarter probably will get at least what you did achieve in the second quarter. So you really need a huge dropout down to about 2% even to reach the midpoint of your guidance. Can you just comment on that?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [28]

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I think it's going to be a couple of things. It's to some degree, what we've -- that -- what we talked about a moment ago in that we do see market conditions continue to be very competitive. We do think that as a consequence of supply delay in the first half of the year that is conceivable, we see a little bit more supply pressure in certain markets at certain locations in the back half of the year. So I think that factors into our thinking here a little bit, coupled with the fact the second point being that we really began to get the momentum on the lease-over-lease performance in the back half of last year. And a lot of that, as I said, was recovery taking place in some of the legacy Post asset locations. As we now come full cycle full year on that improvement trend, the comparisons will get a little bit tougher. So I think that for a couple of reasons, you'll just see the lease-over-lease comparisons get a little bit more challenging in that regard.

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [29]

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And just to make sure to add, it is very common and expected in our business, in our model, that in the fourth quarter because there's lower traffic and things, you will have a moderating blended lease over lease. We've seen that in the past. We expect that -- we expect to have good comparisons compared to prior year, but that is a typical part of our business. So I think when you think about that plus the occupancy decline that we've built in of 20 basis points, to continue to get that pricing, that drives your total revenue.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [30]

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Yes. And I'll add, John. I mean the midpoint of our lease-over-lease pricing is 3.9%. We're 4.5% year-to-date through June, so it's still implying a pretty strong call it 3.5% lease-over-lease growth for the full 6 months of the back half.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [31]

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Okay. And is there any update on the portfolio-wide rebranding?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [32]

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Nothing really to talk about of substance at this point. It's something we continue to look at and refine and work on. We'll have more to say about that as we go into next year.

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Piljung Kim, BMO Capital Markets Equity Research - Senior Real Estate Analyst [33]

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So it's more of a 2020 event?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [34]

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Yes, yes, yes.

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Operator [35]

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And we will take our next question from Haendel St. Juste for the Mizuho.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [36]

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So a question on your investment activity. So you lowered your full year acquisition expectation by $75 million. Despite an improved cost of capital here versus the start of the year and given your comments earlier, it sounds like market pricing has reached levels you're not quite comfortable with. So what's your mindset here on perhaps more opportunistic dispositions? Any other markets beyond Little Rock that you may consider exiting on an opportunistic basis?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [37]

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Haendel, this is Eric. I mean our plans for the year really and the focus we have is limited to the Little Rock dispositions. We continue to think about looking for ways to continue to deploy capital to capture growth, and between our free cash flow and the asset sales that we are triggering, that covers it. And so I mean, broadly, we like the diversification we have in our portfolio. We like the footprint. We like the balance between both some of the larger and some of the smaller markets. So there's nothing fundamental about the portfolio composition today that we think needs to be altered and needs to be changed. It's really just a combination of what are our capital needs for supporting new growth and how do we fund that growth. And I think asset sales should always be a part of that effort. And right now, we're just finding that the best usage of capital other than the redevelopment effort that we have really centers on the in-house development that we're doing as well as some of the JV development that we're doing. We're essentially prepurchasing something to be built. And when we look at the opportunities that we have to deploy capital at the moment, coupled with free cash flow and the cash postage we generated from the asset sales, it all kind of how it works, it keeps the balance sheet strong. And so doing anything beyond what we're doing at the moment just doesn't seem to be something we need to do.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [38]

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Got it. Got it. Helpful. And maybe some more commentary on the land acquisitions in the quarter. It sounds like Orlando and Huntsville, you're on track for late 2019 start. I think you previously mentioned your development yield target 6%, 6.5%. So I'm curious how the current underwriting for those 2 projects compares to the overall pipeline. And then maybe some color on how those yields compared to prevailing cap rates in those specific markets?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [39]

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Well, just to be clear, we mentioned Huntsville, that was an asset sale. We're not buying land in Huntsville. But we did buy a site in downtown Orlando. We continue to believe that based on our latest underwriting with those -- that property along with the others that we've forecasted to start and we're going to be able to deliver stabilized yield in that 6% to 6.5% range. One of the things that we look at in an effort to make sure that we're deploying capital in a value accretive manner is we take a look at what is the cap rate that we will -- that we're delivering, if you will, a new development at using today's rents, looking at assumptions that we make regarding CapEx and the management fee, and then what our all-in basis is going to be. And if we can deliver an asset today into the market at 100 basis points or more spread in terms of a cap rate versus where assets are trading at in the market today, we think that that's value-add. And in every one of these properties that we're looking to tee up to start this year, you will fit that hurdle easily. So we still think that it makes sense to continue moving ahead with the development that we are doing.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [40]

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Thanks for the clarification. But within the -- what assumptions for rent growth and expense growth are embedded within that stabilized yield projection?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [41]

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Usually, we assume 0% to 1%, if anything, in the first year or 2. And by the time we get to actually starting to deliver units, that first year we're delivering units, I guess, again it will vary by market, it will vary by project, but it may be 2% to 3%. And of course when you factor in what we always assume is some kind of lease-up concessions that we bring into it, it brings the effective rent growth down to 2% or less. So it's fairly modest assumptions, obviously, during the construction and the lease-up period before we get to a stabilized situation wherein leasing concessions can be burned off and then you get into more of a normalized 3%, 3.5%, whatever, depending on the market and depending on the particular location.

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Haendel Emmanuel St. Juste, Mizuho Securities USA LLC, Research Division - MD of Americas Research & Senior Equity Research Analyst [42]

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And on the expense side, any trending there? Or are the cost fairly locked in?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [43]

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We usually trend that pretty consistent, 2.5% to 3%, and we kind of start that on day 1. I mean generally, during the -- in the modeling in the first year or 2 during the development period, I mean, our expense growth rate exceeds our revenue growth rate.

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Operator [44]

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And we can take our next question from Drew Babin with Baird.

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Andrew T. Babin, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [45]

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This is Alex on for Drew. Just one quick one for us. We were curious if you could break down the leasing performance of Post and Legacy MAA assets in Atlanta, Dallas and Charlotte given your guys' impressive performance year-to-date. We are just curious on what the juxtaposition is in those really important markets and are hoping to hear the Post, it is really flowing through the P&L at this point.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [46]

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Yes, the Post movement certainly helped us. Blended for Mid-America is 5.3%. Post is 3.9% on an overall basis. But when you take just the assets for Post in Austin, Dallas, Atlanta and Charlotte, they're like 340 basis points better than last year and -- so that has helped a great deal.

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Operator [47]

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And we can take our next question from Rob Stevenson with Janney.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [48]

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Tom, most of your markets are outperforming expectations, but where do you see the sort of pockets of weakness? Or the smallest level of outperformance among your major markets?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [49]

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Yes, I -- Rob, I would say -- I mean, you can look at the numbers and sort of be comparative. Dallas is weaker, but it is -- it sort of moved along at a good pace. The 2 markets that were a little weaker than we expected were really Houston and Orlando. And those are -- they're still pretty -- they're both doing fairly well. We just expected a little more blended progress out of those in the first half of the year than we got.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [50]

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Okay. And then why was the per unit rate development cost so low in the second quarter? You were about $600 per unit lower than the first quarter.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [51]

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I mean it's just likely just a mix on that, Rob. I mean there are no real changes with it. But it just depends on where the availability comes on it, whether it's at a high cost renovate. We just did more lower than higher this time around, but no real strategy shift and it will change again.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [52]

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[Okay, you did] skinny redevelopments.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [53]

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I'm sorry, say again. You were blocked there a little bit.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [54]

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Yes, so you were -- so-called skinny redevelopments or you just do a kitchen and no bath or a bath and no kitchen and things of that nature that did not factor into the mix? It was just [like] that.

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [55]

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No. We didn't change our strategy there. Just which units turned are what generated the difference.

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Robert Chapman Stevenson, Janney Montgomery Scott LLC, Research Division - MD, Head of Real Estate Research & Senior Research Analyst [56]

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Okay. And then last one for me. Al, the preferred derivative numbers. Is that a onetime item? Or is that a recurring sort of amortizing thing?

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [57]

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Yes. What will happen is it will slowly, over time, amortize. We have an asset on the balance sheet now because of the favorability that's built up in that and was recorded initially. It'll slowly for about 9 more years amortize off, but it's going to be very volatile with primarily interest rate changes, Rob. And so there is no cash value to that, no change in our business. I mean that's really frustrating us. So what we do is, as you saw in our guidance, we had a very favorable amount this quarter, purely ready to the changes in interest rates, we thought that -- volatile, who knows what's going to happen. We just like to take that out. And so in the fourth quarter we set the year-to-date favorability of $0.03. We took it out in the fourth quarter and it had zero impact on earnings for this year. That's why we prefer you guys to think about it. That's really how we think about it. And so that's kind of how we viewed it.

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Operator [58]

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And we will take our next question from John Guinee with Stifel.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [59]

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Looking at your development strategy, you got 1,100 units under construction right now, mostly in the early phases, then some in lease-up. And I think you said you were going to announce 4 more in addition to what you got on Page S8. Is there a trend? Because what we see throughout the industry is more movement away from high-rise and podium and into wrap and garden, and more move maybe into secondary locations where land can be acquired at a more reasonable number. Any trends you could comment on?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [60]

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I think you're right, John. I think we are seeing more suburban garden style or midrise wrap out in some of these satellite cities and/or suburban locations and less downtown CBD type development. Of the 4 projects that will begin later this year, 1 is in downtown area of Orlando. The other 3 are out in satellite market, satellite cities in Denver and Houston and in Orlando. So I think you're right. I think you're seeing some of the capital migrate more to -- away from some of the more intercity-type locations.

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John William Guinee, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [61]

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And any comment on wraps versus podium in terms of what it costs to build and where are you getting? You see a better return right now?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [62]

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Usually, the wrap is going to be a little bit better, but -- for us right now. I mean all 3 of the locations that we're looking at are surface parked. So it varies a bit. And of course, the numbers are -- the costs are moving around a little bit, as some of the impact tariffs and other things start to make an impact.

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Operator [63]

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And we can take our next question from Hardik Goel with Zelman & Associates.

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Hardik Goel, Zelman & Associates LLC - VP of Research [64]

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You guys, during NAREIT I think it was, or maybe before that in March, you guys put out the margin for the Post portfolio and your MAA Legacy portfolio. And there was quite a spread there. What is the spread today? And where do you expect it to go maybe over the next couple of years just longer term?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [65]

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I don't have -- we don't have that right in front of us at the moment on the -- where it is right now. But I would tell you, obviously, the gap is closing. I mean we fully anticipate that the Legacy Post margin -- Post asset margin will surpass the Legacy MAA margin at some point. I think we're probably another couple of years away from that as the redevelopment effort continues to work its way through that portfolio. We got a lot of the expense gains already and that's what helped close the gap. As Tom's alluded to, we're seeing great pricing momentum out of the Legacy Post locations now that I think it's going to continue to work on that gap and it will close more over the next year or so. And then as the redevelopment continues to kick in, I think it will -- at some point, it will surpass it. I mean that was ultimately -- one of the things that compelled us on the merger transaction itself was that when you look at the 2 portfolios side-by-side, recognizing that the Post locations commanded an average rent structure that was $500 more per month than what Legacy MAA was commanding, but yet Legacy MAA had a 100-basis-point higher operating margin, we knew there was opportunity there and we'll see that continue to emerge over the next couple of years.

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Operator [66]

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And we we'll go next to Wes Golladay with RBC Capital Markets.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - Associate [67]

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As we look to the second half of the year, are you seeing any submarkets that stand out as causing maybe the biggest variance to your forecast at the end of the year from developers offering a lot of concessions and not available to push rate, any occupancy risk? Sort of like we had in uptown Texas a few years ago?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [68]

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No. And that uptown deal happened kind of as the first the leading edge of supply hit that market and I think in those places, I'm trying to think of an exception right now, Wes, and I can't. The pipeline is pretty steady. And I think we will see it taper off in the back half of the year as it always does seasonally. But I don't see us going over a cliff on pricing in any one market at this point.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - Associate [69]

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And how is the Dallas market progressing for you? Is supply now starting to move to different markets? Do you see it gradually improving as we get to next year?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [70]

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The -- Dallas is -- I mean, there is a fair amount of supply moving through the system. It is competitive, but we're making better progress there. So Dallas is a group where blended pricing is up 250 basis points. So we're handling it well. Demand is excellent. But it -- we're going to need demand to stay intact for it to continue, but we like the progress that we've made in Dallas and particularly in uptown.

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Wesley Keith Golladay, RBC Capital Markets, LLC, Research Division - Associate [71]

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Okay. And then just for the portfolio level, how is rent to income trending for new residents?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [72]

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It hadn't really budged. It's right there in that 19% to 20% range. I mean very, very steady.

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Operator [73]

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And we will take our next question from John Pawlowski with Green Street.

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [74]

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Eric, what type of blended cap rate do you think you could fetch on the Arkansas portfolio sale?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [75]

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We will see. I mean we're in the market right now. But I would anticipate something in the 5.5% range.

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [76]

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Okay. Tom, apologies if I missed this. Marketing costs were up 10%. Are you guys doing anything different on the concession front for your stabilized same-store pool?

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [77]

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No, we are not. That is not gift cards. Thank you for asking that question, John. We had some onetime expenses with -- related to the ramp-up of our new marketing platform. Expect that to trend down over the last half of the year and be in more normalized range for marketing. It never occurred to me to address that in that way, and I really appreciate you asking that.

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John Joseph Pawlowski, Green Street Advisors, LLC, Research Division - Analyst [78]

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Not coupon, it's not gift cards, it's not ...

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Thomas L. Grimes, Mid-America Apartment Communities, Inc. - Executive VP & COO [79]

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It is none of those things. Al won't let me do any of those things.

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Operator [80]

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And we will take our final question from Buck Horne with Raymond James.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [81]

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Just following up on the expenses and the operating expense guidance here. And I know property taxes have kind of been out of your control to a degree here. And I understand the comment about tougher year-over-year comp against the savings from Post last year. But I guess the question is, why weren't those savings that were achieved a little bit more sustainable on a year-over-year basis? I'm just wondering. I know you're at an elevated level historically, but why weren't those overall operating level synergies more sustainable?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [82]

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They were sustained. I think that our point is we captured those efficiencies. They are now, if you will, memorialized into our system. And so we absolutely believe that the synergies that we capture last couple of years and the margin improvement that came from that is very much intact. I think the point really is just that there is some -- it's not so much inflation into some degree. It's -- I mean you've seen some wage inflation and you're seeing some level of material -- maintenance material cost rise taking place. And so our ability to rework the staffing model or rework the model that we did last year on how we turn apartments and how we staff for that, those gains have already been captured and they are still there. But we don't have the gain this year to offset the rise that we see taking place in some of these other line items. So that's really the point that we're making. But we're absolute certain the gains that we have made over the last 2 years are very much intact.

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Albert M. Campbell, Mid-America Apartment Communities, Inc. - Executive VP & CFO [83]

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And just add on to that. In our long-term history, Buck, and you all know this, one of the things we've seen is very good expense control. It's been about 2.5% on average. 3% this year is really that some of the pressure from the real estate taxes and as Tom mentioned, in the back half of the year, some of the other expense line items are going to moderate a little bit and get us 3%. So I think we still, long term in the business, expect 2.5% range with a short-term impact from taxes as that hopefully moderates over the next couple of years as cap rates remain stable.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [84]

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That's very helpful color. I appreciate that very much. And just real quick on the acquisition guidance reduction, just how competitive it is out there. And just wondering if you can maybe just add a little bit of color in terms of what you're seeing and how competitive the bidders are. I just -- I think you mentioned earlier in the call that cap rates were stable. But it seems to suggest if your -- with your improved cost of capital and how competitive things are out there, if you're having to reduce the guidance, it seems like yields might be compressing out there. And any extra thoughts you may have there?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [85]

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I do think yields are compressing. I think that we're seeing, as a consequence of efforts by a lot of private equity to get the capital deployed, that they are at a point where, I mean, they're either getting much more aggressive on their underwriting assumptions in terms of rent growth or other line item expectations or they are compromising yields a little bit. I don't think there's been a material shift in cost of capital for them per se other than just they're forcing a more modest return on some of the equity that they perhaps were hoping to get earlier. So I think yields are compressing a little bit.

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Buck Horne, Raymond James & Associates, Inc., Research Division - SVP of Equity Research [86]

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Any chance you could kind of quantify what you think? Class A or Class B? And core Southeastern market is going for these days?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [87]

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I mean it's compressed a good bit. I mean we're literally seeing Class A assets that are trading 4.25% to 4.75% range in terms of the cap rate. An older B asset, maybe 5% to 5.5% range. It depends on the market. But it's in some cases even lower that on the Bs if you think there's a redevelopment or repositioning opportunity. That is where you see a lot of aggressive activity occurring where you will see a 10, 15-year old asset trade in some cases at a sub 5 because the plan is to go in and do a massive upgrade, and I think they'll get massive rent growth as a result and get the return thereafter and therefore, they'll pay up big time upfront.

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Operator [88]

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And we will take another question. It comes from Rich Anderson with SMBC.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [89]

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I jumped on late and I -- was the topic of rent control brought up at all on the call yet?

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [90]

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No, it was not, Rich.

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Richard Charles Anderson, SMBC Nikko Securities Inc., Research Division - Research Analyst [91]

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And so I guess the question is do you have any of that percolating through your portfolio in terms of something that could be coming down the pike that you have to defend? I'm just curious if it's happening anywhere. It's a big news item in California and New York.

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [92]

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Right. No. To be honest with you, we're not seeing really much happening in any of our markets or any dialogue along those lines. Denver, we've seen a little conversation taking place out there. But I do think that we're very alert to the growing issue of housing affordability. For the most part, throughout our southeast markets, where we see the issue kind of coming up is new development starts requiring a certain affordability component to what they do and certain percent of the units have to be limited in terms of the rent that can be charged. And at this point, anything beyond that is not something that we see being actively talked about, but we're staying very closely attuned to a lot of the local associations and State Apartment Associations. It is something we're all watching very closely.

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Operator [93]

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This does conclude the Q&A session. I'd like to turn the program back over to our presenters for any additional comments.

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H. Eric Bolton, Mid-America Apartment Communities, Inc. - Chairman, President & CEO [94]

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All right. Well, nothing else on our end. Appreciate everyone joining us this morning. And we'll see everyone, I'm sure, later this year. Thank you.

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Operator [95]

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Thank you for your participation. This does conclude today's program. You may disconnect at any time.