Good morning, my name is Lori and I will be your conference operator. At this time, I’d like to welcome everyone to the BRE properties third quarter 2008 earnings release conference call. (Operator Instructions). I will now to the conference over to Constance Moore. Please go ahead.
Thank you, Lori and good morning. Thank you for joining BRE’s third quarter earnings call for 2008. If you’re joining us on the internet today, please feel free to email your questions to askBRE@breproperties.com at anytime during this morning’s call.
Before we begin our conversation, I’d like to remind our listeners that our comments and answers to your questions may include both historical and future references. We do not make statements we do not believe are accurate and fairly represent BRE’s performance and prospects, given everything that we know today.
But, when we use words like expectations, projections or outlook, we are looking forward-looking statements, which by their very nature, are subject to risk and uncertainty. We strongly encourage listeners to read BRE’s form 10K for a full description of potential risk factors and our 10Q’s for inner room updates.
On this morning’s call, management’s commentary will cover our operating results, investment activities and financial reporting. Ed, Henry and I will provide the commentary and Steve Dominiak, our new Chief Investment Officer, is here today with us and will be available during the Q&A session.
Steve joined us in September and will be responsible for all of our investment related activities. Steve returns to BRE after most recently serving as JPI’s divisional president and managing partner for its western division. We are so pleased that Steve has joined our team and we look forward to introducing him to many of you during the upcoming NARI conference in San Diego.
Let me start with our third quarter results and the key take-always for the quarter. Our FFO was reported at $0.72 per share for the quarter and $2.09 year to day, resulting in core FFO growth of 9% for the year. These results for the quarter met our expectations. While we are pleased with the performance, the economic backdrop continues to deteriorate, further weakening fundamentals for the fourth quarter beyond the usual seasonal patterns.
We may see a modest decline in FFO in the fourth quarter and have tightened our guidance to reflect this environment. I’ll provide some comments on this later in my commentary.
Sequentially, we had positive revenue growth in all market, except the Inland Empire and Phoenix. Year to day, same-store NOI growth was 3.7%, with market rent growth of 2.8% and revenue growth rate at 4%.
As reported in the earnings release and supplement, the results depict relatively positive operating conditions in San Francisco, San Diego and Seattle. Year to date, revenue growth in these markets range from 5% to 8%. Not surprisingly, operating markets with a grazed exposure to job losses and single family housing, specifically, the Inland Empire, Los Angeles, Sacramento and Phoenix have posted weaker year-over-year results.
Revenue growth in these markets has been flat to up 1.5% year to date. Development deliveries and leasing are proceeding well and our current construction estimates, relative to cost and schedule, remain on target. Ed and Henry will discuss our operations and our financial topics. But, I will continue with our investment activities.
During the third quarter, we sold three properties in Sacramento. The proceeds totaled $72.5 million. The composite cap rate on these three assets was 6.1%. The proceeds were used to pay down floating rate debts.
Our 2007 and 2008 proceeds from the Sacramento sales totaled approximately 120 million, with a weighted average cap rate 5.9%. At the end of the quarter, we had four operating properties classified as held for sale, located in Sacramento, Seattle, the Inland Empire and the Bay Area. Also included in the held for sale line is an excess land parcel from our Santa Clara development site and we continue to work all of these transactions and will continue to report on the sales as they occur.
(Inaudible) to the close of the quarter, we sold one community in Seattle, Park at Dash Point, a 280-unit property located in Federal Way. It closed mid-October. The sale price was 30 million and we will record a gain on sales of about $15 million, which will be recognized in the fourth quarter.
The transaction cap rate was 5.7% and our internal rate of return on this asset was 14%. Proceeds, again, were used to pay down floating rate debt. Including this October sale, year to date sale proceeds total 103 million. With the anticipated year-end closings, we expect gross proceeds from property sales for the year to come in or at $160 million.
Cap rates continue to move upward, but the absence of transactional data does make it very difficult to peg with precision.
Based on the transactional data we have seen and the information we’re receiving on pending or proposed transactions, the composite cap rate for our portfolio has moved up about 65 basis points over the last year to 5.65%.
If you take a look at our supplement on page 18, the NAV exhibit, you will see the adjustments we have made by market. Where cap rates end up at the end of this cycle is subject to a great debate and speculation. There may be a period of time over the next 12 to 18 months where distressed or force selling triggers a near-term spike, but then we would expect cap rates to settle down.
Unless the 10 year treasury moves north of 5% and or the GSC abandon the apartment space, California cap rates should not rise maturely above 6%. But, this may take some time to play out and to be accepted.
We turn to our construction and development properties. There’s no material news to report with the development program. Cost and schedules remain consistent with our reporting last quarter. As three properties lease-ups, Emeryville, Pasadena and Orange continue to make progress. Emeryville, which is 224 units, achieved physical stabilization during the second quarter and is 96% occupied and today we are burning off leasing concessions.
Pasadena, which is 188 units, is currently 92% leased and is in a position to begin eliminating concessions. Orange has reached physical stabilization. We are 93% occupied. Traffic levels actually quite robust, averaging more than 110 per month and interest in the community is quite high.
However, given the operating conditions in Orange County, we would expect to see concessions at this Orange site throughout 2009.
We commence unit deliveries at our 5600 Wilshire site at the beginning of the month, as scheduled. We have delivered 119 units of the 284 and have leased about 65 units. While market conditions are tough in Los Angeles, we have executed a strong marketing campaign and market acceptance of our product is very high.
Every operator in the sub-market has cut rents over the past year and specifically, in the past quarter. We have adjusted pricing about 10% to an average rent of $2600 per unit and are using the one month concession.
Leasing velocity is close to planned. We’ll complete unit deliveries during the first quarter of 2009 and our cost and schedule estimates remain on track.
The four remaining construction sites, Anaheim, two sites in Seattle and Santa Clara are progressing very well. There has been no change to estimates for cost or schedule. Park Viridian in Anaheim and our two Seattle properties, Taylor 28 and (inaudible) will deliver units during 2009.
2009 advances for the projects under construction are expected to total about $100 to $110 million. The Wilshire La Brea development plan outlined last quarter remains intact. The current schedule will place us in a position to begin demolition mid-2009 and begin construction at the end of 2009 or at the beginning of 2010.
Capital requirements during 2009 to complete project approval, construction drawings and site prep are not significant they’re at or about $20 million. We will proceed as planned and assess funding availability for this site once we complete project approval.
For the balance of the development pipeline, we are evaluating next steps, given the current economic environment. While we enjoy a good balance sheet and have sufficient liquidity to move ahead with construction starts, we are working to slow down some of the activity. There are a number of moving parts working at once here.
First, with the well-located sites in California, specifically Pleasanton, Pasadena, Walnut Creek, the two sites in San Jose and our Seattle site on Mercer Island, we are taking advantage of the anticipated shift in commodity and labor prices and may delay starts to reduce hard costs.
Second, in some cases we are re-working land terms and prices. And finally, in some cases we may hold sites for a period of time or abandon a marginal or weaker site. Steve’s Dominiak and his team are working on the various options available and once we make determinations, we will report on the direction we’re taking.
Development and construction funding for 2008 will be approximately 150 million and we have mixed this with a combination of asset sales and line utilization. For 2009, we believe advances could range between 150 and 250 million, depending on the direction we take with the pipeline.
Current balance sheet capacity and liquidity will cover this activity. Continued property sales, following the program we put in place over a year ago and secured GSC borrowings will meet the modest debt maturities we have next year, which total about 220 million and it will also manage our overall leverage.
We’re in relatively good shape from capital standpoint and we will not make a mistake on this front. Before handing the call over to Ed, let me comment on our guidance. We tightened our FFO guidance to a range of $2.75 to $2.80 per share, taking a couple of cents at the top end of the range. In this environment, operational visibility is a week to week phenomenon. It does not take much for the ground to shift.
Our guidance started the year with a midpoint for FFO of $2.78. In our view, bringing this year in at or about that feels like a pretty good performance; not a statement of immodesty, it’s just merely a reflection of how tough the market conditions are.
When we kicked off 2008, we indicated this would be a challenging year and we set a fairly wide range for guidance that considered flat to modest job growth at the high end and abrupt and painful mid-year economic contractions across the board at the other. That’s essentially what’s occurred. Conditions have evolved from ugly to really uber-ugly and we may be experiencing another leg down as we speak.
Clearly, fourth quarter economic metrics are expected to be very poor and all industries, globally, are contracting. Our view is this recession will impact department fundamentals throughout 2009 and into 2010. Expanding on a thing we hit on earlier this year, this recession is about de-leveraging the overall economy, most specifically in the finance and single-family housing sectors and the consumer; a process that will prove to be very long and painful.
Capital preservation will continue to be the key in this environment. We recognized this in advance of the crisis and the steps we took in 2007 gave us sufficient liquidity and capacity to main our development activity. However, should the environment deteriorate from recession to depression, with a prolonged inflationary cycle, we are creating the flexibility to decelerate development and handle that scenario.
We will offer our earnings guidance for 2009 in mid-December, as we’ve done in the past few years and further on our economic and operational views at that time. I’ll now turn the call over to Ed, who will now go through our operations and provide additional market commentary.
Thanks, Connie. Good morning to everyone. There are really two different topics for consideration today. One, how we did during the third quarter and did it meet our expectations and secondly, what’s going on across our operating markets and how is it shaping our views.
Same-store performance came in just about as we planned. We took a more defensive posture at mid-year, moved some operating dry powder through concessions and got the occupancy revenue growth that we were after. It’s a great effort by the team and virtually all regions chipped in.
Revenue growth at 3.5% occupancy, occupancy at 95% and concessions still at only eight days rent, the rent roll looked great at the end of the third quarter. Expenses came in $500,000 off target and with relatively small absolute figures, a miss like that can play hell with the percentage growth results. If heavy miss in expenses takes a 2.5% percentage growth and makes it 5% and takes 4% NOI growth and makes it 3%.
The primary drivers on the expense side were non-routine repair items in So Cal and greater than expected turnover. Pardon me.
Market rents are up 3% year-over-year and occupancy at 95% is up 70 bits year-over-year and up almost half a point sequentially. This all leads to a nice sequential move in revenue, 1.2% in relatively strong year-over-year growth.
Turnover is the deceiving metric in the numbers this quarter. For the year, it still remains slightly less than the ’07 amount, 62% versus 65%. However, the sequential move for the quarter was significant. If you annualize the figures, it moved from 59% in the second quarter to 64% in the third quarter.
We experienced more on-schedule move-outs, which we covered by new leasing, but in this environment, that’s unsettling and certainly we few as a leading factor to look for the fourth quarter and 2009.
Up to this point, we’ve fared pretty well. Seattle, San Francisco and San Diego have performed quite well. Year-to-date rev growth that ranges 5% to 8% in those markets. But, for Phoenix, we have revenue growth in all regions here to date.
But, we’re an industry that’s dependent upon job growth and resident wage growth. The past couple of months have clobbered the consumer, the economy and the markets. We’re seeing actions by employers, just in the past few weeks that are consistent with the bleak economic forecast that we’re all reading and I’m going to dig into this a bit region by region for the portfolio.
I’ll start with jobs. Overall, the composite September to September movement in jobs was down a half of point, not a terrible figure, which also supports the operating results. But, when you peel back the overall information, problems begin to emerge.
Seattle was the only market with job growth; grew by 35,000 jobs, a growth of 2%. Business services picked up 16,000 jobs, up 7%. Still, the local economy got a big wake-up call when Washington Mutual was taken off the board. This bank employs 7,200 in Seattle. So, not even in the top 10 in terms of employers. Yet, the action has caused a chill in the market.
Starbucks has made public moves to reduce cost and headcount and recently, Microsoft took moves to free spending. While closures are running about 400 to 450 homes per month and that’s beginning to get some attention in Seattle.
Home prices are down 4% to 5% and unsold inventory is eight months. Against most markets, those numbers sound like paradise. But, Seattle’s now feeling the economic pinch and the check-writing experience is now creeping into leasing. We’re beginning to get some push back.
We’re fine for 2008, for the balance of the year, but the big Seattle growth move is beginning to slow, which has implications for 2009.
In San Francisco, jobs fell about a half a point or 16,000 losses. However, all the job loss was in Oakland. San Francisco and San Jose were slightly up about 5,000 to 7,000 jobs per region. If the market in San Francisco is not growing, the market here gets nervous. However, home inventories are not rising.
The inventory index is six months, but foreclosures are continuing to climb. Most of the damage is in the East Bay, which is running more than 1,500 homes per month for the last three months.
San Jose has more than 500 homes per month and San Francisco is running less than 200 homes per month.
Median home prices are down 19% in San Francisco, 22% in San Jose and 38% in Oakland. So, now to Seattle, great growth all year, we’ve got plenty of room to run relative to the rent to own gap, but as companies continue to hunker down, pricing power’s going to decelerate.
In the Inland Empire in Southern California, jobs fell 1.6% or 20,000 losses. 15,000 came out of the construction sector, 7,200 in manufacturing.
Median home prices is now 239,000, down 33% year-over-year, off 41% from the peak at fourth quarter of ’06. Inventory is beginning to clear, though, down 20% year-over-year to 43,000 unsold homes. Foreclosures are still staggering, running more than 5,000 per months, but the monthly volume has flattened since July.
In Orange County, jobs fell 2%, 30,000 losses there; ugly across the board. 11,000 came out of the financial services, 9,000 out of professional services. 6,000 construction jobs were lost and 4,000 came out of manufacturing.
Median home price in Orange County is now $440,000, down 30%. Inventories are beginning to decline, though, running at eight months. There’s 18,000 unsold homes in Orange County. Foreclosures are running greater than 1,200 homes per month. The rate of monthly growth has slowed, though.
In Los Angeles, jobs fell about 26%; 24,000 job losses. 14,000 came out of trade transportation utilities, 10,000 out of construction, 7,000 from financial services and 6,500 from construction. The TTU losses are important because 70% of that component is comprised of retail and wholesale jobs, so we’re now seeing retail jobs coming into the unemployment figures.
Median home prices are down 33% to 380,000. Inventories are running about eight months at 40,000 unsold homes. Foreclosures continue to increase, running more than 4,000 per month. We got a relatively small portfolio in Los Angeles and given how our 2,100 units are located, we may have felt the brunt of the L.A. economy first, but this market is challenged and it’s not necessarily just the job losses and it’s not necessarily just single-family homes coming into the rental stream or other types of supply because L.A.’s a relatively supply-constrained market.
Households are beginning to consolidate and have been consolidating. There’s a game-changer that’s needed and all eyes are still on the Actors Guild negotiations, which have now gone to mediation. Like all operators in Los Angeles and Southern California, we believe the recovery there will eventually be very sweet, but we’re a long ways away.
In San Diego, jobs fell about .4%, 5,000 losses that came out of construction and financial services. Home inventories are down. There’s 17,000 unsold homes, less than five months. Prices are down 26% year-over-year to $350,000. Foreclosures have flattened to 2,000 per month.
So, with Seattle and San Francisco we’ve had great performance all year, but there will be deceleration as we finish up the year and enter 2009. In Sacramento, jobs fell about 1 to 1.2%, 11,000 losses. Again, trade transportation contributed, construction, those are the two big factors.
Unsold inventory of homes is beginning to burn off. There are 14,000 unsold homes, four months worth of stock. Median home price is down 33% to $240,000. The foreclosures continue to climb, running more than 2,000 a month.
In Phoenix, jobs fell 2.3%, 43,000 losses. 32,000 of those losses were out of construction. Unsold inventory of homes here has increased sequentially, but is down 3% year-over-year to about 48,000 unsold homes, which is nine months worth of stock. Foreclosures are down 4% since July, but are still running more than 4,000 per month.
Perhaps in all that data you may have noticed a pattern. Homes are beginning to clear, inventories are beginning to decline, even as foreclosures stay at high levels. According to several economists, there’s a bit of certainty with the level of home price decline that there’s a feeling that a bottom is visible and there’s still mortgage money available for those that qualify.
It appears from a lot of economic data and forecasting that a future pattern may be emerging. Where the U.S. and global GDP may go flat to marginally down over the next few quarters and then recovery. Declining inventories point to a U.S. home market beginning to see bottom some time mid-2009, maybe a little bit later, but certainly sometime around the second, third quarters of 2009.
Yet, foreclosures in a weak job market may extend throughout ’09 and into 2010. So, essentially, a marginally slowing GDP line that begins to grow in the second half of ’09, home prices bottoming sometime in that’09 period, but job weakness continuing through ’09 and into 2010.
Job losses are expected to continue with U.S. unemployment reaching at or about 7.5% and California topping out at 8.5% and 9%. Some of those figures may be optimistic. Large employers are looking at the GDP line and taking any and all actions to cut costs, but are trying to minimize job losses. They don’t want to miss the expected growth in GDP.
The big job losses continue to be in construction, financial services, with a growing losses in retail. Basic business remain in fairly good shape, but there’ll be no growth to offset the continued losses from those other sectors.
The actions we took mid-year have us fairly well prepared, but fundamentals are weak and they’re getting weaker. We’re actively marketing into foreclosure markets and renewals are critical. We’re aggressively working with our residents to renew. We’re using concessions as we described at the end of the last quarter.
In an industry with 30-day concessions common, we've typically not used concessions and they run about one to three days rent, typically in our portfolio. This is dry powder and we're beginning to use it. We try to set our market rents at the right level and use a small concession to get the lease closed.
We're currently running about 5 to 10 days rent. Still less than the industry average and what the industry typically provides, but for our markets, even that modest concession helps to close the lease. Not surprisingly, with the combination of economic and housing turmoil, our traffic levels are high.
The real issue is the credit quality of the consumer, which may end up being the headline issue concerning the U.S. economy over the next couple of years. We're holding the line on income requirements, which in the end will help keep late payments and skips down and keep those in check; however, is the leading contributor to low closing ratios.
So overall, we like the job we've done with operations so far this year. Each market has a certain challenge that requires a different response. In general, the relationship between occupancy pricing and concession is quite good heading into the fourth quarter.
Our 30-day available metric, they can see in schedule move-outs ended the quarter at 7%, but has since moved up in the last month to more than 8%, which depicts the tough operating conditions we face and the sluggish fourth quarter that we expect.
It was a good quarter, with good results, no real surprises, but we definitely have a more challenging environment in front of us. I'll now turn the call over to Henry.
Henry L. Hirvela
Thanks Ed. I'd like to take a few minutes to touch on the financial highlight that have not already been covered by Connie and Ed. I will start by reviewing our financial position in light of the extraordinary market conditions that we have all experienced over the last couple of months.
To date, the current debt capital market situation has not had a material impact on BRE. Based on our latest projections, BRE's current sources of new capital, asset sales and the $750 million bank revolver will be sufficient to meet our funding requirements through 2009. Therefore, we will not need to access the bank or public markets to raise new capital to fund our activities through 2009.
The current balance on our revolving credit line is approximately $265 million, which is down $30 million from the end of the third quarter. Our weighted average floating interest rate in the third quarter was basically flat from the second quarter.
LIBOR rates on new borrowings have increased since the end of the third quarter and we expect to report a slightly higher average floating interest rate in the fourth quarter versus the third; however, interest expense in the fourth quarter should be flat due to the impact of asset sales and capitalized interest in the quarter.
Our funding requirements in 2009 are expected to total approximately $400 to $450 million, which consists primarily of $220 million in debt maturities and as Connie noted earlier, $150 to $250 million in development advances. We will continue to use a combination of asset sales and borrowings to fund our capital requirements.
Consistent with our long term capital recycling plan, we will target another $150 to $200 million in non-core asset sales in 2009. The bulk of the proceeds should come from the sale of properties in Sacramento. It's also likely that we will market some additional assets in other non-core markets like Phoenix and the Inland Empire to achieve our 2009 goal.
In addition to the current capacity available under our revolving bank line, we have the ability to access Fannie Mae and Freddie Mac loans and credit facilities, which could provide us a significant secure debt capacity at very attractive rates.
Currently, secured debt is 5% of total assets and it’s 8% of total debt. Over the past few years, we have purposely left secured debt capacity as dry powder specifically for market conditions such as those we are facing today.
We have reviewed the financial position of the banks in our revolving credit facility with our lead banks. The majority of our funding commitments are with financially strong banks and recent mergers and government support actions have strengthened the weaker members of our bank group. Based on our discussions, we do not currently anticipate that any of our lead banks will fail to fulfill our lending commitments under the revolving credit facility, which matures in 2012.
Just a few comments on our reported third quarter results and then I will turn the call back to Connie. Starting with the balance sheet, we classified Parkside Village and Inland Empire Property as held for sale during the third quarter. The decline in the real estate investment line for the quarter reflects this change. The assets held for sale balance at September 30th reflects this transfer, net of the sale of the Sacramento assets Connie noted earlier.
The other asset line is up sequentially by $13 million. The increase was driven primarily by the premium associated with our property insurance policy, which was renewed during the quarter and predevelopment-related costs.
Corporate G&A is reported at $14.8 million year-to-date, this is up 9.6% from 2007. The results this year are in line with our expectations and the annual increase is the result of additional staffing and increased expense for incentive stock compensation and legal matters. Full year G&A expenses is expected the lower end of our guidance range, which at the start of the year was $20 to $22 million.
Interest expense, year-to-date, is running at the high end of our initial guidance range for 2008, which was $82 to $85 million. All balance sheet items and borrowings are in line with our range of expectations for the year; however, 2008 development advances and property sales will come in at the lower end of our initial guidance range.
The lower level of development advances reduce the amount of capitalized interest in the slower than anticipated property sales delayed debt repayments, which had the effect of increasing interest expense during the year. However, this increase in interest expense was offset by the continuing NOI contribution for properties held for sale during 2008.
And now I’d like to turn the call back over to Connie.
Thank you Henry. Lori, we’re available for questions now.
(Operator Instructions). Your first question comes from the line of Dustin Pizzo of Banc of America.
Dustin Pizzo – Banc of America
Alright, thank you. Good morning.
Good morning Dustin.
Dustin Pizzo – Banc of America
Connie, given your comments on cap rates, what type of unleveraged IRRs are you targeting today on the acquisition side? And on a related note, is there some shorthand rule of thumb as to where you’d underwrite new development as it relates to what you’re seeing on acquisitions? Has that changed at all?
Yes, that’s a good question Dustin. I mean we, actually we’re not targeting any new acquisitions today. And so I think what we look at, I mean I think as we’ve mentioned in our last quarter call that we have increased our expected returns on new developments so it’s stabilized returns for new development needs to be in the high sevens, but we’re really not targeting any new acquisitions today.
Dustin Pizzo – Banc of America
Okay. And on the development side, have the future developments that were listed or that the start dates were listed previously been delayed indefinitely at this point just given the environment?
Well I think as we said, there’s a number of moving parts in that entire development pipeline as it relates to that, the land that we currently have under, that we own and then the land that’s under contract and we’re evaluating start dates, as I said Steve and his team are renegotiating contract terms and then we’ll evaluate whether we hold them for a period of time or we abandon some of them.
Your next question comes from the line of Michael Billerman of CitiGroup.
Michael Billerman - CitiGroup
Hi. Good morning. David Todi’s (ph) is on with me as well
Michael Billerman - CitiGroup
Can you walk through with concession and sort of the free rent activity, how that trended throughout the quarter and sort of what’s been the experience for the last four weeks as things have been evolving. I'm just trying to get a sense of how much deterioration has really occurred.
Are you talking about concessions releasing? Yes, Ed, why don’t you take that.
Yes. I think I’m not going to do a week-by-week or month-by-month. I mean when we decided to let concessions go out a little bit at the end of the second quarter, we expected to see the conception line move out to about six to eight days and it basically did. So that hasn’t really grown much further in the past month.
I mean I think in terms of our own expectations, we don’t really believe or we really don’t allow concessions to get much more than two weeks. So I think our expectation for the stabilized pool is that we’re not going to see that concession line move much beyond 10 days.
So it could grow to be about 8 to 10 days’ rent. Now that’s different than what we do with a leasing property where in a leasing property, you will routinely provide the four to six weeks worth of concession to maintain your moving velocity.
David Todi – CitiGroup
This is David here. Just a follow-up question and I know you talked about this a bit, can you just provide a little bit more color on the expense growth in Phoenix and Sacramento and the Inland Empire?
When you get down, if you look at how small the absolute figures are, you’re not really talking about much in terms of absolute dollars. So we had some large percentages. That’s where in the Inland Empire in Southern California, that’s where the bulk of that $500,000 variance was.
We had some non-routine items, repairs that had to occur to a couple properties during the quarter that tripped that and we had some storm repair in Phoenix in the summer. They have, it doesn’t get a lot of discussion but you do get some pretty heavy rains and the monsoons that basically come through. The monsoon season in August and so we had some storm repair to a couple properties that basically took that line up.
Your next question comes from the line of FongBolin (ph) of Goldman Sachs.
Fong Bolin - Goldman Sachs
Good morning. Question for Connie. You guys mentioned on the Wilshire development that you’re going to lease up on that rents are down 10% to $2,600 a unit with a month of free concession. Could you talk about where that is relative to your underwriting?
Sure. Let me turn that over to Ed because Ed’s been really looking at our proforma rents in relative to our lease up rents.
Yes, I think when we, probably and I guess it’s just shorted we’re probably down $300 or $400, but I think as Connie said we’ve just cut our rents about 10%. That marketplace is, I would say that Wilshire corridor, in all candor, is pretty beaten up.
I mean I think we’ve got a number of properties that are around the 5600 site that are big, class A properties and when you look at where market rents were a year ago, when we were getting our final pricing put in place to start the leasing effort, market rents there are down anywhere from a range of 13 to 20%.
So you've seen quite a bit. And this is also a market that, from ‘96 to ‘07, enjoyed average annual rent growth of almost 8%. So market rents there can recover quite a bit. We’re still talking about a pretty big absolute dollar.
I mean our rents are still about $3 a foot as is across that whole area. So that’s still a pretty healthy rent but they’re down, as I said, probably over the last 15 months, there’s probably been about anywhere from 15 to 20% that's come out of that corridor.
Fong Bolin - Goldman Sachs
Okay and then a kind of separate follow-up. Did you guys get the IRR on the three Sacramento sales you did in the quarter?
No but they were all in the mid-teens.
Fong Bolin - Goldman Sachs
Okay. Thank you.
Your next question comes form the line of Rob Stevenson of Fox-Pitt Kelton.
Rob Stevenson – Fox-Pitt Kelton
Hi. Good morning guys.
Good morning Rob.
Rob Stevenson – Fox-Pitt Kelton
Ed, when you take a look at the Inland Empire and a bunch of foreclosed homes being sold recently there, I mean where is your $1,300 and change rental rate versus home ownership in that market now?
Are you talking about rent-to-own gap?
Rob Stevenson – Fox-Pitt Kelton
Yes. What’s happened in that market especially?
Well I think all of us that know you really, the visual of you driving around the Inland Empire in a convertible looking at single-family homes is something that could be precious for all of us. I’d love to accompany you on that.
It’s a tough market out there. I would say that rent-to-own right now, where we compete is on the multiple bedroom apartments. You can get a three-bedroom home in probably rent it for about $900 a month, $1,000 a month. So it’s highly competitive with our two's and three's.
We’re still very competitive on the one's but that’s where the rub is and what we’ve experienced over the last, and Inland Empires, about I’d say (inaudible) about 18 to 24 months into this right now, 18 months into it.
So at the start of it, that was highly competitive and the shadow market was really having an impact. If you look back at some of our historical data, our occupancies were, they dipped to as low as 91% but something happens when you rent a house.
When you rent a house, you’re accepting the obligation to do all the repair work, to pay the utilities, and what we have found in the last 12 months is that we’re getting more renters coming out of the shadow market not renting the single family homes any longer and coming back into a professionally managed environment.
I think it’s helped us balance our occupancies in the Inland Empire back up to 93% or slightly north of that. I hope that helps.
I think the other thing I would add Rob is that historically, until we went to a zero-down payment, markets such as the Sacramento and the Inland Empire, which were always more affordable from a single family home perspective, the barrier was the down payment.
So single family and multi-family could live and coexist quite nicely together, but at a time when we took down payments to zero and it clearly pushed home prices up to an extraordinary amounts, that obviously were not sustainable and when we’re seeing that come back down, so I think you’re seeing home prices come back down clearly in those areas where they pushed way beyond what they really should have.
But you’re now bringing back that barrier to home ownership called the down payment and I think that that will allow, in some of these more, some of our non-core markets that we will still own assets for a period of time to coexist with single family homes. And Ed’s right, p in our apartments don’t want to mow lawns.
Rob Stevenson – Fox-Pitt Kelton
Okay and then the second question, I mean what did you guys see in terms of the trend on bad debt during the quarter and in through October? And did any markets in particular stick meaningfully out?
No. Our bad debt didn’t really move up during the quarter. We’re still running about a half of 1%. We really didn’t see that move and I think that ties back to we really haven’t changed our income requirements in terms of the credit application process.
Your next question comes from the line of El Ense (ph) of Credit Suisse.
El Ense - Credit Suisse
Hi. Can you please help me understand why the rents and occupancies in the L.A., Inland Empire and also (inaudible) strong and what is your worst-case NOI decline estimate models markets?
Well we’re probably not going to give you a worst case NOI decline in those markets right now. We’re probably going to save that for when we start talking about our guidance for 2009.
I think that the explanation on terms of the market rent growth that we’ve seen in Orange County and the occupancy and granted that’s not a lot of market rent growth and I think the explanation’s pretty candidly is that we’re catching up a little bit.
Operating team’s been working real hard down there. We probably made up some ground that we had lost in the first half of the year, we’re right where we want to be and the occupancy has to do with the fact that again there’s a lot of traffic going around the Orange County area.
And what you’re seeing is we’re beginning to see, and we don’t have great data on this, but when you look at the traffic levels, they’re running about 10 to 20% higher than what we estimated they would for this year and we’re seeing people move from the Inland Empire back into Orange County.
So if you moved into the Inland Empire to buy a house and you’ve been foreclosed on or you’re under water in terms of equity, there’s a lot of movement back into Orange County to be closer to where they were and I think we’ve been able to take advantage of that move.
El Ense - Credit Suisse
So do you think that occupancy is indeed serious, could stay strong for a while or do you expect them to drop?
Well I think we’re also going to basically wait on that until we get guidance for 2009. But I think in terms of a general sense, if you look back over previous economic cycles, previous economic downturns, recessions, the thing about California, coastal California for certain is that there was a market rent that we can all set that will maintain occupancy at or about 95%.
So we really would expect to run -- we wouldn’t be surprised to see occupancy be maintained sort of in a range of 94 to 95, 95.5% if there's a damage is going to be occur, there’s damage, further damage to occur, it’s going to happen in the market rent line.
Right. I agree.
Your next question comes from the line of Michelle Ko of UBS.
Michelle Ko – UBS
Hi. Thank you. I was wondering if you could talk more about how the conditions have changed recently over the last four weeks in terms of specific markets. Are there certain markets that maybe have been weak that you see getting weaker and which markets that have done well that are looking like they’re deteriorating, you briefly mentioned Seattle, San Francisco, if you could talk a little bit about that more.
Well I think our comments did a pretty good job with that. I’ll just offer a couple more points of color meaning Seattle and San Francisco, we’ve been running, and all of us, I think all the operators in San Francisco and Seattle have enjoyed really two, three phenomenal years. I mean look at Seattle the last three years, market rents have grown 9% plus, average annual revenue growth has just been really astounding in both of these markets the last two, three years.
Even in normal economic conditions, it’s highly unusual to push those type of almost double digit rent growth through to the consumer, to the residents without the markets taking a pause so that even if these markets were, if we were in a normalized economy, we would expect to see some type of a pause in terms of continual market rent growth at those levels.
That being said, with what’s going on, I mean just in general, I think the way to generalize or the way we feel about the check writing experience is becoming more of an issue regardless of what market that you’re in so that we would expect to see deterioration or deceleration in terms of the level of market rent growth that we would expect in San Francisco and Seattle, still positive and still not a bad figure but and we’ll get into more of that when we set guidance for ‘09 but we expect to see those markets continue to have market rent growth into ‘09, just not at the level that we’re seeing now.
In terms of the last few weeks, I mean it’s really just the continuation of the, as I said, my comments that we’ve had unscheduled move outs and that’s coming from job losses so that as I think in two or three markets, we pointed out that what’s coming into the job loss figures now is no longer strictly a construction and financial services event. We’re now seeing job losses coming in to the retail area as well so that in Los Angeles and a couple of other markets, the crate and transportation job losses are starting to get some attention.
So we’re seeing some unscheduled move outs. We’re able to cover it with new leasing but we don’t believe this is a one-quarter phenomenon. This is going to continue into 2009. That’s going to clearly impact the level of market rent growth that we’re going to get in Southern California as we get into 2009 but we’ll get more information on that when we set guidance.
Michelle Ko – UBS
Okay. And just one other question. You briefly touched on it being tougher to push rates on renewals. I was just wondering if you still expect loss to leases on renewals next year?
Well again, this is probably better, a topic better served when we set guidance, but we've learned in the last economic recession, now we were front and center because, at that time, 35% of our NOI was in San Francisco, it was a tech-led recession, we saw employment in San Francisco go up and through 10%. So we were front and center on that.
And what happens when you get into the meat of a recession is that loss to lease is the first thing that’s going to go so that all the operators will begin to aggressively market their renewals. We all say that we do anyway but there’s going to be a doubling down on that renewal activity.
So instead of going out talking to your resident renewal’s 30 days in advance, we may be out there talking to them in 60 or 90 days in advance and the loss to lease is going to evaporate across the industry in these weaker markets.
Where we still have pricing power, the loss to lease is still something that we can work with but in weaker markets if there are operators that feel that they’ve got a loss to lease, if the job market gets worse from here, that loss to lease is going to go away and you’re going to be offering aggressive terms to keep the renewal in place and to maintain your rent role.
(Operator Instructions). Your next question comes from the line of Karin Ford of KeyBanc Capital Markets.
Tom – KeyBanc Capital Markets
Tom along with Karin. Quick follow up to the last question. Do you have occupancy figures as of last week or the end of October?
No. we don’t. we’re not going to get that detailed with it. No.
Tom – KeyBanc Capital Markets
Okay. And then secondly, on the land parcel held for sale in Santa Clara, how does the $17 million book value compare to your expectations and also what are you seeing in terms of land prices in your markets given that you’re going back to take another look at some of the land on your future development projects?
When we allocate, when we bought that site, we allocated the purchase price across the acreage. We’re not expecting a gain on that, didn’t expect a gain. That contract’s been in place for the last three years so that really the buyer’s just honoring the game, the contract that’s in place.
I think in terms of land prices, I think I’ll just defer that to Steve.
Stephen C. Dominiak
We really haven’t seen enough transaction volume this year to determine whether or not there’s been substantial reduction in land prices, we’re seeing some flexibility or some changes on terms.
Your next question comes from the line of Michael Billerman of CitiGroup.
Michael Billerman – CitiGroup
Yes, Ed, I just wanted to come back on the development then, I may have missed, actually I jumped on late. On Wilshire, how does -- and I understand that you’ve cut the rents and increased the concession, how does your trended return, at least your current return, change relative to then your expectation of your trended return?
Well I think we’ve got a building that we’re finishing up and we’re going to lease it and I’m going to, I guess I’m going to answer your question but I’m going to answer it the way I want to answer it, which is when you bring a property out and you’re in a recession, the rules of engagement change.
You’re basically doing whatever it takes to stay alive and get the building filled and then you go back and you reprice the rents later when the market recovers so that we’ve marked our rents down 10%.
What we’ve discovered in the marketplace is, we’ve got some lease ups that are going on around us where some of the operators were offering up to two months’ concession. There’s no value to the extra month of a concession. What the resident’s looking for is their focus on the check writing experience. Yes, this has impacted what would be the mathematical current return right now.
What we’re looking at is where is this property going to be when we get it economically stable and where do we have to move market rents to get it back to the 6.5 to 7% return and that we need to get this building filled.
We’re going to basically get it filled during 2009 and we’re probably going to have to then hold until we get to a market rent recovery, which right now most economic forecasting is pointing toward 2011 for that market where if you look at the newspaper articles that are in Los Angeles and Orange County and San Diego right now, there’s recent articles warning renters to be on the lookout for 10 to 12% market rent growth two years from now. And all I can say is bring it on.
Yes. I think as Ed mentioned in his commentary the turnaround could be pretty sweet and rapid. So I think that’s what we would expect.
So that it’s similar to our Orange property. I think if we get to an area of market rent growth, if we get back to a point of recovery late '10 or 2011, it probably extends the period of time we’re going to need to get to our economic targeted returns, again which were 6.5% to 7% by about 18 months.
Michael Billerman – CitiGroup
I’m just trying to think about also the dilutive effect that we’ll have next year given that I assume all the interest capitalization will start hitting in the first quarter on your $135 costs.
We’re going to address that. properties always have losses at the start of their leasing period, alright and that really doesn’t change materially. The question is by the time you get the property physically stabilized so, that by the time you get to the property, 95% occupied is the market rent per unit where you underwrote and is the level of concession in a position where now you can begin burning off concessions. That’s probably the more material item. There’s always operating losses.
We’re delivering podium properties. We’re delivering bulk units. So there’s always going to be some modest losses or level of losses that are going to come through. So we’re going to have those with this property in the first half of next year.
What’s missing from the discussion is that we just leased up three properties this year, Pasadena, Emeryville, Orange, that are all physically stabilized, are capable of covering their debt plus into ‘09, will help offset some of that.
So again, I think it’s going to be at the end of 2009 when we get this property physically stable, it’s where’s that market rent number, where are we with concessions? Can we begin to burn and that’s going to tell us how much recovery we’re going to need to get to our economic target returns.
Michael Billerman – CitiGroup
That’s very helpful and then thinking just as you mentioned, the three developments that came in, in the third quarter results, those are effectively, I guess the NOI that you’re getting off relative to the implied cost of carry, that is effectively neutral or do you think there’s some accretion or dilution?
Overall it’s about neutral right now. We’re burning concessions at Emeryville. We’re burning concessions in Pasadena, but not at the rate that we had wanted to and that’s in the Los Angeles market. And as I think Connie said in her comments, we’re not in a position to burn concessions in Orange. Overall they’re neutral.
Michael Billerman – CitiGroup
And then Wilshire, is there a staged delivery at all or everything comes on in the first quarter?
It stays between now and the end of the first quarter.
Lori we did have one question from our email so let me go through that Ben Lentz from LaSalle asked if we could break out NOI from sold versus held for sale properties in the quarter. The total NOI associated with the properties held for sale in the third quarter was 2.9 million and the NOI that came from the properties sold in the third quarter was a half a million. So I hope that answers your question Ben.
Are there any other questions Lori? We’re about ready to wrap this up. We’ll take one more question if there is one.
Your final question is a follow up from the line of El Ense of Credit Suisse.
El Ense - Credit Suisse
Hi. Regarding your developments in progress, do you take on any construction loans or are they through your cash on hand and revolving credit facilities?.
We do not have any construction loans in place. We fund development draws eared with cash generated by asset sales or by drawings under a bank line.
El Ense – Credit Suisse
Okay and that’s also the plan for future developments in progress?
Yes. Yes it is.
El Ense – Credit Suisse
At this time, there are no further questions. I will now return the call to management for any final remarks.
Thank you Laurie and now we look forward to seeing all of you at NARI in a couple of weeks and thanks for participating in our call this morning.
Thank you. That does conclude today’s BRE Properties third quarter 2008 earnings release conference call. You may now disconnect.
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