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Home Properties Inc. (NYSE:HME)

Q3 Earnings Call

November 6, 2008 11:30 am ET

Executives

Edward J. Pettinella – Chief Executive Officer, President, Director

David P. Gardner – Chief Financial Officer and Executive Vice President

Charis W. Warshof – Vice President Investor Relations

Analysts

David Doty – Citigroup

Michelle Ko – UBS

Richard Anderson – BMO Capital Markets

Paul Morgan – Friedman, Billings, Ramsey & Co

Michael Salinsky – RBC Capital Markets

Karen Ford – Keybanc Capital Markets

Operator

Ladies and gentlemen thank you for standing by, and welcome to the third quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the conference over to Miss Charis Warshof. Please proceed.

Charis Warshof

Thank you. Good morning, everyone. This is Charis Warshof, Vice President of Investor Relations. Thank you for participating in Home Properties' third quarter 2008 earnings conference call. You can listen to the call and use synchronized slides on our website at homeproperties.com. We also have posted our news release, supplemental schedules, and a PDF of the slides on the website. The call replay and script will be posted later.

Here with me this morning are Ed Pettinella, President and CEO, and David Gardner, Executive Vice President and Chief Financial Officer. I would like to remind you that some of our discussion this morning will involve forward-looking statements. Please refer to the disclosure statement on slide two and the Safe Harbor language included in our news release, which describes certain risk factors that may impact our future results. Each slide is numbered in the loser left-hand corner. Now David will discuss our financial results for the quarter.

David Gardner

Thanks, Charis, good morning, everyone. The first chart I will discuss is on slide three. This chart shows our funds from operations per share of $0.86, which was $0.02 higher than FFO for the third quarter of 2007, and within our guidance range of $0.85 to $0.89. The primary reason FFO was a penny less than the $0.87 midpoint of guidance was from costs associated with our non-core property in Ohio, which is consolidated in our results.

Slide four shows our core property performance for the quarter. We define core properties as same-store properties owned since January 1, 2007. On a sequential quarter-over-quarter basis, although rental revenues were down 30 basis points because of the normal lower utility reimbursement due to warmer weather, base rental income was up 70 basis points. Total revenues were down 10 basis points. Expenses were up 2.3%. NOI and the sequential basis was down 1.8%.

If you look at physical occupancy, that was flat compared to the second quarter at 95.1%, which continues to be the highest we've seen since 2000. Comparing results for the quarter to the third quarter a year ago, average monthly rental rates, including utility reimbursements, increased 3.3%. Offset by a 0.3% decrease in economic occupancy, growth in same-property rental revenue was 3%. With an increase in other income, total income was up 3.4%. Weighted average rent-per-unit is now $1,142 per month. Occupancy was 95.1%, up 10 basis points from the year ago quarter.

Turning now to expenses, we saw an increase in operating expenses at our same-store properties of 4.6% compared to last year's third quarter. The major area of increase was in repairs and maintenance and legal and professional expense. These increases were partly offset by a reduction in property insurance.

As far as natural gas heating costs go, we now have 96.4% of heating costs for the 2008/2009 heating season fixed in an all-in weighted average cost of $8.48 per dekatherm. This compares to a cost from last year's heating season of $8.21. With the wide price fluctuations we witnessed this year, we were very pleased to have just a 3.3% increase to the upcoming heating season, most of which will be absorbed by our residents.

The various income and expense changes resulted in NOI growth of 2.6% for the quarter compared to the third quarter of '07. Some of our same-property NOI reflects incremental investments in our communities above and beyond normal CapEx. After charging ourselves a 6% cost-to-debt capital and needs expenditures, adjusted NOI for the third quarter of 2008 was 0.9%. Traffic for the quarter was very good, up approximately 17% over the year ago quarter, with signed leases up 3%.

This pie chart shows our current capital structure. With a stock price of $57.95 at the end of the 2008 third quarter, those good old days, leverage was 46.1% on our total market cap of $4.9 billion, with approximately 94% of debt at fixed rates.

Looking now at capital market activities, at its meeting last week the Board raised the common dividend by a penny per quarter to $0.67, the 14th consecutive annual increase since the IPO. Despite the market turmoil of the past weeks, the Board had confidence in our future operating results and is comfortable with the adjusted FFO payout ratio of approximately 94% and our payout position relative to the apartment peer group. During the third quarter there were no stock repurchases since the stock price was low, over $50 a share, for most of the period.

On October 31st we repurchased $18 million face value of exchangeable senior notes for $13.9 million. A gain of approximately $3.9 million will be recorded in the fourth quarter, which after fees and other accruals, will add $0.07 per share to FFO in the fourth quarter.

For our 2008 guidance, first I wanted to review how we did in the third quarter compared to our expectations. For the quarter, FFO per share was $0.01 below the midpoint of our guidance range. NOI was 2.6% versus guidance of 2.8%, or about four tenths of a penny less than expected. Both revenue and expenses were slightly lower than guidance. This was due primarily to lower utility reimbursement revenue from lower utility expenses, as natural gas heating costs have come down from expectations.

Slightly lower G&A and interest expense offset the negative in core properties. The primary reason that FFO per share was $0.01 below the midpoint of guidance was from costs associated with our only non-core affordable property. This property has become more of a challenge for us and negatively affected both rental income and operating and maintenance costs.

Before I review guidance for the remainder of 2008, I would suggest that you look at our supplemental where we have provided more detailed assumptions than in the earnings news release. For 2008 we increased FFO guidance to a range of $3.44 to $3.48 per share from previous guidance of $3.37 to $3.45 per share, which is an increase of 7.4% to 8.7% compared to 2007 results. This reflects the fourth quarter benefit of the note repurchase I described earlier.

The range for the fourth quarter has been increased to $0.89 to $0.93 per share from prior guidance of $0.83 to $0.87 per share. We expect an increase in total revenue growth for the year of 3.5%. I would like to point out that the current midpoint of guidance for 2008 of $3.46 is identical to the original 2008 midpoint of guidance we gave at the beginning of the year after backing out the $0.07 for the note repurchase.

In such a difficult and volatile economic and operating environment we are very pleased that we expect to achieve our original guidance. I have raised the level of acquisitions for the year to $102 million from $50 million based on the acquisition of Saddle Brooke in Maryland, which closed last week, and one other acquisition scheduled to close in 2008.

Dispositions for the fourth quarter remain at $50 million, with a large pipeline scheduled for the first and second quarter of '09. You'll find more detail on 2008 guidance in the supplemental. I will now turn it over to Ed.

Edward Pettinella

Thanks, David. Looking first at transactions, we did not have any acquisitions or dispositions during the actual quarter, but after the third quarter closed we made our first acquisition of the year. We purchased Saddle Brooke in Cockeysville, Maryland, which is about 11 miles from downtown Baltimore. It has 468 units. This purchase price was $51.5 million at a Cap rate of 6.7%. The property fits our repositioning strategy and is about 35 years old with outdated kitchens and baths that we intend to upgrade for a rent premium of approximately 10%.

Despite the economic downturn, this submarket is extremely strong with no concessions currently being offered. We have seen market rents in this area increase by approximately 6% per year over the last 2 years. Our top field property, which is less than two miles away, has had a year-to-date rental rate increase of 7.1%, which is almost double the Baltimore region average of 3.6%.

We also have an acquisition schedule to close in the fourth quarter. This property is in the Silver Spring area, another extremely strong submarket for us, and is expected to close at a Cap rate of approximately 6.7%. These acquisitions were two positive outliers in what continues to be a very difficult acquisitions market. To make the point further, beyond this next one that we'll close in the fourth quarter, we do not have any more in the pipeline.

We continue to look at deals, but find it very difficult to make them work. Especially in the current environment, we will not deviate from our current purchase criteria. We see Cap rates continuing to trend up slightly, and the third quarter Cap rates increased probably by another 20 basis points. By our estimations Cap rates since October of last year in '07, are up about 65 basis points.

Also subsequent to the end of the third quarter, we sold one property, Village Square, 128 units, in the Philly region, for about $13.1 million at a Cap rate of 6.5%, bringing total dispositions year-to-date to $78 million. Now I'd like to give you an update on our recent property results in our key regions.

Our occupancy level has remained very strong at 95.1% for the second and third quarters and even higher for the month of September at 95.3%. In the supplemental package you'll find occupancy detail for each region. You will also find detail in the supplemental on base rent, total revenue, expenses and NOI for each region, both sequentially and year-over-year. I'll hit just a few highlights.

Base rent is up 70 basis points sequentially for the core properties and was positive in every key region. Year-over-year third quarter base rental revenues were up 2.5%, with Florida the only region showing negative growth. Chicago led the regions at 4.2% increase in base rent followed by D.C. at 3.2%. Apartment available to rent, or ATR, which is usually a good predictor of future occupancy, at the end of October was 50 basis points better than the same period a year ago, so we're feeling very good now for our fourth quarter.

Florida has had the best ATR of any of the regions at the end of October, like it did at the end of July when we last reported the figures. So we continue to see improvement in a weaker region. Florida's availability was better by 260 basis points from a year ago. The only regions with weaker ATR compared to a year ago were Baltimore by 40 basis points and Chicago by 190 basis points.

Looking at concessions, except for Chicago where market concessions increased, market concessions either remained unchanged or decreased in the third quarter in our key regions. From our perspective we have had little change in concessions, largely due to LRO, which right sizes rents. We offer no concessions in D.C., Baltimore, and Philly. In southeast Florida, the only concessions may be waiving an application fee or security deposit, and every market our concessions, if any, are significantly below what the market offers.

We currently rank our markets from high to low based on property manager's perception of market strength with Washington D.C. being number one, followed by our suburban-near city region, Chicago, Boston, Baltimore, Philadelphia, and then finally southeast Florida. That covers our recent regional property results.

Turning to our new development efforts during the third quarter, the new development at Trexler Park Apartments in Allentown, PA was completed on schedule and under budget. All 260 units are in service as of mid-August. Our yield is 7.5% with a 12% IRR. At 1200 East-West Highway in Silver Spring, Maryland the excavation, sheeting, and shoring activities are complete. The building slab at the bottom of the garage level is poured. The plumbing and electrical installations have been roughed in the garage levels. At the courts at Huntington Station in Alexandria, Virginia, excavation of the underground parking garage is underway.

Perhaps the best news on the development front this quarter comes from Falkland Chase. The Planning Board voted 4/0 to recommend to the County Council that the north parcel not be elevated to the historic master plan, essentially allowing for this parcel to be redeveloped. The next step is for the County Council to agree with the Planning Board's decision, which we expect should occur in early 2009. After that we will need approval from the project design and feel positive about that decision.

One last item before going to questions is the appointment of a new independent director, which we announced earlier this week. Steve Blank will begin his term on January 1st and is a very welcome addition to our Board. He knows Home Properties very well as he worked with many of our people on the IPO when he was Managing Director of Real Estate Investment Banking at CIBC Oppenheimer; prior to that he held similar positions at Cushman and Wakefield, and at Kidder, Peabody.

Steve is currently a Senior Fellow, Finance, of the Urban Land Institute, which as you all know is very highly regarded as an educational research resource for our industry. We look forward to Steve joining our Board, and know his financial and real estate expertise will contribute significantly in the future.

That concludes our formal presentation. Now we will be happy to answer any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Bilerman – Citigroup.

David Doty – Citigroup

It's David Doty with Michael. Just to start, can you talk a little bit about your thoughts around liquidity versus your appetite for debt repurchasing, your acquisition appetite, how you're balancing those different strategic objectives?

David Gardner

I think I kind of mentioned as far as future acquisitions we do have the one in the pipeline that is scheduled to close, and I'm sure it will close. I think we were very pleased with the financial results that we expect there, a 6.7% yield. And the one we just closed, and this one we're closing later, is from the same seller. We're looking at about an 8.5% un-levered IRR, so we're very comfortable with that kind of level.

They all come with a decent amount of debt assumption, so the equity cash needs are somewhat minimal. As I said there's nothing additional in the pipeline and I think we would, again, kind of hold to those higher underwriting standards. So in the near term it certainly could limit the availability of getting something that will meet that criteria.

Edward Pettinella

I just wanted to let you know we moved up our underwriting criteria from 7.5% to 8.5%, so that's the key and I think that's one of the key reasons why I said we probably will not see too many more deals. These two, I would say, are probably more aberrations. That would be my guess unless we're pleasantly surprised, but the hurdle has been raised on our model.

David Gardner

I think to your second part of the question on the convertible debt repurchase, we have a continued appetite. It's difficult to suggest a level. It could be anywhere from an additional $20 million to maybe $40 million, and we're talking about getting somewhere in the neighborhood of a 75% discount, so we'd need 75% of that $20 million to $40 million. We think we can even do a little better than the 77% that we just did on the first $18 million, so we're going to be prudent though.

I mean we think with a discount like that, you're looking at an IRR of 13% to 15% kind of area, so we do think it's a very logical use of our funds today. There is a $200 million bullet maturity in 2011. If we take off $50 million or $60 million of that around now, it doesn't do anything to our debt levels. It will leave them equal, but we'll certainly – if I can get it at 25% to 23% discount today, we think that's a wise thing to do with three years left on those deals.

David Doty – Citigroup

If you can just go back to the acquisitions, what was the seller in this business? It sounds like you bought two assets from him, or from them, and what were the sort of the selling process? And then lastly, you mentioned that on the most recent, on the larger of the two acquisitions that you have a refurbishment plan and expect to take rents up 10%. What's sort of your dollar amount that you expect to spend, and sort of that pro forma yield on the total capital?

Edward Pettinella

Well the first answer is that we won't say explicitly who the seller was. It's somebody we have dealt with before. They know us and felt very comfortable. They wanted to know that this deal could get closed in the fourth quarter, so it is somebody that we know well and have done other deals with and have had great success.

David Doty – Citigroup

It's just an individual?

Edward Pettinella

It's not just one individual, no.

David Doty – Citigroup

Was there a chance to offer units or they wanted the cash?

Edward Pettinella

I'm sorry, could you say that again?

David Doty – Citigroup

Was there an opportunity to offer units, or they wanted cash?

Edward Pettinella

They wanted cash.

David Gardner

I mean it would be difficult in this environment to issue units. I mean we certainly would not issue them where we were trading. We would issue them at a much higher level where we felt our stock would be worse, and past times when there's a pretty big disconnect, it's a very difficult thing to achieve.

Edward Pettinella

Then we are getting to the –I don't have the precise figures of that particular deal in front of me right now, but I will tell you that there is substantial opportunity to upgrade. The kitchens are dark cabinets. Most of the rest of them are a Euro-style, outdated, old-style ceramic tile floors in the bathrooms, dated cabinets, and fixtures, single-glazed aluminum sliders in very poor condition. The community center was built in the 70s. It needs to be revamped. There's substantial deferred maintenance.

I mean this is a classic Home Properties buy where we feel there's going to be substantial returns, at minimum 10% cash-on-cash returns, on all of these. So this, in knowing how well we've done within a few miles of this area, this was something we really wanted to jump on.

Operator

Your next question comes from Michelle Ko – UBS.

Michelle Ko – UBS

I was just – wanted to over your plans for dispositions for the rest of the year. You said another $50 million, so I think that would bring you to about $128 million for the year. Does that mean that you're shifting the balance into '09? I believe originally at the beginning of the year you had anticipated $240 million, so does that mean shifting about $112 million in dispositions to '09?

David Gardner

The figures may not be perfect, but yes, I mean I have in front of me more of a net after mortgage payoffs. I mean we're looking to net about $35 million from sales in 2008, and if you look at 2009, again net of mortgages that will be assumed it's more in the $60 million to $85 million that I expect to receive from there. But I think there's one property that was always, that we were on the fence about, but everything else that has been in the pipeline is still there and it's just a little bit of shifting going on time-wise.

Michelle Ko – UBS

And also can you tell us, have you been in talks with Fannie and Freddie Mac lately? Can you tell us how you plan to refinance some of your upcoming debt maturities?

David Gardner

Sure. I mean we have about $58 million that's maturing in the fourth quarter. We've already paid one of them off completely and just put it in the unencumbered pool temporarily, and we're refinancing some others. And I'm looking at getting a net refi of about $46 million on that $58 million that's coming due, and these are already quoted, kind of in place. If you look at kind of all-in rates on 10 years, it's going to be about 6.2%. We're looking at spreads about 230 to 235 basis points, so I would say the fourth quarter is very much put to bed.

We're also – just to kind of carry forward to next year, we have about $45 million maturing. Most of that's in the middle of the year. I can't image that we're going to have any problem there. I'm earmarking leveraging those up a little bit and ending up with about maybe $25 million more in net proceeds after those refis, but I mean anything with Fannie and Freddie is going along smooth; whether it be refis or new loans, or I know on sales we have a lot of buyers that are looking at using Fannie and Freddie, and all those transactions are going very smoothly.

Michelle Ko – UBS

And have you also been talking about upsizing maybe your LOC or negotiating a new one, because I think the current one expires in September of '09 even with the one-year extension?

David Gardner

Yes, it's premature to do that. I mean we extended one year from September '08 to '09 and we did that in the middle of the summer. I think it was actually maybe the beginning of the summer, a May, June timeframe or whatever, and it's just way too premature to have those discussions. We're planning on having those at probably April, May timeframe.

We think that a few things will settle out between then and now with just the debt markets in general and we expect to be in a better position at that time, but April, May timeframe gives us a number of months to have discussions with different parties. As we said before, we'd be interested in upsizing it, but if we just replace it that will be also comfortable.

The one thing I'd like to mention is that the lead bank in our current line, and they have the lion's share of the credit is M&T Bank, they haven't been in the news anywhere near as much as a lot of the other bigger banks that may be a little bit more leery to be involved in the line these days. M&Ts not having very little sub-prime write-downs, and I think the only write-downs I've seen recently are from some Fannie/Freddie preferred or whatever.

So I think they're in very good financial shape to continue to lead our underwriting. That's not to say that we won't test the market. I think we owe it to ourselves to do that, but we feel very comfortable that we'll able to replace that.

Michelle Ko – UBS

And lastly, I was just wondering if you've seen any deterioration in New York City yet from the economy and the higher unemployment?

Edward Pettinella

I wanted to be especially prepared for that today, because I've seen things written about the New York City market. So far we're holding up. While I'm actually looking at, and I'll give you some statistics as of just a couple days ago, I'll get you deeper into the fourth quarter. The available to rent a year ago was 5.5%; it's now 4.6%. The average, the core, now is 5.8% so we're substantially above that; better than that in Long Island. In New Jersey we're 0.2% better.

A year ago was 5.9%; we're now 5.7%, so about 0.1% better than the composite average for us right now. So just this morning, before I came into the meeting, I wanted to double check with the New York City operations, and they still do not see any effect in our markets and the suburban markets in Nassau and Suffolk County and also in northern Jersey.

One other thing that I would like to tell you is we try to go back, and we feel very strong about that New York City metro market, how it affects us in terms of the below-to-moderate income. We don't think the financial service sector will rock us nearly as much as some others. For instance, if you go back to 2001, and just to give you a sense, our core occupancy in that market was ahead by a better – by what – 1.9% in that region, and we had revenue growth of 10.3% versus 6.2%.

If you look at '02, but we beat core occupancy by 2.6% in that market and hit a 9.5% revenue growth versus 4.1%. Okay, you say that's an aberration, well '03, that region beat the rest by 2.4% and had a revenue growth of 5.3% versus the core of 3%. And then lastly in '04, at the other end of the recession beat core occupancy by 1.5% in that region and had 4.3% revenue growth versus 3.3% for core.

If you take the four-year average, occupancy in that region was 2.1% better, and revenue growth was 9.9% versus 4.2%. So in our world I would argue that those regions are expected to hold up better than some other regions that not only that we have, but across the country.

David Gardner

But just to give you two more facts that is in your supplementals, you may have seen it already, but our sequential occupancy gains in the New York Metro region were the second best, up 60 basis points, and our sequential base rental growth was third best, but above the average at 1.1%. So it's tough to see any effects today.

Operator

Your next question comes from Mark Lutenski – BMO Capital Markets.

Richard Anderson – BMO Capital Markets

It's actually Rich Anderson here with Mark and Carmen Electra. I just wanted to make sure I got this right. No concessions in Cockeysville?

Edward Pettinella

That's right.

Richard Anderson – BMO Capital Markets

What do people do in Cockeysville? Seriously, what is the –

David Gardner

It's only about 10 miles away from the urban area. It's a very upscale, upper middle class neighborhood. It's obviously – we can't say that all Baltimore is like this, but it's just experienced great rental growth. Home prices there are sky-high compared to certainly rental levels that we have seen in that area, so it's just a great area.

Richard Anderson – BMO Capital Markets

Correct me if I'm wrong, but it seems like a lot of your peers are in the preservation of capital mode, and not to say that you aren't, but you seem to be a little bit more, not aggressive, but opportunistic now about moving ahead with your investment plan. Is that a fair way to characterize where you stand?

Edward Pettinella

I think a couple of things. Partially, but it's, as you know, Rich, I'm a believer; let the marketplace come to us and not push it. The two deals we had we've gone over a year without seeing much of anything, and then this seller surfaced, that, as I said earlier we dealt with, and we think we've got very good returns. So we decided to move ahead and they're both very strong markets.

The other recent use of capital is buyback of a smaller portion of our $200 million convertible issue and those returns on an IRR basis are north of 13%. Once you get above a 20% discount, we felt that was a very good – and it's pure economic. It's affecting FFO and we felt that was something that we probably were not going to duplicate any time soon, so we think those two uses.

I also would say I don't expect, it will be a big surprise, but I don't expect a lot more acquisitions near term hitting our revised hurdle rates, so I call it more of the two special situations. Let's put it this way. The second one we didn't expect, and neither one quite frankly, but I don't see a lot more of those opportunities surfacing which will cause us to just hold on to our cash, if you will.

Richard Anderson – BMO Capital Markets

Did you talk about the maturing debt in 2010, what the nature of it was, $344 million?

David Gardner

I did talk about it. In 2010 it is one of the larger slugs of maturities. I mean it's kind of just normal secured debt that we have. I don't remember the exact numbers, but I know there's a significant amount of value embedded in those.

By the time we get to 2010 I think those loans will be at maybe 35% loan-to-value, 40% loan-to-value, and we'll have the opportunity to, depending on again what our needs are, to either leverage them all back up to 75% or leverage a portion up, and have some excess available for other uses, so it's – but otherwise, I mean, it's very typical Fannie/Freddie stuff that in today's environment is very easy to refi.

Richard Anderson – BMO Capital Markets

You talked about your exposure to natural gas for this winter season, obviously that's bounced around quite a bit, but do you think if you were to be using the spot market today, would you be leaving some money on the table because gas prices have come down, or where do you stand do you think? Just out of curiosity.

Edward Pettinella

First, I'd say the average is we're – our first goal was to try to keep our cost equal to where we were last year and I think we've been successful in doing that. We are hedged into this winter at one of the highest percentages we've been ever, 96.4%, and when we worked our way up to that level, we have been able to pick some of the near months here, in going back to your spot question, and that helped lower the average, which is at 8.48, so it's almost a push from a year ago.

It's interesting you raised that point. What we are trying to do is we're trying to lock in '09 – '10 right now, and we've got about 31% of that because the prices have dropped precipitously. Yes, if you went pure spot, we'd probably be down closer in the $7 to $7.50 range recently, but I don't have enough hair on my head to gamble like that.

I mean as you recall, our shareholders did not like the idea that we weren't hedged a few years back and we consider this a golden opportunity right now. From our consultants and our own feelings we think natural gas prices are the lowest they've been in a while, quite a while, so we're trying to lock that in and feel comfortable. We just don't see them dropping too much more from current levels.

If we're wrong, yes, we'd leave a little on the table, but we feel comfortable, and as you recall, we push 70% plus off to the residents, so our whole idea is we're trying to not rock them from year-to-year, and when we don't do that, which is good news, that allows us more opportunity to push rents.

Richard Anderson – BMO Capital Markets

I'm not suggesting you should or shouldn't hedge but I mean it's just a question just to see where you stand relative to the market. And then lastly, AvalonBay had a hard stop on their conference call at 11:30. I was just wondering if there was some reason why they wanted people to hear your call?

Edward Pettinella

Can we talk to Carmen Electra instead of you? No, go ahead.

Charis Warshof

See, Rich, what happened was we were planning to do our call at 11:00 like we usually do, and they asked if, because of scheduling issues that they had, if we could accommodate them going before us, so they went at 10:30, we went at 11:30. We were able to accommodate both of us so that's why we did it.

David Gardner

And they were nice to not go over the timeframe.

Richard Anderson – BMO Capital Markets

I'm just checking.

Operator

Your next question comes from Paul Morgan – Friedman, Billings, Ramsey & Co.

Paul Morgan – Friedman, Billings, Ramsey & Co.

Can you talk a little bit about signs of stress that you might be seeing on the tenants? Are you seeing much doubling up in the units and is this something you're keeping an eye on more now than you had been recently? And then maybe just delinquencies and are there other signs that the labor market is really starting to pinch some of your renters? And if so then what markets are you seeing it?

Edward Pettinella

So are we seeing the clear sign that the economic conditions are deteriorating would be our bad debt levels. We're at around 1.4. We've moved up I think in a 1.1, 1.2. That's a high-water mark for us over, I know since I've been with the company eight years, that would be the indication, but the doubling up we have not seen that.

The other thing and I keep asking in all our regions, are you seeing some substantial layoffs that affect our suburban sites? And the answer is no. There's nothing out there that we can really point to that we're concerned about. To substantiate that, through the month of September our occupancy was 95.3 and quite frankly as of a couple days ago, it's driving even higher than that right now, so we're getting fannies in the seats, if you will, and we're not seeing the economic conditions from a job loss perspective have a material impact yet.

Now I understand that we could fall off a cliff here. I think that's what happened in 2001 for the sector, but we usually hold up in these tougher conditions. I would make the point that we seem to be holding up even better than we did during the beginning of the last recession, so I feel pretty good about it so far. We feel pretty good how things are playing out in the fourth quarter, so, and I think as we looked at everything that's one of the reasons the Board of Directors decided to go ahead with the $0.01 increase in our dividend.

David Gardner

Just to give a little bit more color in the bad debt again, but that's really the one area that we're seeing a little bit of a queue, and from a regional point of view, the three regions that are experiencing a much higher level than the average are Florida by far is our highest at about 2.65%. Chicago is next at 1.72%, and Baltimore is at 1.58%. The rest are either at or a little below the average for the portfolio. So those three regions definitely are a little bit weaker credit right now.

Paul Morgan – Friedman, Billings, Ramsey & Co.

Any sense of people – the reason for move in being – trading down?

Edward Pettinella

We're the trade-down spot. We are starting to see, about four months ago, for the first time we started to get responses from the field that they're coming down from the A's. Prior to that point we hadn't seen it, so I think that's definitely an issue. I think that going from A's to B's, or A's to C's, is starting to happen. I think the small base what I think about 20% that probably could qualify potentially for a mortgage.

Between the banks either shutting down or substantially tightening down and/or people just not wanting to make a move right now, that's creating less churn in our portfolio. And I do think, as you've heard me say before, I definitely thing there's people leaving homes, not necessarily where they've gone Chapter 7 or whatever, they are coming to us. And those three things I think are having a materially positive impact on ATR and vacancy levels for us today.

Paul Morgan – Friedman, Billings, Ramsey & Co.

And then you mentioned doing the kitchen and bath work at your new acquisition. Could you just talk about the way you look at the CapEx for remodels in a deteriorating market and what we should maybe expect to see for that going forward versus –

Edward Pettinella

Yes. How we look at it is we've got, I mean we're backed up this year in terms of what we think we're going to save for kitchens and baths. That's why it's probably closer to $80 million projected this year, which is up from last year. You might say why is that? Because we do them basically one at a time and there's still a huge demand for the improved units, and what we look for is around a 10% minimum cash-on-cash return. We have that laid into the budget of the individual properties that are doing the upgrades and it seems to be working.

We have one particular package for the kitchen that seems to be extremely popular right now, and we're going to just keep doing it because people are willing to pay the increased rents for that. But that's been our story since the beginning. I don't see that dissipating at all right now, so whatever is going on along the East Coast markets we're in, there is a segment that are still willing to pay up for upgrades. And we're pushing it, and as you know we can turn the spigot off at any point that that does not work any more.

Paul Morgan – Friedman, Billings, Ramsey & Co.

Do you think that the market for acquisitions is pricing in upside from the rehab like it was a year ago, and maybe particular in the case of Saddle Brooke, what the delta would have been if it had been on the market a year ago? And because of the tighter capital situation, are the people kind of left willing to jump into something that may be low-hanging fruit from an upgrade perspective?

Edward Pettinella

Yes, I think, if I understand your question, first I would say this. I think what's happening to us is some of the mom and poppers, individuals that may have played in this game, they certainly have dropped off. There's a precipitous drop-off, and when you're talking about a major rehab site, yes. Home, that's our bread and butter. We're known in the industry for it, so yes, we'd probably have a competitive advantage, better competitive advantage today than we have over the last four years.

That's coming back in vogue and I do believe that's going to become even more pronounced, but that flies in the face of what I said earlier that I just don't think there's going to be a lot of sellers out there at the moment. But when they do surface the properties that were built in the 60s and 70s, I think we will stand a very good chance.

You've heard David talk about the cost of funds. We were looking at near around 6% six months ago; well we're at 6.2%. So not a substantial jump up in terms of what the all-in cost is from the agency so as long as that continues the numbers should work. And we will be, for the major rehabs, I think we will be a key player going forward.

Operator

Your next question comes from Michael Salinsky – RBC Capital Markets.

Michael Salinsky – RBC Capital Markets

Dave, you mentioned Cap rates across your markets over on a year-over-year basis were up 60 basis points. Now how would you characterize –

David Gardner

Sixty-five I think.

Michael Salinsky – RBC Capital Markets

Sixty-five basis points, sorry. How would you characterize Cap rate movement, call it in the last maybe 45 to 60 days, in light of the credit environment?

David Gardner

I mean we basically thought that was like 20 recently.

Michael Salinsky – RBC Capital Markets

On the market?

David Gardner

Yes.

Edward Pettinella

Some markets a little more and some a little less.

David Gardner

I mean that's embedded in the 65 that we just gave you.

Michael Salinsky – RBC Capital Markets

That's embedded in the 65? Second of all, any update on the progress with the plans to sell out of the Hudson Valley, as well as your opportunities you've been looking at in the Florida markets?

David Gardner

Well it's tough to get too specific with different deals out there at different points of when they're going to close, but I think the lower Hudson has been marketed earlier than the quote higher northern Hudson region. I think that the lower Hudson is going very well. There's a very good chance that it'll close by the end of this year, and we're just starting to really have a few feelers on the rest of the Hudson Valley. That could be early '09 or that could be pushed a quarter or two.

I mean the difficulty is you get into the winter months and then the question is if you find that right buyer that you can go quickly with, otherwise you may have to wait until the spring when you have a better time to market it from a climate point of view, so. But it's going very well and we definitely feel that we'll be out no later than the middle of the year next year.

Michael Salinsky – RBC Capital Markets

And then finally, in terms of – I don't know if you disclosed this yet, but do you know what the impact is going to be from APB 14-1 next year, rate to the exchangeable notes?

David Gardner

We haven't disclosed it. I know it's in our Q that's coming out right now and I'm trying to – I think it's around $0.07, but certainly '08 would quote restated and it would be $0.07 higher, and '09 would have about the same $0.07. Now certainly that's before any kind of repurchase we've just made, so I'm telling you based on the whole $200 million made outstanding.

Operator

Your next question comes from Karen Ford – Keybanc Capital Markets.

Karen Ford – Keybanc Capital Markets

I know there's been a lot of moving pieces since the end of the quarter. Can you just tell us what your line availability is as of today versus the September 30th availability?

David Gardner

I can't do that. I just don't have it today, but let me give you a different way to look at it. What I can tell you is the big moving parts that we expect in the fourth quarter. One is I expect disposition net proceeds of $35 million. I expect net refinancing proceeds of $46 million, so that's about $81 million of larger sources. On the uses we have acquisition equity of about $15 million, development needs of about $15 million and the note repurchase that we've already closed on of $18 million.

So that leaves about $48 million net, so that leaves about $33 million of net sources. As we said already, that we may find some more opportunities in the note repurchase situation that some of that could go towards, but I don't expect the line to be much different from, even if I were to do that, much different from where we ended the quarter at.

Karen Ford – Keybanc Capital Markets

On the $127 million or so that's left to spend on Huntington Station and the other project in the ground today, how much of that do you think needs to be spent in 2009? And it sounds like that's coming off your line next year?

David Gardner

First I'll answer the first question. If you look at the entire development pipeline, we have about $95 million in our cash flow for '09. Of that, I think, $25 million is discretionary on starts and haven't occurred yet, and $70 million is more associated with those two projects that you mentioned.

Sourcing, it's really across the board. I mean we've got, as I said earlier on the call, we have some disposition proceeds of about $85 million that we're targeting, that net of mortgage payoff. We have some mortgages coming due. We have some unencumbered properties in our portfolio that we could refinance, but all in all we're looking at about $140 million net from refinancing proceeds. So if you combine those two you've got about $230 million.

And the big uses would be development of $95 million, excess CapEx, so it's kitchen and bath upgrades about $65 million, and I threw in equity for acquisitions. I don't know that that will happen but let's say there was acquisitions and we needed $50 million of equity. That would all total about $210 million.

So the major things that we'd like to continue to do could be sourced, but we have some discretion in development. We have a lot of discretion in acquisitions. So I'm very comfortable with being able to source what we need to do, and also if we want to do more we have that capability also.

Karen Ford – Keybanc Capital Markets

And the kitchen and bath program is pretty discretionary as well, right? You can shut that off pretty quickly?

David Gardner

It's very discretionary. You can stop on a dime there, so again, the lease on some markets and some properties, the demand may not be there and we won't do it. But if we're going to continue to get 9%, 10%, and plus and into the low teen kind of returns on those we think it makes all the sense in the world to continue that.

Karen Ford – Keybanc Capital Markets

And last question, I notice that LIBOR resets daily on your line and there were a lot of gyrations, obviously, in LIBOR so far in the fourth quarter, is that going to have a big impact on your interest expense?

David Gardner

I don't think it's going to be too large. I mean LIBOR has come down a bit lately, but I agree with you, it's very volatile. It's hard to predict but I don't see it being a major volatile item.

Operator

(Operator Instructions) And there are no further questions at this time.

David Gardner

All right. If there are no further questions we'd like to thank you all for your continuing interest and investment in Home Properties. Have a great day.

Operator

Ladies and gentlemen that does conclude the conference call for today. We thank you for your participation.

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Source: Home Properties Inc. Q3 2008 Earnings Call Transcript
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