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Executives

Leslie Wolfgang – Director of External Reporting

H. Eric Bolton, Jr. – Chief Executive Officer

Simon R. C. Wadsworth – Chief Financial Officer

James Andrew Taylor - Executive VP & Director of Asset Management

Albert M. Campbell - Executive VP & Director of Financial Planning

Thomas L. Grimes, Jr. - Director of Property Management

Analysts

Michael Salinsky - RBC Capital Markets

Napoleon Overton - Morgan Keegan

Paula Poskon - Robert W. Baird

Carol Keller – Hilliard Lyons

Richard Anderson – Investor Corp. Inc.

Rob Stevenson – Fox Pitt Kelton

Shelia McGrath - Keefe, Bruyette & Woods

Steve Radanovic – BB&T Capital Markets

Mid-America Apartment Communities (MAA) Q3 2008 Earnings Call November 7, 2008 10:15 AM ET

Operator

Good morning, ladies and gentlemen, and thank you for participating in the Mid-America Property Communities third quarter earnings release conference call. The company will first share its prepared comments followed by a question and answer session. At this time, we would like to turn the call over to Leslie Wolfgang, Director of External Reporting.

Leslie Wolfgang

Good morning, everyone. This is Leslie Wolfgang, Director of External Reporting for Mid-America Apartment Communities. With me are Eric Bolton, our CEO; Simon Wadsworth, our CFO; Al Campbell, Treasurer; Tom Grimes, Director of Property Management; and Drew Taylor, Director of Asset Management.

Before we begin I want to point out that as part of the discussion this morning company management will make forward-looking statements. Please refer to the Safe Harbor language included in yesterday’s press release and our 34-Act filings with the SEC which describe risk factors that may impact future results. These reports, along with a copy of today’s prepared comments, and an audio copy of this morning’s call can be found on our website.

I will now turn the call over to Eric.

H. Eric Bolton, Jr.

Thanks Leslie, and thanks for joining our call this morning. We were pleased with FFO reports for the quarter, despite continued weakness in the economy, extraordinary volatility in the debt markets, very challenging prior year expense comparisons, and steps taken to further strengthen the balance sheet, FFO was better than we expected.

FFO for the quarter was driven by stable revenue performance, lower G&A costs, and lower financing costs. Excluding the expenses associated with Hurricane Ike, FFO was $0.02 above the mid-point of our guidance, and equal to the record high third quarter FFO result reported last year.

Revenue growth was driven by stable occupancy and strong results in collections. Same store occupancy ended the quarter at a very solid 95.4%. When compared to last year’s exceptionally strong 96.4%, the 100 basis point decline did pressure year-over-year revenue performance, but given the more difficult economic environment, we are encouraged with the results. Ninety-five percent occupancy is pretty strong. Helping to offset some of the moderation in leasing conditions is lower resident turnover and vacancy lost from move outs, as compared to last year.

As we indicated would be the case in our second quarter conference call, we believe it will be difficult to push pricing aggressively on new resident leases over the next few quarters.

We were encouraged, however, by the performance in pricing renewal leases as effective pricing on leases renewals was up 4% as compared to prior year. Capturing that level of price increase, while at the same time reducing resident turnover by 6%, is pretty strong performance and brings further support to our belief that revenue performance from Mid-America’s portfolio should hold up over the next few quarters.

It’s also important to point out that two markets across the portfolio were largely responsible for the overall moderation in year-over-year revenue growth: Atlanta and Jacksonville.

Atlanta is a market where weak employment trends earlier in the year became more pronounced in Q3. Year-to-date job losses in Atlanta are 53,000 with 35,000 of those losses coming in Q3. This pressure generated a 240 basis point decline in effective occupancy for our Atlanta properties.

Jacksonville has battled a combination of new supply that came on earlier this year and weak employment conditions with 22,000 jobs lost year to date. This generated a 250 basis point decline in effective pricing for our Jacksonville group of properties.

We expect both of these markets will show improving trends next year as new supply pressure moderates and job loss trends bottom out.

While our outlook for revenue growth over the next few quarters will be impacted by weaker job growth trends, remember that Mid-America’s portfolio is not materially exposed to the oversupply of single-family homes and condo markets.

And, given our investment in a number of secondary markets in the Southeast that are not experiencing the volatility in employment conditions seen in the larger markets, we expect Mid-America’s portfolio performance will not experience as much pressure as others.

As reported in our earnings release, you’ll note that Mid-America’s stable income in smaller market segment outperformed the other two segments of the portfolio. Overall, same store leasing traffic was up on a year-over-year basis, resident turnover was down, occupancy is holding up, and pricing weaknesses largely isolated to new resident leases. As a result, we believe Mid-America is well positioned to weather this slowdown in the economy.

Longer term, the continued shift of more households to apartments and away from the single family market, along with the dramatic decline in new apartments starts, once we get some positive traction back into the employment trends, leasing conditions should turn positive and do so quickly.

As expected, same store operating expenses in the third quarter, reflected higher than normal year-over-year growth as we were comparing against an unusually low prior-year benchmark of only 0.3% growth in operating expenses.

In addition, the quarter’s results were also pressured by expenses from Hurricane Ike. Simon will give you more details on the various components driving the expense performance. But we’re comfortable that after another tough comparison in the upcoming 4th quarter, with a prior year benchmark of negative expense growth of 1.2%, we will see property operating expenses trend more in line with our historical norms.

In addition to questions about the leasing environment, the other item under focus in this market is, of course, the balance sheet. This is another component of our platform and strategy that places Mid-America in a solid position. Of the total $1.4 billion in outstanding financing, we have only $39.0 million, or roughly 3%, of our total debt facing refinancing next year. Further, in 2010, we again have only another 4% of our debt facing refinancing.

Mid-America has one of the strongest dividend and fixed-charge coverage ratios in the sector and we’ve raised $104.0 million of additional equity this year, prior to the recent collapse in the capital markets. Altogether, this puts us in a solid position to be more disciplined in our management of assets, sales, and in our pursuit of new growth opportunities. Mid-America does not have the pressure of liquidity concerns and exposure to the current debt markets associated with securing financing for new development and material re-financing requirements.

We’re very pleased with the acquisitions completed in the 3rd quarter and we remain active in the market, looking at a number of opportunities. Obviously, given the dramatic shift in the capital markets and the rise in the cost of capital over the last couple of months, we’re being very careful in our analysis and decisions of any current use of capital. We continue to believe there are going to be some terrific buying opportunities over the next year.

In summary, we believe Mid-America is well positioned to weather this period of moderating leasing conditions and volatility in the capital markets. With our exposure to a wide range of markets and a proven operating platform, we like our situation.

We have several new initiatives underway for next year that will we believe will further boost our internal growth prospects, including a new bulk cable program, a fully integrated online leasing program, and new resident utility billing programs.

Our interior redevelopment program continues to make steady progress and will make an increasing contribution to revenue growth. We have a number of lease-up and new developments projects underway that are diluting this year’s FFO by $0.16 per share. These investments will all become productive next year.

The balance sheet is in terrific shape. We have the ability to selectively and carefully pick opportunities for capturing new value for our shareholders. In all, we believe that Mid-America is in a good position to play defense as needed during this period with the added capability to jump on opportunities that these markets will undoubtedly create.

That’s all I have. I’m going to turn it over to Simon.

Simon R. C. Wadsworth

We were pleased that our third quarter FFO was ahead of our forecast, given the economic issues, the impact of Hurricane Ike, and our reduced leverage. Our top line was softer than we anticipated and property expenses showed a temporary spike, but these were more than offset by less G&A and interest expense.

As Eric mentioned, revenues were weak in Atlanta and especially in Jacksonville, and excluding these two markets, our revenue performance was more in line with our expectations for same store revenue growth of 2.5%.

We stepped up our marketing efforts after the slowdown in traffic we experienced in June and walk-in traffic was up by 2.7% over the same quarter a year ago on a same store basis.

We saw leasing conditions become more challenging as although our lease applications rose, the number of credit turndowns increased by 5%. Physical occupancy ended the quarter at 95.4% which was solid performance, as the level we achieved at the end of September a year ago was exceptionally high. Effective rent increased by 1.6%, which was the major contributor to our same store increase of 1.4%.

Our bad debt expense continued to improve with net delinquency down 9% to 0.5 % of net potential rent, although we do think credit will become more challenging as we go into next year. And so we’re taking all early steps to combat this potential pressure.

The same store concession rate dropped from 2.2% to 0.8% of net potential rent, as we continue to migrate towards net effective pricing of most of our properties.

We continue to see a reduction in the number of our residents leaving us to buy a house, down 22% from 25% of move-outs in the third quarter last quarter of last year to 21.5% this year. The number of our residents that left to rent a house is insignificant at 4% of move-outs.

Quarterly resident turnover on an annualized basis dropped from 77% to 71%, or from 63% to 62% on a trailing twelve-month basis. The same store operating expenses were above the level we projected.

As mentioned in the release, two events, Hurricane Ike and the large credit to real estate taxes last year, contributed 2.5% of the increase. A further 0.8% was due to higher personnel and make-ready costs we discussed in the release. In other words, without these unusual or one-time items our same store expense increase would have been 3.6%, more in line with our normal expectations.

As Eric mentioned, these issues should work their way through by the fourth quarter or at least by the first quarter of 2009. We’ve noted before that expense comparisons with the fourth quarter of last year will be tough, a period when our same store expenses dropped by 1.2%.

As Eric mentioned, our balance sheet is in great shape with minimal commitments, and all but $6.0 million of our developments are complete and funded. We have no further debt maturities in 2008 and just $39.0 million of debt maturities in 2009, which will pre-fund with new Freddie Mac debt during the fourth quarter.

We’re putting this brief funding in place four or five months ahead of the more normal schedule. We figure this will cost us $0.02 a share, including $0.05 a share in the fourth quarter, but we’re willing to pay this just to be doubly sure we have the financing we will need.

In 2010 our only debt maturity is our $50.0 million line of credit that we anticipate renewing in the ordinary course of business, and our major debt funding, which is through agency credit facilities, begin maturing in tranches between 2011 and 2018.

We use swaps on our credit facilities to reduce interest rate risk and these are laddered to mature over the next seven years. At the end of the quarter, we had $174.0 million of combined capacity available in excess cash, pre-committed agency credit facilities, and our bank line of credit.

We’ve continued to strengthen the balance sheet using our continuous equity program. We raised $99.0 million of new common equity through the end of the third quarter, plus a further $5.0 million in October, and we’ve averaged a net price of $52.98 before we closed down the program when REIT stock prices dropped.

Our debt stands at 51% of gross assets, down from 52% in September last year, and this compares to a second quarter second sector median of 55%.

At the midpoint of our 2008 guidance, our dividends are 66% of FFO and 83% of AFFO, both in the best one-third of the sector. Our fixed-charge coverage ratio of 2.5 is also in the top one-third of the sector.

Our cash flow and FFO are high quality, almost entirely derived from income derived from income related to apartment rentals, not from transactions or asset sales.

Our swaps and floating red debt are either directly or indirectly tied to LIBOR and increased volatility impacts our cost of funds. In the six weeks following the Lehman bankruptcy, LIBOR spiked, rising from 2.80 to 4.82%, before dropping back down again. It seems that LIBOR volatility is declining and returning to more reasonable levels. We estimate that this spike will cost us around $0.15 per share of FFO in the fourth quarter.

During the quarter, we acquired three high quality properties, which represent the kind of opportunities we are increasingly seeing as sellers become more anxious and the acquisition environment improves. We expect a blended NOI yield of approximately 6.3% from these properties in the first quarter of the first year of operation.

We targeted four properties for disposition totaling 990 units, representing a cross section of all the properties that no longer fit our objectives. At the present time we anticipate that three of them will sell for about $28.0 million, a 6.8% cap rate around the end of this year or early next year.

We’re reviewing purchase proposals on the fourth, with a possible delay of the sale until the markets settle. For the same reasons that acquisition opportunities are improving, disposition pricing is becoming a little less attractive. But we’re in the fortunate position of not needing to sell assets to raise cash to fund our business and are entirely focused on the smart recycling of our capital.

Our redevelopment program continues to generate attractive returns with interior renovations on 3,100 apartments completed through the end of September. We’ve planned to redevelop a total of 3,800 this year, at an average cost of $4,900 per apartment. So far, we’ve seen the renovated units generate an average incremental revenue per lease of $95 a month, and a 10% unleveraged IRR.

In addition, we have five exterior repositioning projects scheduled to begin this year totaling $2.0 million. We underwrite these exterior projects to generate the same kind of returns, through additional rental rates, as for our interior renovations.

We’re carefully monitoring our redevelopment program as some markets soften. It’s likely that due to the tougher economy we will tend to focus more on some of the renovate-like projects, lower investment per unit, where we don’t need to achieve such a large revenue increase. And we may moderate the number of apartments selected.

The two new development projects, Copper Ridge in Dallas, and St. Augustine, Phase II in Jacksonville, are on schedule for completion in the fourth quarter with total remaining investment of $6.0 million.

Copper Ridge has started lease-up, which is proceeding well, and at the end of October 90 of 141 available apartments were leased.

The first building of St. Augustine is just coming online and we have 19 apartments pre-leased.

Due to the rapid lease-up of Copper Ridge, we’re exploring bringing forth the construction of 45 additional units and will likely commence construction early in 2009, with a probable additional investment of around $4.0 million, partly built on 12 acres of adjacent land that we purchased during the quarter.

We’ve dialed back our expectations for the economy, and for the balance of this year we project slower revenue growth, partly offset by reduced G&A costs.

In the fourth quarter, we expect increased interest cost due to the LIBOR spike that I mentioned, and due to the early funding of the $39.0 million of 2009 debt maturity.

We’ve taken the mid-point of our FFO forecast for the fourth quarter, and for 2008, down by $0.03 from our prior guidance. We’ re now projecting same store NOI growth for 2008 in the range of 1% to 1.5%. This is based on revenue growth of 2.0% to 2.5% growth, and expense growth in a range of 3.25% to 3.75%.

We’ve previously pointed out that we have tucked comparisons in the back half of 2008 due to the very favorable insurance renewal and real estate tax adjustments that have benefited us in 2007.

The reductions in forecasted same store NOI is partially offset by increased NOI from acquisitions and by less G&A expense than we had anticipated.

We have a few more shares outstanding than we’d planned last quarter, which is modestly dilutive to FFO per share. Year to date, we’ve raised $104.0 million more equity than we originally forecasted, costing us $0.04 per share of FFO dilution for all of this year.

We expect about $0.16 of FFO dilution for the full year from the recent acquisitions of properties and lease-ups , including Taos Ranch in Phoenix and from development in properties.

H. Eric Bolton, Jr.

We hope that the key points you take away from this morning’s call are the following:

First, the fundamentals driving revenue growth, while moderating in Q3, are holding up. We expect to carry our current trends in occupancy and pricing into Q4 and 2009, at which point prior-year comparisons should turn more favorable towards the back half of the year.

We believe Mid-America’s profile, quality of product, and strength of operating platform will drive stable performance over the next few quarters.

Second, a significant aspect of the operating expense pressure in Q3 and expected in Q4 is attributable to very tough prior-year comparisons, one-time events, and trends that we expect to moderate.

And lastly, Mid-America’s balance sheet is in good shape. We’re fortunate to have raised $104.0 million of additional equity earlier this year . We have the capacity and coverage to be patient and disciplined with capital decisions during a time of significant volatility and opportunity.

And a final point that I want to make, with only a couple of months left to go this year, our revised FFO expectations for the year are within $0.03 per share at the midpoint of where we started the year.

When you consider that our original expectations did not assume we would raise any new equity this year, or that the economy would be this week for this long, or that the capital and debt markets would b this volatile, and yet, overall FFO expectations are this close to where we started t the year, it says something very positive about the stability of our strategy, the high quality of our earnings, and the strength of our operations. We believe we are well positioned for this part of the cycle and we look forward to executing on the opportunities before us.

That’s all we have in the way of prepared comments. I’m going to turn it over for any questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Salinsky - RBC Capital Markets.

Michael Salinsky - RBC Capital Markets

Eric, you talked about Jacksonville and Atlanta, are there any other markets right now that you are seeing really concerning trends?

H. Eric Bolton, Jr.

You know, Mike, I would say, generally not, but I’m going to let Tom answer that question.

Thomas L. Grimes, Jr.

The good news is generally not in a place where we have a high concentration. South Florida and Phoenix, though, on an absolute basis, have seen the most job loss with about 116,000 jobs here today in Phoenix and over 100,000 in South Florida.

But we’ve held up fairly well in those markets because of location and frankly, low exposure. Those are the two toughest.

H. Eric Bolton, Jr.

As you know, we only have one property in south Florida and two in Phoenix, so it’s not a big component of our portfolio.

Michael Salinsky - RBC Capital Markets

So the rest of the Texas markets and everything, Memphis, Nashville, they seem to be holding up pretty good?

Thomas L. Grimes, Jr.

Yes, it’s all holding up fairly well. Our big exposure on the tough side was really Jacksonville and Atlanta this go around.

Michael Salinsky - RBC Capital Markets

Can you talk a little bit about acquisitions, are you seeing any distress out there, where is asset pricing right now?

H. Eric Bolton, Jr.

We are definitely seeing some distress out there. We’re seeing a lot of deals that we’ve passed on or that we put numbers out on that are coming back, and I couldn’t being to tell you where cap rates are right now. There’s not a whole lot, as you know, trading hands right now. Not a lot of activity happening. There’s still a spread, I think, between the bid/ask, and there’s still a sort of a point of who’s going to blink first I think is still out there.

I think that if the fundamentals continue to hold up, I think we’re going to continue to see transaction volume remain somewhat low simply because I think if the sellers can hang on, I think they’re going to definitely hang on.

But you know, where we’re seeing the best opportunities and the most distressed are clearly in the lease-up situations. Developers are having a very difficult time. Of course there’s some real distress out there with some of the failed condo projects and frankly, just anybody that’s facing any sort of re-financing requirement over the next year tends to be a little bit more motivated to make something happen.

Michael Salinsky - RBC Capital Markets

Where are your target rates right now for new acquisitions?

H. Eric Bolton, Jr.

Target rates?

Michael Salinsky - RBC Capital Markets

Yes.

Simon R. C. Wadsworth

Our hurdle rate? Well, obviously our cost of equity has risen dramatically, and you know we use this dividend discount model primarily to evaluate our hurdle rate. I think our dividend yield now is probably 7.5%, so it takes using this long-term growth rate to get up to 15 %to 15.5% hurdle rate return on equity.

Michael Salinsky - RBC Capital Markets

I know you haven’t given guidance for 2009, the bulk cable program you announced, how much should we look for that to contribute to earnings next year?

James Andrew Taylor

We like bulk cable. It’s something that we’ve got testing right now and something that, with our one connect bulk cable program, it’s generally good for us and good for our residents, but it’s certainly not without risk, it’s not a lay down deck, so we want to approach bulk cable, you know, somewhat cautiously, much like we would do any other major new initiative.

I think the long and short of it is right now we have $1.4 million in cable revenue. Most of that is traditional. Next year we expect to grow at something on the order of $600,000 and then in 2010 another $750,000 or something like that.

Michael Salinsky - RBC Capital Markets

So not a significant contribution next year but probably the year out?

H. Eric Bolton, Jr.

$600,000 would be the number for next year, which is meaningful, that’s $0.02 a share and then maybe $750,000 the year after, so it’s meaningful.

Michael Salinsky - RBC Capital Markets

There are no expenses associated with that?

James Andrew Taylor

That’s net revenue.

Operator

Your next question comes from Napoleon Overton - Morgan Keegan.

Napoleon Overton - Morgan Keegan

A couple of things, the $0.16 estimated dilution from development projects this year, do you think that stays about the same next year? Does it go up or down, what’s your gut feeling?

H. Eric Bolton, Jr.

Al Campbell is going to answer that for you.

Albert M. Campbell

$0.16, that’s going to improve pretty significantly next year as some of these projects begin to become formed better and begin to meet expectations. We expect it to do down to about $0.10 next year.

H. Eric Bolton, Jr.

Go from $0.16 to $0.06.

Napoleon Overton - Morgan Keegan

Does that response incorporate any anticipated new projects or unanticipated new projects?

Albert M. Campbell

No. That’s current projects in place now. It does include the latest ones we did in Atlanta that was somewhat lease-ups we bought a few months ago and ends at Lion’s Gate, that has slight lease-ups that remain, but that’s it.

Simon R. C. Wadsworth

And if we go ahead with this expansion of Copper Ridge, which is a couple of buildings, that would an additive to that, and then you know it’s a good point that we might find some really good struggling lease-up so we might try to buy.

Napoleon Overton - Morgan Keegan

I know you don’t know the answer to this question, but if you were to take a reasonable estimate at acquisition volume over in 2009, what would a reasonable man estimate that might be?

Simon R. C. Wadsworth

My guess is in normal times we would be modeling $150.0 million, but we’d probably be going in with an estimate more like $100.0 million next year, just because we’ve got to look at all the alternatives when we go into next year, but I think that would be a reasonable man’s.

H. Eric Bolton, Jr.

And I would tell you that in this environment, the acquisitions that we would be looking at, I mean, obviously, as always, we ‘re looking for an internal rate of return that’s in well in excess of our cost of capital.

We are a little more sensitive to putting money out that has current dilution impact right now and thus if our acquisition volume next year was say, $100.0 million, I certainly would hope that a good component of that would be break-even to slightly accretive next year, in terms of FFO. There may be some dilution associated with putting that money out but we just don’t know yet.

Simon R. C. Wadsworth

The other component, which we really haven’t talked about is that we are going to be trying see if we can put the fund, too, and a joint venture together, which again we would hope that we could, which would be additive to earnings and we’re obviously we’re just beginning work on that and we don’t know the demand for that kind of a value-add type of fund but we’re going to be working on that and probably with a goal of maybe $150.0 million of acquisitions in that next year, if we can make it happen.

Napoleon Overton - Morgan Keegan

Simon, what was it, I think I understood you to say in your remarks that you had about $174.0 million in total capacity between cash and excess facilities and bank lines of credit. The difference, if I understood that right, between that and the $132.0 million availability that shows up in the text of the press release, would be what?

Albert M. Campbell

$132.0 was on the agencies alone. And the other was on our credit line with Commercial Bank [inaudible].

Napoleon Overton - Morgan Keegan

So when would you expect in this cycle, when should we expect concessions to start edging up? They’ve been coming down for several quarters in a row, when would you expect them to begin to edge up?

James Andrew Taylor

Just to give you a yield management perspective on it, we’re sort of a net pricing operator now. We really don’t employ concessions as part of our model so I think what you would see, really rather than concessions go up, you know, in a weaker leasing environment, you see front-end pricing go down.

I think what we’ve seen, in the third quarter we saw our new lease pricing go down about 1%, our renewal pricing go up about 4%, all the while maintaining an occupancy, a stable occupancy, at 95% +. So I think that’s what LRO tends to do in a weaker leasing environment, which is hang on to occupancy, and if there’s a trade-off, it’s sort of to give up a little bit on front end on rents.

H. Eric Bolton, Jr.

You seem to refer more and more to what we call, refer to, net effective pricing, which is really the combination of rent change and any concession change, and we just use that metric now because it kind of brings everything into play, but the idea of going back and using a lot of concessions, that’s really not in our business model any longer.

Operator

Your next question comes from Paula Poskon - Robert W. Baird.

Paula Poskon - Robert W. Baird

Could you talk a little bit about any information you might have, anecdotal or otherwise, about trading down trends among tenants or doubling up?

Thomas L. Grimes, Jr.

We monitor that a little bit and sort of the main thing that would indicate the trend down would be an abandonment of our one-bedroom units, you know as people double up, and we’ve monitored pretty closely, they remain in our highest lease percentage unit in the portfolio. So that’s sort of the key thing.

And then we also measure a number of resident quality metrics, but I don’t think that’s quite what you’re after right now, it was really the trade-down answer, is that correct? And we’re not seeing that right now.

Paula Poskon - Robert W. Baird

And then just keeping with the tenant profile discussion, have you made any changes to your desired credit profile?

James Andrew Taylor

We have made, I would say, some targeted, small changes, but , you know, our credit profile is something certainly that we take very seriously and you know there are a lot of implications to lowering those and making any sort of dramatic shifts in the way we approve people.

So, I would say we’ve made some slight modifications in certain situations where we feel like we could give up a little bit in terms of our quality so that we can attract, perhaps, more people, move in more people, but I think, in general the answer is no.

H. Eric Bolton, Jr.

I would tell you that in n effort to maximize revenues and capture the best occupancy performance we can, we’re willing to trade-off on pricing as needed, but we’re very unwilling to trade off on credit quality to get there.

Albert M. Campbell

And the results, you know, of net delinquency 0.5% of total net potential, you know, it would support that pretty strongly.

Paula Poskon - Robert W. Baird

Turning to the portfolio activity, some folks have mentioned to me that maybe you are, have gotten in to, markets like Phoenix and what not, a little bit early given the projected downturn that’s still to come. How would you answer that criticism?

H. Eric Bolton, Jr.

I think that when markets are down, that’s when you want to be in there buying, honestly. I think the Edge at Lions Gate, the one we just bought, I mean we bought it on a basis of where we expect the market to be very weak for some period of time, and as long as you buy on those expectations and your model supports that kind of assumption and it’s still, at the end of the day, you believe capture and internal rate of return that is well in excess of our cost of capital, which is really what drives our decision, then we think it’s a good decision to make.

And so we bought that property with the full knowledge that that market is going to be pretty weak, I don’t remember the specifics , we can get them for you, but I’m sure we‘re carrying pretty extensive vacancy assumptions and minimal and no rent growth for probably at least a couple of years.

So I think that that’s where some of the best buying opportunities in terms of your ability to buy at a discount to replacement value and to buy on a basis that’s going to drive a very attractive IR, you want to go into these distress situations, and as long as you understand that you’re going to have that kind of distress for awhile and dial that in your assumptions, it’s the right way to go.

Paula Poskon - Robert W. Baird

And just thinking about the timing of those recent purchases versus where you think your hurdle rates have moved, just given that your given pricing model, do you think that those projects would still pencil out given your new hurdle range?

H. Eric Bolton, Jr.

What we do is we take our cost of capital and then we put a safety cushion, if you will, on top of that, and so the answer is yes. I think that even with a cost of capital today versus where it was 60 days ago, I’m confident that it would still be in excess of our cost of capital in terms of the return we expect to capture.

Paula Poskon - Robert W. Baird

Can you just help me understand your approach, your philosophy, around utilizing the controlled equity offering? I know in your prepared comments you had said that you’ve ceased that with the recent sell-off, but at what levels do you think you’d like to see your share price get to before you’d consider re-instituting that?

Simon R. C. Wadsworth

We obviously don’t disclose that, but clearly we’re very unhappy with the current stock price and when the stock did start to go, I mean, you can to some extent gather from the average price that we sold at, which is about $53.00 net-net net, that sort of says something about where we are willing at sell at. But I think a lot would have to do with what we see on the horizon in the way of deal potential and if we absorb a flurry of really knockout deals, then we would be much more prone to do something.

But clearly at the current levels, where honestly, we’re trading, at the way we look at it, at about an 8% cap, about $61,000 a unit, we’re very reluctant to give away the company at that price. So it’s a bit of a long-winded answer, but you kind of get where we’re coming from.

Operator

Your next question comes from Carol Keller – Hilliard Lyons.

Carol Keller – Hilliard Lyons

On your recently acquired Brookhaven asset, how much did you pay for that?

H. Eric Bolton, Jr.

Sanctuary at Oglethorpe, you’re referring to?

Carol Keller – Hilliard Lyons

Yes.

H. Eric Bolton, Jr.

$38.5 million.

Carol Keller – Hilliard Lyons

And what kind of renovations are you expecting to do on that and how much do you think that will cost?

Simon R. C. Wadsworth

It’s about $8,000.00 a unit, I think is what we’ve got scheduled over about three years, if I remember right.

H. Eric Bolton, Jr.

What it starts with, frankly, is some upgrades to the amenities area, and the leasing center, and some of the common areas, and then, after the first year, our plan is to move into the unit interiors and after that, you know this is a property that is very, very well located half-way between Brookhaven and Buckhead, right across the street from Peachtree Golf Club, and every unit has a garage attached to it, so there’s huge floor plans, so we really think that the opportunity here is quite significant and we’ll get into the interiors in years two and three which will involve the counter-tops, the cabinetry, light fixtures, the faucets and things like that.

Carol Keller – Hilliard Lyons

What kind of rent are you charging on that asset now?

H. Eric Bolton, Jr.

Let us pull that information on that, we don’t have that handy right now in terms of the current rents at that property.

Carol Keller – Hilliard Lyons

But it’s probably much higher than some of your other assets.

Thomas L. Grimes, Jr.

Just that real estate alone, locations, that is far and away probably our highest rent per square foot in Atlanta.

Operator

Your next question comes from Richard Anderson – Investor Corp. Inc.

Richard Anderson – Investor Corp. Inc.

You didn’t say anything, I don’t believe I heard anything, about your Preferred H stock.

Simon R. C. Wadsworth

We put something in the press release about it. We believe we have no current plans to call that. And, so it is callable as you know, but we have no plans to do so.

Richard Anderson – Investor Corp. Inc.

I was wondering if you had considered at all buying any off the market with it selling about $20.00.

Simon R. C. Wadsworth

We have, and we don’t have any current plans to do that either.

Operator

Your next question comes from Rob Stevenson – Fox Pitt Kelton.

Rob Stevenson – Fox Pitt Kelton

Back to the Atlanta redevelopment asset, does it make sense, are the rents that you could get out of that now, still the bump, still great enough, that you would, in a weakening markets spend redevelopment dollars, or do you think that you just wind up postponing that and waiting until the market will drive, will accept higher rental rates, to warrant the investment?

H. Eric Bolton, Jr.

I man the way we do any of these redevelopment projects is we sort of test the market, particularly when we get into unit interiors, we will do a few units and make sure that we are getting the rent bump that we thought we would.

Having said that, clearly if Atlanta continues to show weakness throughout next year or maybe even into the following year, and we don’t think we can get the rent bumps, then we’ll hold off. We’re not going to put the money out unless we think it wise.

Rob Stevenson – Fox Pitt Kelton

I know it varies from market to market, but call it a $750.00 average rent in the portfolio, what’s the gap between the cost of home ownership, especially something like foreclosed housing and the vast majority of markets relative that rental market rate?

H. Eric Bolton, Jr.

Obviously it does vary quite a bit by market, and in the Southeast, we frankly, single family housing has always been readily affordable, and the gap and between renting and owning has never been as significant as you see in some of the coastal markets, and so on average, the gap is a couple hundred bucks, maybe more than that, maybe $500.00. It will vary by market.

But for us, quite honestly, in a region where single family housing has always been readily affordable, the pressure point for us over the last few years has been the ability for people, renters, to move into home ownership because they could do so, with no down payment, generally, with no established credit, per se, or maybe even weak credit, and the ability to secure financing to buy the home was really the driver. It wasn’t the pricing issue, it was just the ability to get the financing, and they didn’t have to come out of pocket for it. So that, of course, has now changed and the mortgage market is a little more disciplined about their lending practices and we think it will be that way for quite some time.

Rob Stevenson – Fox Pitt Kelton

What is the sort of max that Fannie and Freddie are currently out there lending on a LTV basis these days?

Albert M. Campbell

I think the max would be somewhere around 75%. That’s certainly not what we’re going for, but I think they can get that high for the right borrower. We typically are going for the 65% to 70% route.

Simon R. C. Wadsworth

And they might say it’s 80% but it would probably end up being 75%.

Albert M. Campbell

The underwriting is much more disciplined and the coverage ratios and those things are very tied on, so they may broadcast 80% and then work their way back to actually 75% on the proceeds.

Rob Stevenson – Fox Pitt Kelton

Given the type of buyers that you’re generally selling assets to, can they really make the numbers work at 75% LTV?

Simon R. C. Wadsworth

We’ve got four properties that we’ve got being marketed right now. One of them is, the buyer is using bank financing and I honestly don’t know what LTV he’s using, but the other three that we’re talking to are using Fannie and Freddie and, again I really don’t know the answer, but of the four properties, we’ve got three contracts actively working and two of them have said they’ve got their Freddie and Fannie financing sort of lined up, so.

But whether they’re at 75% or 65%, I don’t know, but I‘m assuming you’re right and that they’re probably right at 75%. Now, clearly as we said on the call, the disposition market is suffering from the same issues as the acquisition side of it and it’s not as easy as t was. There are fewer buyers but there are a lot of people out there looking for apartment real estate.

Operator

Your next question comes from Shelia McGrath - Keefe, Bruyette & Woods.

Shelia McGrath - Keefe, Bruyette & Woods

I was wondering if you could discuss the long- term debt financing strategy? Are you still think that having the large facilities with Fannie and Freddie is the most efficient way to go?

Simon R. C. Wadsworth

Yes, we’re very sold on the facility as the way to go. I think the question we have to see going forward is whether that pricing that Fannie and Freddie are going to put on those facilities is going to be competitive.

I think we’ve also got to accept the fact that 2010 when we begin to think about the credit facility maturities that begin in 2011, we’ve got to revisit our refinancing strategy. And I think everything is on the table, because we don’t know what the new administration is going to do or what their attitude toward Fannie and Freddie is going to be.

Clearly, we’ve seen Fannie’s and Freddie’s spreads widen and clearly, Al, I think you would say that their credit facility pricing has become relatively unattractive relative to single asset pricing.

Albert M. Campbell

Yes, it has. Mostly Treasury-plus financing is best for us right now. And I would also add to that, too, that in looking at our contracts, it’s important to remember we do have long-term contracts. We’re always looking at the best strategy for the company. Our contracts are long term, and if it becomes necessary to allow for an orderly exit, to find the right product, the right approach, and that’s the important to remember, I think.

Shelia McGrath - Keefe, Bruyette & Woods

On percent of floating rate, what are you comfortable with now, looking into next year? What percent do you feel comfortable with left floating?

Simon R. C. Wadsworth

The strategy we have used is to have somewhere between a low of 10% and a high of 30%. We are right now at about 20%, give or take a percent floating, and I think we would probably feel pretty good about keeping it about that level. And obviously we’re going to be looking at that.

We’ve got probably $100.0 million of swap maturities next year, that we’ll be replacing. I think one comment I would say is that we’ve seen, Al has seen, that some of the Fannie and Freddie products with caps, as opposed to being just pure swapped debt, has become pretty attractive from a pricing standpoint.

So, it may be next year, if we go with some financing in addition to our current facilities, if we were to find the need to do that, we might be looking at some floating products with caps. But, otherwise, I would look to keep it at 20%.

Operator

Your next question is a follow-up from Michael Salinsky – RBC Capital Markets.

Michael Salinsky – RBC Capital Markets

The cap rates on those three Q3 transactions were?

Simon R. C. Wadsworth

The NOI yield was about 6.3% on those three transactions and that would put the cap rate at about 5.6%, something like that.

Michael Salinsky – RBC Capital Markets

Eric, one of your peers put a presentation on recently, suggesting negative growth next year. Now, just given what you’re seeing with the home ownership rates, job growth, I mean, do you think revenue growth was negative at this point or do you think you can hold in there at this point?

H. Eric Bolton, Jr.

I think, for our portfolio, collectively, we don’t think we’re looking at anything approaching negative growth next year in revenues. We believe that with the turnover continuing to show positive trends, with the mix of our markets that we have, as you know with a larger presence that a lot of others in the some of the secondary markets across the region, coupled with just absolutely, supply has just shut down, and we’re not seeing any pressure from that. We still had a little that came on early this year, as I mentioned in Jacksonville and Atlanta.

But on a macro basis, we don’t think we’re looking at anything similar to what we saw back in 2001 and 2002, the last time the market really took a stumble, and at that point, as you know, we were faced not only with job loss but we also had the pressure of move outs due to home buying as well. There was a lot of new supply coming onto the market.

We’re only battling the job growth trends at this point. And as I mentioned earlier we also don’t have the pressure from the excessive exposure to vacant homes and condos that some of the other markets that some of our peers have big presence in.

So the answer is no. We think we’re going to hang in there on a positive note. We think occupancies are going to hold in there where we are right now. We think we’ll continue to capture positive pricing traction on lease renewals. We think as we go out and try to bring in new residents, the competition will be a little more intense and probably we’ll be looking at sort of flatish rent growth prospects for the new residents, the new leases we write, but on renewals they would be positive and occupancies will hold in there.

We’re seeing a terrific performance on our collections and so everything that we look at, at this point, would suggest that slight positive trends, early part of 2009, and then by the time we get to Q3 and Q4 of next year, when we’re comparing against this year, I think the comparisons get to be quite a bit easier.

Operator

Your next question comes from Steve Radanovic – BB&T Capital Markets.

Steve Radanovic – BB&T Capital Markets

Just focusing back on expenses for a little bit, I know you had some unfavorable adjustments year over year. As you look into the next twelve months, are there any areas you think you could carve out some more expenses in light of what’s going to be some tough sledding here? Aare there any particular ongoing initiates you have ongoing right now?

H. Eric Bolton, Jr.

Certainly, yes. We’re taking a hard look at all our expenses right now, our operating and G&A, and I’m not prepared to give you any specifics on that right now, but some of the pressure that we saw this year on the operating expenses was in the area of personnel costs, which is kind of a good news/bad news story.

The good news is that our employee turnover went way down this year. We’re already below industry average and it went down significantly below that this year, and we’ve kind of seen that throughout the course of this year. That’s the good news. We’re holding on to our people and they’re better trained and we think this is a good time to hold on to good people.

The bad news is that we’re carrying a lot less vacant positions at any given time this year as compared to last year and so that created some pressure. Now, we don’t think our turnover will go even lower next year than where it is right now, because we are already incredibly low.

So I think that pressure point that we had this year will not repeat itself next year, and as you can imagine, personnel cost is a huge cost component of our operating structure. So that’s been a pressure point that we’ll moderate.

And then beyond that we’ll just continue to trend down in resident turnover. That’s going to be hugely helpful as well. Obviously not turning apartments saves a lot of costs. So we’re continuing to take a hard look at all of our expense structure, recognizing that in a period of weaker top line growth, you need to find ways to cinch the belt up a little tighter.

Steve Radanovic – BB&T Capital Markets

As you look at it now, most of the low-hanging fruit you feel like has been taken care of, or you’re going to just to continue to look at each item and try to make improvements?

James Andrew Taylor

I would add there are a couple of specific initiative that we’ve got planned for 2009 that I think are going to add some value in terms of reducing costs. First would be an addition of a second screening partner for when we look at residents coming in the front door. Adding a second screening partner should save us around $300,000.

A second initiative that we’re looking at and plan to do in 2009 is to bring the calculation of our billing in-house with what is really called statement billing you’re starting to see with some other of the trusts, and it’s something we’re starting to look at as well. We think that has the potential to save us something on the order of $650,000 annually.

You know right now, we’re use Vista to do all of our utility billing. We’re looking at bringing that in-house, considering that. I think that has some real potential there.

Operator

There are no further questions in queue. I would to turn the conference back over to you for any closing remarks.

Thanks for joining our call this morning. If you have any follow-up just feel free to give us a call. Thank you.

Operator

This does conclude today’s conference. You may disconnect at this time.

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Source: Mid-America Apartment Communities Q3 2008 Earnings Call Transcript
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