Equity Residential Q2 2009 Earnings Call Transcript

| About: Equity Residential (EQR)

Equity Residential (NYSE:EQR)

Q2 2009 Earnings Call

July 30, 2009 11:00 am ET

Executives

Martin McKenna - IR

David Neithercut - President and CEO

Mark Parrell - CFO

Fred Tuomi - EVP of Property Management

David Santee - EVP of Property Operations

Analysts

David Toti - Citigroup

Michelle Ko - Bank of America-Merrill Lynch

J. Habermann - Goldman Sachs

Rob Stevenson - Fox-Pitt and Kelton

Alexander Goldfarb - Sandler O'Neill

Richard Anderson - BMO Capital Markets

Michael Salinsky - RBC

Michael Bilerman - Citigroup

Operator

I would like to welcome everyone to the Equity Residential second quarter Earnings Call. (Operator Instructions).

Thank you. Mr. Martin McKenna, you may begin your conference.

Martin McKenna

Thanks Jennifer. Good morning and thank you for joining us to discuss Equity Residential's second quarter 2009 results. Our featured speakers today are David Neithercut, our President and CEO; and Mark Parrell our Chief Financial Officer; Fred Tuomi our EVP of Property Management; and David Santee our EVP of Property Operations are also here with us for the Q&A.

Certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the Federal Securities Law. These forward-looking statements are subject to certain economic risks and uncertainties. The company assumes no obligation to update or supplement these statements that become untrue because of subsequent events.

And now, I'll turn the call over to David.

David Neithercut

Thank you, Martin. Good morning, everyone. Thanks for joining us for our second quarter earnings call. As noted in the last night's press release, we delivered quarterly operating results that were at the high end of the range that we provided you on our first quarter earnings release in early February.

Excluding the $0.04 impairment charge for writing down the carrying values from vacant land, we were actually well in excess of our prior guidance. Mark will provide a bit more color regarding the explanations for this in just a moment, but the primary factor was better than expected property level operations. We're very pleased about that because it's no surprise, the very, very challenging operating environment out there that we are working in each and every day.

Now, it's not tougher than we might have thought possible at the beginning of the year, but we think it's certainly worse than what the midpoint of our original guidance might have suggested. Yet we think, we've managed pretty well through the first half of 2009, and we expect the second half of the year to be pretty much close to our original plan as well.

Now we have reduced our same store revenue guidance midpoint for the year by 25 basis points, from minus 3% to minus 3.25%, and this was based primarily on continued concerns about California and Seattle. Our expenses have been kept very much under control and we're now confident that we will beat our original expense numbers by quite a bit. We've reduced our guidance range for our same store expenses.

David Santee and Fred Tuomi, they are here to help me answer questions, and they run all aspects of our property operations. I'm going to tell you, their teams have done a fantastic job on expenses so far this year and for the balance of the year we know they will. This was particularly off a very challenging comp here in 2008 when expenses were up only 2.2%. But where this team has really excelled this year, is on our renewals.

We are renewing existing tenants at rents that on average are 1% below their expiring rental rate. We think that is a very, very strong level given the state of the economy today and to put that minus 1% renewal rate in perspective, our net effective new lease rate, and this is something we talked about on our last call, and we could find that as the rates that we are achieving on our new leases on a net effective basis. That number is down about 9% from the rates that vacating residents were paying.

We're doing eight percentage points better on our renewals than on our new leases, and I congratulate to team out there in the field for that. The other point to mention about our net effective new lease rate is that though down 9% this year, this average rate has been relatively stable for the last six months, about the same levels that we first mentioned about this concept on our earnings call in late April.

It means a couple of things; first, our average rent's rolled down a lot in the fourth quarter of last year, and then our average rents have not eroded further from there, and I need to emphasize the word Average, because in some markets our net effective new lease rates have continued to deteriorate since the beginning of the year. Those markets would include Los Angeles, Orange County, San Francisco, Seattle and Phoenix.

In some markets the net effective new lease rate has stayed pretty much the same since the beginning of the year and those markets would include New York City, the Inland Empire and South Florida, and in other markets the new net effective new lease rate has actually increased since the beginning of the year. Those markets would be Boston, D.C. and San Diego.

While same-store revenues have decreased quarter-over-quarter and it will certainly continue to do so throughout the year. It's not because the markets continue to get worse on average, but because we still have above market releases that will need to roll down to this new lower level. Obviously, we continue to be concerned about the job picture and it can certainly worsen which could negatively impact rental rate, but that's the picture we are seeing across the markets as we are sit here today, and David and Fred can certainly go in to more detail about that during the Q&A.

On the transaction side we have continued to sell assets in the second quarter. As I've said over the past several calls our strategy continues to be to sell our older non-core assets while there continues to be a bid, and frankly as long as the GSEs are providing financing, because that is certainly positively impacting the bids of these assets we want to sell.

Another thing that is positively impacting the bid is the size of the deals we are selling. Through the first half of this year the average sale price of our assets was $15 million. Now much of the information about the sales that we've done this past quarter in the supplemental, but I do want to add a couple of things. Of the 12 assets that we sold five were in Dallas. So this continues our previously announced decision to exit the Texas markets.

We sold three assets in the state of Washington, two in what we consider we call non-Boston at New England, one in Georgia and one in California Central Valley. We sold those 12 assets at for an unleveraged IRR of 9.7%, and I will tell you that the five Dallas deals were below 9.7 and the rest of the deals were all double digits above that 9.7. So, that IRR was negatively impacted by that Dallas portfolio. In the overall, sales prices came in at about 80% of what we might have considered high watermark evaluations back in 2007.

Now, we acknowledge that these are highly diluted sales when the proceeds are temporarily reinvested at less than 1% per annum, but these are all non-core assets or they are non-core markets. We are frankly not confident that we will see better pricing on these assets or better pricing in these markets if we wait. So, we want to take advantage of the opportunity while we can't, and as I noted on our last call we think the cash in these sales is far more valuable to us than our pocket than in this assets.

Now, you will note on page 24 of our earnings release that we have increased our guidance for dispositions for the year by 100 million to $800 million now. As you know, to the first half of the year we sold $350 million of assets, through today we sold nearly $450 million. We have about $300 million under contract today not all of which will close of course and another $250 million under letters of intent.

Certainly those all won't close and a lot of them won't close this year, but we continue to see very good bids for the asset we want to sell and we've actually seen an increase in the number of potential bidders as of late. They are mostly local and regional players as we've discussed in our recent calls and again primarily driven by Fannie and Freddie. I think that Fannie and Freddie have about 100% market share of financing the deals of that we have sold year to date.

As the GSEs commitment to multifamily financing goes, so goes our ability to sell our non-core assets and we are here to tell you that both Fannie and Freddie remain extremely eager to lend and that's enabled us to increase our disposition guidance for the year.

On the development side, as I've noted on the last several calls, we have no plans to start any new projects at the present time. Our total focus is on completing, leasing and stabilizing our existing deals. That's a fair number of projects in 2009 because this year we will complete the greatest volume of new development product in our history, very high quality assets in core markets across the country and we believe we'll experience strong demand and growing rents for years to come. That represents about 1800 units and nearly $800 million of construction cost.

During the quarter we had a total of 10 properties in various stages of lease-up, today of those 10, eight remain in lease-up and not yet stabilized. Now like everywhere rents are below our original expectations, down 10% to 12% on average and consistent with the rent levels we're seeing on existing product in their respective markets.

Again, we've got get great product and leasing velocity is very good, we're right on average pro forma absorption at about 20 units a month and our leasing teams are doing a fantastic job on these lease-ups across the country.

From a return perspective, our development deals will initially under perform original expectation and stabilize at mid five yields rather than the previously underwritten yields of the mid sixes. This again, for all the obvious reasons that we talked about, but again, they are all great assets, we're delighted that owned them and they will do very well for us over time. By the end of the year, the development pipeline reduced to five projects, where about $250 million yet to fund.

Lastly on development, as noted in the press release last night, we did take a $0.04 per share impairment charge on a land parcel, that's a parcel in the D.C. area on which our joint venture partner had put a non-recourse loan that is maturing soon. There is some question today is to the value of that land and therefore whether the loan will be repaid where the property given back to the lender.

Now I will tell you, no final decision has yet been made, but in the impairment charge it was appropriate to take at this time. Lastly note on the dividend, as we noted in the last night release, we expect to reduce our annual dividend with $35 per share, when dividends are declared later this quarter for payment in early October. That's a 30% reduction or $0.58 per share on an annualized basis.

Now first, we feel that a reduction in our payout is warranted and prudent due to the extremely challenging operating environment that we're experiencing today. We think this level of payout is supported not only by our 2009 operations but also by what we expect in 2010 when we'll likely experience another year of negative same store net operating income.

Second, we think we will now establish a base level from which we will be able to deliver to our investors a safe, consistent and regularly increasing payout from improving operations.

Third and Mark will go into little bit more detail about this by retaining a $170 million per year, we will improve our credit and leverage which we think is a right thing to do at this time. Lastly and very importantly, we expect there to be acquisition opportunities somewhere down the road and this will help every residence to take advantage of them when they become available.

I will now turn the call over to Mark

Mark Parrell

Thanks, David. Good morning everyone and thank you for joining us on today's call. As David said, we have a good quarter in terms of meeting our expectations for operations, especially in light of business conditions being more challenging than we had expected.

This morning I will focus on three topics, I'm going to review our second quarter results, I will provide color on our third quarter and more importantly full year guidance and I will give a brief recap on our liquidity position and strong balance sheet.

On the same store NOI side, our same store NOI declined 3.4% in the quarter compared to the second quarter of last year. Revenue was inline with our expectations and expenses were better than our expectations. For the quarter, our same store totaled revenues decreased 2.4% over the second quarter of 2008 due to 1.2% decrease in average rental rate and 1.2% decrease in occupancy to 93.7%. While, our occupancy decreased from just under 95% to just under 94%, we think these are good numbers, considering everything that's going on in the economy today.

We are delighted with the terrific work of our colleagues in the field and our corporate operations team in driving same store expenses down 0.6% or 60 basis points on a quarter-over-quarter basis.

I want to give a little color on expenses by focusing on real estate taxes, payroll and utilities, which together make up two-thirds of our same store expenses. Property taxes were up 3.6%, which is less than we expected as assessors were quicker to reflect declines in values than we had originally anticipated. Payroll was down 0.8% or 80 basis points. As we continue to reap the benefits of our high-tech operating platform, which has allowed us to do more with fewer personnel.

Utilities were down 2.8% as we benefited from lower than expected prices for gas and heating oil. We also had decreases in leasing and advertising and in turnover expenses. I also note that in all but a few markets, concessions have been virtually eliminated as our focus is on net effective ramp.

We also had a good contribution in the quarter from our lease-up properties. David has spoken about the great work of our field and development personnel in leasing up our development and other non same store properties in the difficult environment. We anticipate that these properties will contribute an incremental $22 million, which is $0.01 more than we have thought in April to our FFO results this year.

We continued to show good discipline on the non-property expense side, as our G&A spend for the quarter was down approximately 13% or 1.6 million from the second quarter of 2008. Mostly this was due to lower payroll cost.

Now I'm going to chat a little bit about guidance and I'm going to go through as you saw in our release, our guidance for the third quarter and our revised guidance for the full year 2009. On page 24 of the release, you will find the assumptions underlying our annual FFO guidance.

There are three main assumptions to get you to the $0.51 per share midpoint of our third quarter FFO guidance range from our actual pre-impairment second quarter FFO of $0.62 per share.

First, we will have lower property NOI in the third quarter from our same store portfolio due primarily to a continued rolled down of new leases, to a lower net effective rental rate and dilution from our 2009 transaction activity. We expect this decline in quarterly property NOI to total approximately $21 million or about $0.07 per share from the second quarter versus the third quarter.

Second, interest expense will be higher by about $0.02 per share in the third quarter due to higher debt balances as a result of our recent $500 million loan from Freddie Mac and lower capitalized interest due to reduced development activity.

Just to be clear, interest expense will be higher in the third quarter than in the fourth quarter because our remaining 2009 loan payoffs occur mostly late in year, but for the entire year, interest expense is tracking approximately the same as our original guidance. Because the cost of carrying the new secured loan when you net that against the lower than anticipated floating rate debt rates that we have, leads our expected annual interest expense essentially unchanged.

Our last reconciling item I have for you is that we expect lower interest and other income in the third quarter of about $0.02 per share. In the third quarter, I don't expect that we'll have the same gain as in the second quarter from the sale of an investment security.

For the full year, we have revised our guidance range for the same store revenues, expenses, and NOI, as well as our FFO per share. We narrowed the same store revenue range because as we sit here today more than halfway through the year, as well as through most of our primary leasing season, our new range for revenues has a midpoint, negative 3.25% that is in line with our original projections and we see this as positive, as we have operated our assets well in a rapidly deteriorating economic climate.

Quarter-over-quarter revenue declines for the third and fourth quarters are expected to average around 5%. We are very pleased to revise our expense growth guidance to a range of 1.25% to 1.75% through the year because of the trends in the expense items I described previously. We are mindful of the importance of the condition of our properties and will not sacrifice our property's long-term value by scrimping, on needed maintenance or on capital improvements.

Our state-of-the-art central purchasing system and other operating improvements, along with general deflation in material and outside labor costs have allowed us to spend less while keeping our properties looking good. The high quality of our properties is reflected in our customer loyalty scores. We survey our residents several times in each lease year, and their happiness with their homes and our dedicated employees in the field is high and improving.

Based primarily on these revisions to our operating guidance, we have also tightened the guidance range for FFO per share to $2.10 to $2.20 per share from the original $2 to $2.30 per share. The midpoint of the guidance range remains the same. The revised guidance includes $0.03 per share for the net positive from better than expected NOI from our same store portfolio, and lease up activity less transaction dilution, $0.01 per share to the positive from higher interest and other income, and $0.04 per share to the negative from the impairment charge.

Also as David mentioned, we have decreased our acquisition guidance from 250 million to 150 million and increased our disposition guidance from 700 million to 800 million. The additional dilution is included in our revised guidance.

Our increased net sales guidance combined with our new lower dividend will pressure our re-taxable income distribution requirement, but at this time, we do not believe that special dividend will be required. In 2010, at our new dividend rate, we can be a net seller of approximately $300 million of properties without impacting our distribution requirements.

Now I want to discuss our liquidity. As you know, we have been focused on having a conservative balance sheet by maintaining ample liquidity and pre-funding our debt maturities. With that in mind, on June 29th, we closed on a $500 million secured loan from Fannie Mae, loan is interest only, matures in 11 years, has an all-in affective rate for the first 10 years of approximately 5.6% and is collateralized by 13 properties. I commend our excellent treasury team and their partners in our legal team and in the field on completing this loan which was in process for several months.

We now have cash on hands sufficient to fund our maturities and development funding obligation for all of 2009 and all of 2010. Using proceed from expected 2009 dispositions and our undrawn line of credit and without any other debt transaction, we can fund all our maturities through 2011. The company would expect to renegotiate its line of credit, which matures in February 2012, during 2011.

Please recall that our $500 million term loan initially comes due in October 2010 and is included in our maturity schedule as a 2010 maturity. It has an extension option which we can use to make the effective final maturity date October 2012. It is not included in our refinancing needs in 2010 or in the discussion I just went through.

A quick note on the two of our main debt capital sources, the unsecured bond market and the GSEs. The unsecured market is wide open to EQR in large size and at rates of approximately 7% for 10 years. We know that nearly all of our short-term unsecured papers trading at a premium to par which while demonstrative of the unsecured markets recovery has not given us much of a chance to repurchase our debt opportunistically as we have done in prior quarters. In fact we did not purchase any of our debt in the second quarter.

The two GSEs continue to be excellent partners to EQR and they provide a bunged originally priced debt capital to our sector. Recent statement by the HUD secretary and the GSEs conservator have been supportive of the GSEs multifamily mission. A particular note is the substantial recent utilization by Freddie and Fannie of the securitization market to avoid over burdening the balance sheets. The GSEs respective securitization products vary in several important regards and have advantages and disadvantages to borrowers versus on balance sheet execution.

On the whole are huge positive to our sector. As an additional inexpensive liquidity sourcing alternative to the GSEs own balance sheets. Overall, tone from our friends at the GSEs is positive, but political risk of the multifamily mission remains difficult to quantify. GSE underwriting standards have continued to grind tighter and it is not uncommon that property income trended down by the lender.

It continues to take longer to complete a loan transaction now than one year ago as the underwriting process is more involved. That said, in many markets you can readily borrow 10 year amortizing money at about 6% and a 70% loan-to-value. Both GSEs favor acquisition financing over cash out refinancing as the value of the collateral is more readily estimable.

Now, a bit of detail on the impact of the company's expected new dividend policy. We have said in the past that we run a small shortfall on our dividend in 2009 and a slightly larger shortfall in 2010. The reduced dividend we announced today eliminates those shortfalls and our projections indicate that operating cash flow after CapEx will be sufficient to cover both the 2009 and 2010 dividends.

Additionally, as many of you have heard us say, it is our intention to continue to pay all of our regular dividends in cash, not stock. We are in an excellent position when it comes to our liquidity and our balance sheet. We have the ability to access many sources of capital and will continue to be opportunistic in doing so.

Now, I will turn the call back over to David.

David Neithercut

Thanks Mark. Jennifer, we'll be happy to open the call for Q&A at this time.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of David Toti with Citigroup.

David Toti - Citigroup

Couple of questions about the dividend cut and it makes sense relative to positioning, but the language around opportunity, are you seeing any opportunity yet and where do you think that will appear?

David Neithercut

Well the answer to first question is, no, and to the second question is, I don't know. We've not seen what we had considered to be opportunity out there yet. We would expect there to be some opportunity, somewhere down the road. Frankly I'm not quiet sure David that will be the size of our opportunity meaning the sort of discounts that we might have seen back in the late 80s, early 90s in the RGC debacle, but we do believe there will be some opportunities down the road, we just haven't seen any as of yet.

David Toti - Citigroup

Okay. So what about the dividend cut relative to upcoming debt maturities, would that take precedent perhaps?

David Neithercut

Well I would say on the debt maturity side, that the dividend was not so under funded that it is such a substantial source of cash to us David. So, it's not really a key driver. Key driver here is not to aggravate the debt maturities schedule, but cutting the dividend does not really satisfy many of our forward debt maturities.

David Toti - Citigroup

Then just along those lines of debt maturities you've opted to hold cash on the balance sheet at relatively dilutive levels, why not be more proactive in [retiring] some of that debt forward or is it the penalties that are holding it back?

David Neithercut

We've certainly been proactive and you can expect this to be in the past. I mean we did $300 million on the debt tender back in January we bought a good portion of a convert back as well and made 19 million on that. You should expect us to continue to be out there and be active and just because the debt's trading at a premium doesn't mean we won't buy it David. I think that's the implication absolutely. We realize that having the money on the balance sheet at 40 or 50 basis points versus retiring some of our forward debt. We will do that when it makes sense and we're looking at it actively right now.

David Toti - Citigroup

I am just touching upon the operating expenses. The reductions in the quarter are pretty dramatic, and I am just wondering how were you able to roll it out so quickly and so broadly across the portfolio and is that the sort of framework that we can expect going forward in terms of its composition?

David Santee

First let me say that all of our expense initiatives are more a long-term focus and we have no desire to create any short-term needs of reaction. So, a lot of the payroll really is part of a bigger picture workflow transition that utilizes our web tools, engages the resident, transfers a lot of the work to the resident. When you put prices on line and you have that transparency kind of cut down your call traffic about 50% because, people know what your prices are. They don't have to call. So, I think what you are seeing is really just the beginning stages of a longer-term focus that we have a fairly detailed plan that will take us probably the next three years to fully implement.

David Toti - Citigroup

Great, and then one last question and I'll leave the floor. Can you just provide a little bit of detail on what you're seeing in some of your more challenging California markets. Is the weakness being driven by unemployment or the chaos that in the housing market? What's impacting the rentals in all those markets?

Fred Tuomi

California markets, I guess I'll start with Los Angeles that's the biggest disappointment so far this year, and it started really with the broad-based general economy and the global economy. The shipping traffic to the ports is down 30% - 35% and then just a widespread across every sector there's substantial job losses. So, in the beginning of job losses at L.A. were in excess of 10,000 for 2008 and about 180,000 this year. So that took a big toll on the local economy and in a year when we had the relatively a large set of supply coming in the market compared to recent years.

Los Angeles is under a lot of pressure. Entertainment that usually is a good support during a recession has not been there, although recently we've seen a little bit of improvement in entertainment leasing and really it's the situation based on the job loss. The risk going forward is that there's going to more of local government cuts as a result of the California budget crisis and that remains to be seen.

Orange County is under same situation two years in [role] of lost job cuts, there's been a lot of pressure on that market along with some supply coming at the wrong time. San Diego has been really on the upside. San Diego has been in a good favorable situation, all the numbers are positive, a good leasing summer season this year, occupancy is up, rents are up. So San Diego has kind of normally in the California.

San Francisco is as expected we knew its going to be tough there with job losses related to real state constructions especially in Oakland and the far East Bay, Northeast Bay. So, it's kind of as expected but it's pretty tough, lot of job loss there in San Francisco. [Czech] has been okay, but not a source of growth, and it's going to be as expected.

David Toti - Citigroup

Great. Thank you for all the detail.

Operator

Your next question comes from the line of Michelle Ko with Bank of America-Merrill Lynch.

Michelle Ko - Bank of America-Merrill Lynch

Hi, good quarter. I'm just wondering in terms of your guidance increase for NOI, I understand that you had these expense reductions that are due to some longer term initiatives. I was just wondering if you could talk a little bit more about what has typically changed this quarter versus last quarter. Why you are implementing the change in the forecast now?

Mark Parrell

Right. Michelle, it's Mark Parrell. When we think about guidance for the year, we think sort of hardest about it. Now we did not revise substantially any of our guidance back in April. We thought about the leasing season coming up and really wanted that input. So what's really changed from January, that's the point of comparison, is that same-store is better than we thought because of the expense improvements that we've all discussed by a couple of pennies. We're getting a little momentum on our lease ups that we weren't expecting, those are very hard to forecast and adds about $0.03.

With the increased dilution from dispositions frankly, that moved us down a couple pennies. So, when you net that all out and kind of run it through, you are a few cents better there. So that $0.03 or $0.04 in operations sort of offset frankly by the impairment charge that we took this quarter.

So, as we made our guidance adjustments that's what was going through our heads. Interest expense is basically constant through the calendar year and it's about what we expected in January, it still is at this point. You have a follow-up question, Michelle? Jennifer, let's go to our next question.

Operator

Yes, sir. Your next question comes from the line of J. Habermann, Goldman Sachs.

J. Habermann - Goldman Sachs

David, your comments about rents being down as much as they are, and obviously, the turnover that's just inherent to the business. Can you comment a bit about when you think NOI bottoms? Is that sort of a mid-2010 timeframe?

David Neithercut

That's anybody's guess right now, but yes, if we are able to hold this net effective new lease rate, and that is sort of down 9 from a year ago, that would imply that we still have some leases to roll down, particularly those that were renewed during this year at the higher renewal rate. So we will still have some pressure through 2010 but we ought to be able to find some kind of bottom sometime in 2010, I hope.

J. Habermann - Goldman Sachs

In the cases where you mentioned renewals down only 1% and versus new leases down, closer to 10%, I obviously maintaining that delta is going to be a challenge. But are you giving away, for example two-year leases to the renewals? We are basically seeing flat rents for two years?

David Neithercut

No, we are not doing anything.

J. Habermann - Goldman Sachs

Are you giving any concessions away for the future or not at all?

Fred Tuomi

No. This is Fred Tuomi. We are giving no other concessions on renewals. The idea of giving some sort of upfront incentive or a gift card or a free rent or anything to entice a renewal rate is not in our equation at all.

J. Habermann - Goldman Sachs

So it's not flat run for two years or anything like that?

Fred Tuomi

No. Manhattan has the obligation offered two two-year leases, which we have a small number taking advantage of but that's really about it.

J. Habermann - Goldman Sachs

Okay. And then, interesting comments obviously on the asset sales. You are targeting $300 million, you said next year. I guess, David, at this point, are we looking like that's going to wind down your asset sales program?

David Neithercut

What Mark said is, we could sell $300 million next year without having an impact dividend policy.

J. Habermann - Goldman Sachs

Okay.

David Neithercut

And again that we could take-give at $.35 run rate dividend going forward. That doesn't mean we'll not sell more, we have the 10.31 and even anything incrementally above that or we have to start thinking about some kind of special dividends.

J. Habermann - Goldman Sachs

But do you think that the sales program is beginning to reach the end after several years of obviously --?

David Neithercut

I guess we are beginning I think to reach the end of those assets we had identified several years ago. It is non-core asset to non-core markets but I will just tell you that we will every year for our history be sellers of assets that we believe no longer fit or have required capital requirements that we don't think are going to give us an appropriate return. So I think you sort of expect us to be active sellers for really forever. I don't think our portfolio will ever be constant.

J. Habermann - Goldman Sachs

And can you give us a sense of just spread between sort of A and B assets at this point?

David Neithercut

We have talked about a 125 basis point spread as that spreads between the yields. We expect to be selling in the yields, we expect to be buying. And so we are selling lesser quality product and when we buy we will be buying better quality product. So I think you could look at that 125 basis points spread as an appropriate one.

J. Habermann - Goldman Sachs

And I know it comes up a lot. Can you give some specifics on New York City, obviously it sort of fell in your market where you are seeing trends stabilize but any sort of insight there on to -- in terms of what you are seeing?

Fred Tuomi

Yes, this is Fred again. New York, I mean was everything going on or you would expect to have a worse report. I got to tell you I am very satisfied how New York has performed so far through this cycle. This summer has been in particularly encouraging, we had a very strong June demand. Our leasing was up, our occupancies up, and our rents recovered. Our net effective asking rents recovered dramatically during the month of June.

So our [Penthouses] are full. Our occupancy is 95.7% our exposures is less than 8% right now. The rents are holding as David mentioned from the beginning of this year and I'm sure they are down big time year-over-year from the peak, but where we sit now we see steady demand, we're not seeing a lot of job losses and people leaving the city. People are still moving around a lot. Negotiations are tough, it's taken out our people on the ground, there a lot longer to complete every renewal and to secure every transaction as people are moving around the city a lot, negotiating, swapping deals. While that's going on but that hard work is paying dividend because we are pretty stable in New York right now.

J. Habermann - Goldman Sachs

Great, thanks guys.

Operator

Your next question comes from the line of Rob Stevenson with Fox-Pitt and Kelton.

Rob Stevenson - Fox-Pitt and Kelton

When you take a look at the down one on renewals which is great in this type of environment and the down nine on turns, what is the trend as you continue to July is it fairly consistent with that?

David Neithercut

Yes. July is very consistent with the renewals that we achieved in July, 12 months versus 12 months was down 0.7%.

Rob Stevenson - Fox-Pitt and Kelton

Okay. Mark, you talked about when you were giving your guidance for on a sequential basis looking into the third quarter with that sort of down on either the revenues or the NOI, however you want to put it. Does that assume at this point that there is a sort of midpoint of your range assumes that you see a decent size weakening in that as we continue to go forward or is there something else that's coming into play there?

Mark Parrell

No, there is more sequential expenses in the third quarter than the fourth.

Rob Stevenson - Fox-Pitt and Kelton

Okay.

Mark Parrell

So a part of that drop just makes it, it looks like a larger drop, the revenue decline in each quarter the third and the fourth is approximately constant. It's that the expenses in the fourth quarter are just by seasonality less than expenses in the third.

Rob Stevenson - Fox-Pitt and Kelton

Okay. And then within the portfolio right now when a unit becomes vacant, are you seeing any material up tick in the days it is remaining vacant between leases?

Mark Parrell

No, we have a well defined process, a checklist that our maintenance teams go through to get the units turned. We haven't changed that at all. And in fact, all of the metrics that we measure on our proficiency and efficiency are the term of the process are right in the sweet spot.

Rob Stevenson - Fox-Pitt and Kelton

Okay. So I mean the fact is that you are not seeing because of the leasing environment or anything, any sort of material up-tick there?

Mark Parrell

I thought you're referring just the mechanical process getting them back ready. In terms of getting them run, we occupied. Our occupancy is down almost a point year-over-year, so I think there is going to be some slippage there but its not dramatic, I'd say its still pretty much about a month total.

Rob Stevenson - Fox-Pitt and Kelton

What are you guys seeing in terms of the second quarter, in terms of bad debt and how is that compared to the last couple of quarters?

David Santee

Pretty much our bad debt continues to bounce between 90 basis points and 110 basis points, and we really haven't seen any change from January through June. July, we saw an up-tick of 30 basis points, but that is attributable to our one of our initiatives programs as far as a more consistent approach to access charges once people move out. That increase amounted to about 400K of which all that is associated, where just the increase move outs from June and how we account for that in July.

Operator

Your next question comes from the line of Alexander Goldfarb with Sandler O'Neill

Alexander Goldfarb - Sandler O'Neill

I guess first the cost control. I think my memory serves, you guys a number of years ago had a consultant, hire a firm to come and do efficiency analysis and over the past number of years you guys seem to be pretty good at eking out cost savings. Can you just walk us through like where was all this extra stuff that's not needed to run the business today? Was it more corporate, was it property level, was it layers in between, if you could just walk us through this?

David Santee

It was all the above. Let me give you one example. Let's take leasing and advertising for example, as the world turns more towards internet use, we made a decision last year to really just walk away from print. A big part of our savings this year is really being absent from the Apartment Guyz, the For Rent Magazines and now what we've done, if you gone online, you've seen that we've released our new website back in April.

This website is really a Ferrari, so to speak as far as the infrastructure. We've been able to move from page nine on a Google search as far as organic, all we the way to page one. We've also taken more central control of a lot of the ILS spend, the rent.com, the apartments.com and you see, significant optimization year-to-date on that expense.

If it wasn't for our broker fees in New York, we would be down 20% year-to-date on L&A cost, while still increasing our traffic by 5% and our internet leads by 23%. A lot of what we are doing is really taking advantage of technology and as I said before reengineering workflow throughout the company.

David Neithercut

I think the benefit of working in 50 markets however long ago and now really having most of our efforts concentrated and what might be 15 or 16 markets today?

Alexander Goldfarb - Sandler O'Neill

Do you think there is lot more to go or you feel like you've targeted as much stuff and now you're basically on muscle?

David Neithercut

I think the world continues to change and it try to instill people here that expenses are like painting a bridge, once you work through all of these account groups, technology has changed, the world has changed, start all over again. As an example, we've completely transitioned all of our DSL service and all of our properties this year, over the past three or four months with an annual savings of almost $700,000.

We've transitioned a lot of our telecom because, there was movement between AT&T and what have you there. We have tremendous visibility today and we have a lot of great, very focused professionals here that do a great job and I think there is lot more to come.

Alexander Goldfarb - Sandler O'Neill

Then my second question is just on the capital side. With the new Freddie Loan, is there are concern from the rating agencies about the unencumbered pool? Then just thinking about alternative ways to raise capital, if the unsecured debt market may not be quite, where you want it, maybe it is, but what are other options is it like a term loan? Finally, I think in there, you spoke about equity issuance, just want to get your updated thoughts there.

Mark Parrell

Talking about the debt market, the unencumbered pool for EQR and unencumbered NOI is just going to end up to be $705 million, so it's very substantial. Our metrics, as you can see reported in the supplement are very strong. I think the concern that rating agencies have about all real estate companies, is really focused on income and it's focused on income because their concern relates to the fixed charge coverage.

I don't have as much pressure or concern or question frankly about the unencumbered pool, I think from the rating agencies. As just the rating agencies like all of us are trying to figure out, where the bottom is on NOI, so they can understand where their credit metrics will end up.

As for access to different markets for debt, EQR has always been very flexible and we are mindful of what's going on in all the different debt baskets we've borrowed before in the preferred market. I think Alex, you should expect us to look hard at the unsecured market, to look at the preferred market.

In terms of the banks, I don't know that we need to be out in the bank market right now, and that's a very difficult market. There is some big revolver renewals going on now that will help us understand where that market is going. EQR is in an enviable position of not really having to deal with the banks for a couple of years and I guess probably at this point, I probably leave it that way and I defer on the equity to David.

David Neithercut

I guess that really has nothing out in the equity. I guess I mentioned in the last call, Alex, if we were aware of what was going on and my company was raising equity and I'd tell you that we are aware of that, the Boards are aware of that, [Sam] is aware of that and when it make sense or if it make sense for us to raise equity, we won't hesitate to do it, but we don't feel like we have the immediate need to do something.

Operator

Your next question comes from the line of Rich Anderson with BMO Capital Markets.

Richard Anderson - BMO Capital Markets

You mentioned early on that second quarter or [I am sorry the] second half of the year, you expect to come pretty close to the original guidance, so you're talking operationally that while you have some moving parts and dispositions and the impairment in your guidance. The second half of the year is going to be roughly what you thought it was going to be from a same store perspective. Is that right?

Mark Parrell

Yes, just generally on the operational side in revenue we changed our revenue target, the midpoint by 25 bps and will obviously improved on expenses and I guess my comment was really more the way we're really looking at the topline across the marketplace.

Richard Anderson - BMO Capital Markets

Your full year guidance for same store are improved, but I was just wondering if that was a function of what you've already accomplished in the first half or that what you've accomplished will sort of filter into the second half as well.

Mark Parrell

Expenses will also filter through the second half, but I will tell you the comp line has to-date been pretty much what we have expected and we're thinking it would be the same in the back half as well.

David Neithercut

And expenses were better and lease-ups were better, and so those are the real reconciling items and we couldn't have known that back in January when we put the forecast together.

Richard Anderson - BMO Capital Markets

Just on the spread between renewals and new leases, I think the mark of a healthy environment is when new lease rents are well above renewals. I think you would agree with that. So, if that is sort of the litmus test for a return to a healthy environment, how long can you see a spread of eight percentage points being sort of wiped out? Does it take a full year of running through, so if we get stabilization in the middle of 2010 that that sort of situation will take another year to come to fruition? Is that a fair way to look at it?

David Neithercut

Again, if this net effect of new lease rate that we mentioned was down and stays flat through the next 12 months, and assuming it all really is going to be a function of the number of 2010 renewals and whether or not they renew at their old renewing rate or they mark down to this down. So that being the renewals that occur in '09 when those leases expire, but again as I mentioned earlier, we would expect 2010 to find some level of stabilization.

Mark Parrell

And another part of the equation there is, when the economy does stabilize, we get some job growth back in this country, we're going to be positioned in some of our for a quick recovery based on our supply. The supply is coming down in most cases right now, we've got some markets with zero starts for the rest of this year, and if you look at the pipeline for development in 2010 and 2011, it's very, very favorable.

David Neithercut

And with this level of occupancy across the portfolio too. I mean, we would expect when things do stabilize that I think in hopefully 2011 back half of 2010, we think there will two or three year period will be some of the best fundamentals this business as ever seen ones thing begin to stabilize.

Richard Anderson - BMO Capital Markets

Okay. So, fairly mediate. What would you say is a natural thread in good times of new leases over renewal rent? Is it 4% to 5%, is it greater than that?

David Santee

Rich, this is David Santee. I mean, basically what you are referring to is the gain loss on lease. The gain loss concept really kind of goes away in the yield management environment, but historically that's kind of been the number somewhere between 4% to 5% rate.

Operator

And your next question comes from the line of Michael Salinsky with RBC.

Michael Salinsky - RBC

David, first question for you. Can you talk a little bit about traffic patterns throughout the quarter what you seen July and also in terms of move outs? I mean, we seeing housing excess supply starting to clear in certain markets. Are you are seeing any kind of pickup that move out the home ownership for home rental?

David Santee

What I would tell you is that our second quarter move outs to buy homes is lower than the second quarter of 2008. We see the typical Q1 to Q2 seasonal up tick and when you look at that percentage change from Q1 to Q2, it's been the exact same percentage for the last three years. So, in some markets we show as an example, Orlando, we show 40 basis point increase from Q2 '08 to Q2 '09, but our turnover in Orlando is significantly down. So, the raw count is actually negative. So, I think if you look at a lot of the articles that have been in the Wall Street the last week or so, I think the people that really dissect what's going on understand that a lot of this is seasonal and every year there is more home sales in June and May and so we just don't see any significant movement as far as moving out buy homes.

Michael Salinsky - RBC

Overall traffic across the portfolio?

David Santee

Well, the traditional definition of traffic in the industry is people that actually walk into the door. So, that number is up 6% year-to-date. We've seen, July has been very favorable to us. Our applications are tracking ahead of last year, but when you step back and look at how the world's changing with the internet, we kind of look at initial contact. So, people contact initially either by email, they are calling us because they saw us online or they are walking in the door, and when you add all those things up we've seen a 16% increase in that, those three types of activity.

David Neithercut

I would also add that the traffic through the front door is a much better piece of traffic today than it was, because today piece of traffic comes in very well informed and pretty qualified compared to traffic that used to come through the front door, not too long ago, not knowing what the price point was, nor what we had available to [offer].

Mark Parrell

To some releasing season this year, we were anxiously waiting for it and now that we are basically at the tail end and we are very satisfied. Some of our markets have had very good surge of traffic in demand and leasing through the summer leasing season, especially Boston, D.C., I got to mention New York, the CBD of Seattle had a nice recovery and then Orlando. So, we are seeing the seasonal up tick just as we are hoping for.

Michael Salinsky - RBC

Secondly, I know you guys are planning to studying new developments in near-term here. Would the impairment during the quarter, I'm just kind of willing what the predevelopment look like right now in terms of size, maybe some markets that you got an exposure too?

David Neithercut

Well I think our land inventory is couple $100 million, $200 million or so, and that's in San Francisco, L.A., Seattle, I guess we're finishing one in Seattle. So I mean it's not a huge pipeline particularly for our balance sheet.

Michael Salinsky - RBC

That's helpful, and finally probably a bigger picture question for David. If you look at and its kind of following on Jay and Rich's question as well, if you look ahead to 2010 as you cycle through the new lower release rates, renewals possibly moved out and you also face tougher expense comparisons. I'm not asking for 2010 guidance, but is it likely that we're going to see lower NOI and greater NOI erosion that we saw in 2010 than we saw on 2009.

David Neithercut

I guess I'm not sure how we can give that without 2010 guidance, Mike I just passes on that, I guess what we did said that we would expect there to be negative NOI growth in 2010 as those leases that renew in '09 down one expired in 2010.

Operator

You have a follow-up question from the line of David Toti.

Michael Bilerman - Citigroup

Michael Bilerman speaking, David I just want to comeback to the some of the lease spreads between the new and the renewals, and I think you talked about in one of the expense statements you've had is a lot more people are going towards the web, looking at rate, they understand rate, they are doing their leases online, I'm just wondering why if they are seeing tenant, if they can look at where the new rents are and they know they are down 10, why aren't they battling back a little bit more given increased vacancy fees and like move within the asset. I can't understand moving cost away outside of the building. But I would have thought that you would feel more pressure as the consumer becomes more educated as to what rents are in the markets?

David Santee

Great question, this is David Santee. The fact of matter is that, many residents do go online to check rents. One of the things that we've really been focused on is developing more of the brand customer loyalty, providing these value-add services, and we learned all of these things from the customer through our automated survey process. But I think on average you have to look at this on a market-by-market basis.

You go to Atlanta, you go to Dallas, Denver; your average rents are somewhere in the 800. At 10%, 9% drop is $50 or $60, it doesn't take long to eat up that savings when you start moving and you have to change your automatic rent payments every month and you lose your rent with equity points because you are saving equity points to buy your homes someday. All of these programs are really creating value and that's what a brand does, a brand causes people to stay and say great things about you and pay more money.

Michael Bilerman - Citigroup

I guess you talked about there was no sort of long-term leases being done or any sort of rent is being provided to get you stay. Are you doing anything on the expense side in terms of maybe repainting the apartment or providing other upgraded units or anything else that may be coming through to entice that renter to stay put at a flat rate?

Fred Tuomi

This is Fred Tuomi. We do have a well defined process on how we approach our customer loyalty and that includes the renewal process as they come up on each term at lease. And our site personnel know how to negotiate, they know the position that the residents in, and they do have the option of offering what we call non-price, systems in that, but its limited to a touch of paint job, a carpet clean, things such as that and has very little take on that.

Michael Bilerman - Citigroup

And that would be running for your expenses?

Fred Tuomi

Yes, that will be added to pay roll. That will be added in our maintenance again.

Michael Bilerman - Citigroup

We talked a lot about the expense savings that you've been able to push through, was there any specific lever if it does sound like a lot of these programs have been worked on, they weren't short term programs, they were long term programs. So are there any specific lever that you pulled during the quarter that really narrowed those expenses down? I don't know if its full-time equivalent hours in terms of people at sites that you are able to reduce substantially or whether there was any transfer of the corporate versus at the property level. Because sequentially I know there is some seasonality going on and it was really across all market. So it really does seem like a change regarding one specific thing to happen.

David Santee

But I think the two key drivers are; one, the payroll and I would say that's not limited to properties. I think it's more of again, using technology to create efficiencies across the enterprise. And then secondly, big contributor is the natural gas expense. Obviously, if you look at the NYMEX, gas went dropped from January to April about 60% and if we were to walk today, we could kind of walk in another 10% savings for next year. Like I said there is always opportunities as the world changes.

Mark Parrell

And Michael just to be clear, we told you on G&A that we actually are down $1.6 million because you just made a suggestion that maybe some of those cost might have been shifted to corporate, and that's just not the case.

Michael Bilerman - Citigroup

I didn't want to make the suggestion. I was just trying to see how things were going. Great, thank you.

Operator

Your next question comes from the line of [Andrew Mcholic with Greenstreet Advisor].

Andrew Mcholic - Greenstreet Advisor

I apologize if I miss this, I just want to make sure I'm clear. In your operating guidance as your revenue grows, guidance assumes flat net effective market rent on average from now until the end of the year?

Mark Parrell

I'd say yes, that has been the trend so far, and we don't see it changing. In fact, a lot of market is improving and I think those lines will cross by the end of this year.

Andrew Mcholic - Greenstreet Advisor

Okay, great. Thanks. Could you guys just expand giving a bit more color on the South Florida markets and where you think a lot of those markets are in the cycle?

David Neithercut

South Florida, it's been tough to call it the last couple of years as we've discussed on this call. Each time we think we're at the bottom, I remember June of last year we actually had crossed the line and we actually went positive for a couple of months. But then came the national recession. So, first it was the real estate bubble that caused a lot of pain in Florida and particularly, South Florida and Orlando. We did see some stabilization, but then with the national recession, we had more broad based job loss, not just the real state and construction sectors.

So that caused another wave of down, because they were already down, you are not seeing the dramatic drops as we are seeing from some of the other markets. But the trend is just like pretty much across the country. This summer we're pretty good. Orlando has pretty good leasing season, our student oriented properties are filling up nicely and their occupancies are good. South Florida, we are 93% occupied right now, 8% exposure. The rent is only marginally down from the beginning of the year, only down 6% year-over-year. One thing worries me about South Florida is the gateway to South America, it doesn't seem to be giving us a lot of growth right now. And the population growth there and household formation is actually negative right now. So that's a longer term concern. But South Florida is very resilient and when things come back, it seems to come back fast. So that's the situation there.

Orlando, pretty stable. Rents are actually growing since the beginning of the year in Orlando, we are able to move rents up with the good traffic we had this summer. It had a supply surge, but that's over with now. Pretty much all of the '09 deliveries are behind us, and next year there is only 400 proposed units for next year. Orlando is another market that can grow very quickly. On the job base, it's done a good job in diversifying away from only travel and leisure. So I think the longer term picture is favorable for Orlando.

Andrew Mcholic - Greenstreet Advisor

That's helpful. Just one last question on your development stage, it looks like Redmond Ridge is leasing up pretty slowly. Could you just give some color on that asset?

David Neithercut

Andy that is a age-restricted asset, 55 and over, and that asset is certainly underperforming expectations just given the fact that not unlike, really all around the country, many of these residents will need to be sell their homes to run with us, and that's certainly a property that's been far more negatively impacted by what's going on in the economy today than any other project that we have built.

Operator

And there are no further questions at this time.

David Neithercut

Thank you all for joining us today. We are around, if anyone has any other questions you know where to find us. And I hope that everyone is having a great summer. And we'll see you on September.

Operator

This concludes today's conference call. Thank you for your participation. You may now disconnect.

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