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Associated Estates Realty Corporation (NYSE:AEC)

Q3 2013 Earnings Conference Call

October 23, 2013 02:00 PM ET

Executives

Jeremy Goldberg – Vice President-Corporate Finance and Investor Relations

Jeffrey I. Friedman – Chairman, President and Chief Executive Officer

Lou Fatica – Vice President, Treasurer and Chief Financial Officer

John T. Shannon – Senior Vice President-Operations

Patrick Duffy – Vice President-Strategic Marketing

John P. Hinkle – Vice President-Acquisitions

Jason A. Friedman – Vice President-Construction and Development

Analysts

David John Toti – Cantor Fitzgerald Securities

Jana Galan – Bank of America Merrill Lynch

Ryan Meliker – MLV & Co. LLC

Alexander D. Goldfarb – Sandler O'Neill & Partners LP

Jeff J. Donnelly – Wells Fargo Securities LLC

Dave Bragg – Green Street Advisors, Inc.

Tayo T. Okusanya – Jefferies LLC

Michael Bilerman – Citigroup

Operator

Good afternoon and welcome to the Associated Estates’ Third Quarter 2013 Earnings Conference Call. My name is Victoria and I will be the operator for your call today. At this time, all participants are in listen-only mode.

Following prepared remarks by the Company, we will conduct a question-and-answer session. (Operator Instructions) Thank you. Please note this event is being recorded. If you are experiencing calling difficulties, please visit associatedestates.com for additional instruction.

Now, I would now like to turn the call over to Jeremy Goldberg, Vice President of Corporate Finance and Investor Relations for opening remarks and introductions. Please go ahead.

Jeremy Goldberg

Thank you, Victoria. Good afternoon everyone, and thank you for joining the Associated Estates’ third quarter 2013 conference call. I would like to remind everyone that our call today is being webcast and will be archived on the Associated Estates’ website for 90 days.

Prepared remarks will be presented by Jeff Friedman, our President and Chief Executive Officer; Lou Fatica, our Chief Financial Officer and John Shannon, our Senior Vice President of Operations. Additionally, other members of our management team are available for the Q&A.

Before we begin our prepared comments, we would like to note that certain statements made during this call, including answers we give in response to your questions, will be forward-looking statements that are based on the current expectations and beliefs of management. These forward-looking statements are subject to certain risks and trends that could cause actual results to differ materially from projections. Further information about these risks and trends can be found in our filings with the SEC, and we encourage everyone to review them.

As a reminder, Associated Estates’ third quarter earnings release and supplemental financial information are available in the Investor section of our website, and they include reconciliations to FFO and other non-GAAP financial measures, which will be discussed on this call.

At this time, I will turn the call over to Jeff.

Jeffrey I. Friedman

Thank you, Jeremy. 2013 has been transformative for Associated Estates in many ways. With our investment grade ratings we issued $250 million of long-term unsecured notes. We’ve continued to sell non-core assets at huge premiums to our historical costs. We’ve increased our plan dispositions to benefit from the strong bid for quality apartment properties.

While maintaining a sound balance sheet we will continue to sell older assets and use the sales proceeds to acquire newer properties in markets with robust household formation and expected job growth. Last month, we announced the planned portfolio acquisition of seven properties in Charlotte, Raleigh, Atlanta and Tampa. The average age of these properties is two years. Five of the properties are new. These acquisitions are expected to be match funded with the sale of non-core assets. This transaction furthers our emphasis and focus on our overall asset quality and the cap rate assigned to our portfolio.

We continue to focus on improving our margins and reducing G&A as a percentage of property revenue. With regard to our improving margins these younger properties with higher rents would do just that. Relating to G&A, let me comment on the increase this quarter and year-to-date. $720,000 relates to litigation with our master lessee at our commercial property in LA.

Although, we don’t comment on the details of pending litigation, this tenant with a long history of paying late defaulted on their lease. We terminated their lease and they filed bankruptcy. The bankruptcy court has allowed the tenant to remain and we are currently appealing the bankruptcy court’s filings. The tenant is current with all of their rent. Our 2013 annual G&A without these litigation cost continues to be approximately $18 million.

We used the proceeds from our forward equity offering that we received on October 1 to payoff five mortgages with an aggregate balance of $129 million. Two days ago we issued $100 million of seven and 10-year unsecured notes. This private placement allowed us to extend their debt maturities at attractive pricing while paying down our line of credit.

Our same community portfolio delivered very solid numbers with quarter-over-quarter NOI growth of 6.1%. Our non-same community properties, which represent 12% of our NOI, continue to perform ahead of expectations. Our operations team is really doing a nice job.

Fundamentals of the apartment business remain very good. Our entire team at Associated Estates continues to demonstrate a keen and nimble ability to execute on all fronts.

I will now turn the call over to Lou.

Lou Fatica

Thank you, Jeff. FFO for the third quarter and year-to-date was $0.32 and $0.93 per share respectively. Same-community operations were slightly better than projected for the quarter with revenue up 3% and NOI up 6.1%. Year-to-date same-community revenue was up 3.7% and expenses are up 0.8%, resulting in a 5.6% increase in NOI, when comparing the first three quarters of 2013, to the first three quarters of 2012.

We have made a number of revisions to the underlying guidance assumptions for non-property level line items. Our revised guidance range is $1.26 to $1.28 per share, significant changes are the results of the following, the recent $100 million private placement results in incremental additional interest expense, a $0.01 per share negative FFO impact in Q4.

Legal costs and accruals associated with our master lease tenant at our commercial property in Los Angeles, results in increased general and administrative expenses. Approximately $0.02 per share negative FFO impact for the full year and the positive NOI impact of the recently announced portfolio acquisition and the revise timing of dispositions partially offset by increased acquisition costs and interest expense, a $0.01 per share net full year positive FFO impact.

These adjustments results in $0.01 per share decline to the mid-point of our previously provided FFO as adjusted guidance range. The plan portfolio acquisition and the recently completed Rienzi acquisition will be funded from the sale of seven assets. All are in various stages of marketing with three-assets currently listed.

Development spend for the first three quarters is $85 million with an additional $20 million to $30 million to be spend during the fourth quarter. 2014 development spend is expected to be approximately a $115 million and assumes that we’ve entered into a 50-50 joint venture on our 8th and Harrison development in San Francisco.

Based on our leverage post the closing of the forward equity offering on October 1, we have capacity to fund our remaining 2013 and full year 2014 development spend on our line of credit or with project specific construction loans and still operate within our stated leverage metrics.

We would plan to fund any incremental 2014 acquisitions, above and beyond what has been announced so far, with additional dispositions.

Debt to undepreciated book value is expected to remain in the mid 40% range and debt to annualized EBITDA in the low seven times range. Additionally our fixed charge coverage ratio is projected to exceed three times.

As previously mentioned, we closed on a $100 million private placement notes offering on Monday. S&P rated the notes BBB-minus while maintaining the corporate credit rating at BB-plus with a positive outlook. The spreads on these two are 35 basis points tighter than the deal we completed in January of this year.

We are committed to operating as an unsecured borrower and we’d expect secured debt to undepreciated book value to remain under 20%. Pro forma for the five mortgage repayments on October 1, and the $28 million loan assumption on the acquisition of The Apartments at Blakeney on October 10.

Secured debt to undepreciated book value currently stands at approximately 16%, our maturities for 2014 through 2016 are minimal; $45 million in 2014, $20 million in 2015 and $43 million in 2016. At this time, I'll turn the call over to John.

John T. Shannon

Thank you, Lou. Turning to quarter operations, our same community NOI was up 6.1% over Q3 2012. We finished the quarter at 95.8% physical occupancy with total revenue up 3%. Same community revenue was up 5% in the Midwest, up 3.1% in the Southeast, 3% in the Southwest and 0.4% at our Mid-Atlantic properties.

For Q3, same community new lease rents were up 1.6% and renewal lease rents were up 4.2% across the portfolio. Reconciling to the 3% Q3 total same community revenue growth, net rents were up 3.4%, weighted average occupancy during the quarter decreased 80 basis points and other income and fees were up 7%.

Same community expenses for the quarter were down 1.7% over Q3 2012. Personnel, advertising, utilities and other operating expenses combined were up approximately 1% for the quarter. Repairs and maintenance costs were down 5.8% for the quarter, primarily associated with fewer extraordinary projects than last year. For the quarter, real estate taxes were flat to a year ago and all-in insurance costs were down due to claim activity.

Sequentially same community revenue was 1.3% compared to Q2 2013 and average physical occupancies for the quarter was in line with Q2. Regarding our 2012 acquisitions that are not part of our year-to-date same community results, three properties in Raleigh-Durham and one property in the medical district of Dallas all performed well and collectively finished the quarter at 97% physical occupancy with NOI 8% higher than our acquisition underwrites.

In late September, we announced that we had entered into a purchase agreement and completed due diligence with respect to a seven asset portfolio of Class A apartment communities. The 1,606 unit portfolio is comprised of 462 stabilized units, 349 units currently in the final stages of lease up and 795 units being constructed by the current owner that we will acquire upon completion. The properties were in high growth submarkets in the Charlotte, Raleigh, Atlanta and Tampa markets. The properties are adjacent to transportation hubs, upscale neighborhood amenities and high paying jobs.

Another important point to make, we will be responsible for the day-to-day property management and the lease up to these properties under construction. Among the dispositions that will fund the portfolio purchase are five assets with an average age of 23 years. These properties were purchased in 1998 in conjunction with the acquisition of MIG for a total of $99 million. These sales would result in a blended, unlevered IRR in excess of 13%.

The other two planned dispositions are our properties we developed in Orlando and Nashville. Additionally, in September we sold Bradford at Easton, a 324-unit property in Columbus, Ohio for $29.5 million. Our other planned sale in Columbus is expected to close in the fourth quarter.

In July, we acquired the Doral West apartment community located in Doral, Florida. The 388-unit property was built in 1998 that includes Class A amenities and apartment floor plans with an average size of 1,166 square feet, some of the largest in the market.

In September, we acquired Rienzi at Turtle Creek, a 152-unit apartment community in the affluent Uptown neighborhood of Dallas. The property is an eight storey luxury high-rise building with upscale amenities that was built in 2002. The property, originally built as a condominium offers large units with high-end finishes and a high level of services including a concierge. Rienzi is the block from our Cantabria development, a 249-unit community currently under construction in Turtle Creek.

Turning to our current developments, we are nearly complete with the expansion of our San Raphael property in Dallas and as anticipated, we had our first move-ins earlier this month. We are under construction in Bethesda and on our Turtle Creek in Dallas. And site work is well underway at The Desmond on Wilshire in LA.

NOI for the first nine months is up 5.6% and our full year guidance reflects NOI up 5% at the midpoint. To get to the 5%, we anticipate Q4 total revenue growth of approximately 3% with portfolio wide new lease rents up approximately 2% and renewal rents up approximately 4%.

Our same community revenue expectations for the fourth quarter reflect revenue growth in our Mid-Atlantic portfolio to be flat to slightly up. In the Mid-West, we are projecting revenue growth for Q4 to be in the 3% to 4% range and we are projecting solid Q4 performance from our Southeast and Southwest portfolios with revenue growth of 4% to 5%. Additionally, we anticipate expense growth to be approximately 2% for Q4.

I will now turn the call back over to Jeff.

Jeffrey I. Friedman

Thanks John, Lou. Victoria, let’s open up the call for questions.

Question-and-Answer Session

Operator

Certainly (Operator Instructions) Your first question comes from David Toti with Cantor Fitzgerald.

David John Toti – Cantor Fitzgerald Securities

Hey, good afternoon guys.

Jeffrey I. Friedman

Hi, Dave.

David John Toti – Cantor Fitzgerald Securities

Very quickly, I just want to sort of walk through maybe some of the rational for acquiring new assets in the market that look to be having some pressure in terms of what’s your existing portfolio, but also from supply forecast, what was the thought process around by an exposure to a market like that at this point of cycle?

Jeffrey I. Friedman

Well, David this is Jeff. We told in our prepared remarks, we talked about the trade between selling the older assets and then buying newer assets and the growth expectations from the newer assets compared to the growth expectations on what we are selling. So that’s the overriding decision with regard to that.

The question really is very important. The answer is important and a good one relating to the why of the submarkets and the specific properties and how they are positioned in each of those markets. And so with that, I think I will turn it over to Patrick to talk about the specific markets.

Patrick Duffy

In terms of supply, two of the properties are located in submarkets where there is no new supply in the immediate area and those two properties are Lofts at Weston, a 215-unit property in North Cary. This property is located three blocks north of a property that we purchased last year. I mean North Cary is a great market and within the immediate neighborhood there are no other properties under construction.

And when I look at the rental rates at Lofts of Weston, we believe that the rents, the in-place rents from the two and three bedroom apartments are below market and that we’re going to be able to significantly increase those rents.

The second property without new supply in the submarket is a property in South Charlotte, it’s called Blakeney, it’s 295-units. And in that market area there is no new supply. There will be new supply delivered in 2015, but we’ve got this window where there is no new supply.

Then there are two properties where there is new supply in the submarket, but because of the way the two Northwood, the formerly owned Northwood Ravin properties are positioned, we think we’re going to do very well. The first property is St. Mary’s Square, which is a 135-unit in downtown Raleigh. This property has 40% of the units, are studio units and the rent is approximately $1,000. These units are in high demand. It’s a great price point.

The second property that has been supplied, that we are confident will perform quite well is the Alpha Mill Phase I, which is 167 existing units and Alpha Mill Phase II, which is 100 units under construction. Both phases are a value alternative to the nearby downtown Charlotte properties. These are great properties at reasonable rents and we’re confident so to well.

The two properties that are under construction that we will acquire in late 2014 are both incredibly well located. The Atlanta property is in the Perimeter submarket. The Perimeter submarket is one of the strongest submarkets and over the next 18 month, there will be only two other properties delivered in the Perimeter submarket. They will be about 550-units.

And then the second property that’s under construction is in the Westshore submarket at Tampa and Westshore has a really strong employment base. It’s a highly desirable area and this property will have the best community amenity space in the market I believe. The community amenity space is over 25,000 square feet. So we think that all of these properties will perform well and we’re excited to have them in the portfolio.

David John Toti – Cantor Fitzgerald Securities

Okay. That’s extremely helpful. And then my follow-up question is just relative to the seller, and I think you can say much about the motivation of the seller, who the seller was that would walk away from assets that are relatively new, broken developer, anything you can provide there would be helpful?

John P. Hinkle

Yes, this is John Hinkle. I can comment on that. The seller was Northwood Ravin. Northwood Ravin is a developer in the southeast, who builds Class A products. They are generally not a long-term holder. They actually want to recycle into other existing developments that they have planned. And we were able to get this deal, the portfolio was only marketed to a select group of buyers and we were able to leverage our relationship with Northwood Ravin from previous deals. Northwood Ravin was the developer on the Arboretum that we purchased last year and they were also the property manager on that Southpoint Village in Durham, which we also purchased last year.

So our relationship with them allowed us to get in to this portfolio and as I said, they are not long-term holders. So their plan is to recycle capital on their existing developments.

David John Toti – Cantor Fitzgerald Securities

Okay, great. Thanks, very helpful.

Operator

Your next question comes from Jana Galan from Bank of America.

Jana Galan – Bank of America Merrill Lynch

Thank you. Good afternoon. The first question is for John. Thank you for the outlook on your different markets in terms of fourth quarter revenue growth, but I was hoping if you could provide some more color on how you’re thinking about occupancy and maybe protecting occupancy into this slower winter season?

John T. Shannon

Occupancy remains in the mid-95% to 96% range, Jana and we anticipate that we’ll maintain that occupancy through the balance of this year.

Jana Galan – Bank of America Merrill Lynch

Okay. Last year you kind of fell off a little bit in the fourth quarter and so I was curious if that was something you’re anticipating this year, was a one-time event.

John T. Shannon

Let me back up a second and really explain our physical occupancy. When we close the physical occupancy in the supplemental that is the snapshot in time at quarter-end as to what our actual physical occupancy is.

When we go back and look at average weighted occupancy for the quarter, we were at 95.6% for Q3 this year and that compares to 96.4% last year. So it’s really an 80 basis point spread. I mean we still think that we’re pretty at structural occupancy. When you look at the supplemental, the spread is 140 basis points, but again that is not snapshot in time. When you take the average across the entire quarter, it’s 80 basis points.

Jana Galan – Bank of America Merrill Lynch

Thank you. And then, maybe just following up on the tenant bankruptcy at Desmond on Wilshire, I also noticed that was pushed out two quarters for stabilization. And so is that what’s causing some of the hold up in starting that development project?

Jason A. Friedman

Hi, Jana, this is Jason. During the quarter we entered into a contract, the GMP contract with White Residential who we determine to be the best contractor with the best price. They needed some more time to complete the end of construction more than we had anticipated. So we were able to add it to their contract. We’re really hopeful that we’ll be able to finish earlier, but that’s the dates that we’re using.

Jana Galan – Bank of America Merrill Lynch

Thank you.

Operator

Your next question comes from Ryan Meliker with MLV & Co.

Ryan Meliker – MLV & Co. LLC

Hey. Good afternoon, guys. I was just hoping you could give us some color on – particularly when I go through the assets that you’re looking to sell, Germantown to the outcome, which was completed last year in a major market, wondering why you guys have chosen that asset to sell at this point in time.

Jeffrey I. Friedman

Hi, Ryan, Jeff. From a strategic standpoint, it’s one of those things. We bought a piece of property below market in the darkest hours of the financial dislocation. We let contract to build it and our development team built it when pricing was the best we’ve seen in a long time. And the institutional interest in that market, because Nashville is really a very strong market due to the state capital and the music industry and what is going on with medicine and research related to medicine has become attractive to a mini institutional investors who haven’t been interested before.

The opportunity to benefit from that is something that we think is worthwhile and that is the reason we are going to sell that property and benefit from the significant profit and returns that we’ve been able to capture through our development efforts.

Ryan Meliker – MLV & Co. LLC

Certainly, I understand that. And the development creates a lot of value it just seems like actually you’re looking to sell a little bit more of a pruning of the portfolio improving the quality whereas the Germantown obviously a little bit different than that. How does the institutional investor base look for some of the other assets that you are looking to sell, that aren’t quite as strong as Germantown, is it of a similar demand base, what’s going on in terms of what you are hearing from pricing et cetera and in terms of the demand for those assets?

Jeffrey I. Friedman

The other six properties that we are selling three are located in the Baltimore Washington metro area. One is in Orlando and two are located in Broward County, Florida. Those three markets are very strong rental market and there is a high level of interest in acquiring well located, well maintained property in those three markets that we expect that there will be a high level of interest in these six properties.

Ryan Meliker – MLV & Co. LLC

And that is helpful. And then just from modeling standpoint, any idea how this is going to flow from a timing standpoint?

Jeffrey I. Friedman

That is the dispositions Ryan?

Ryan Meliker – MLV & Co. LLC

Yes, the dispositions are we going to see evenly spaced for the next 12 months or is it going to be more back half of the year et cetera.

Jeffrey I. Friedman

I want to say Jeremy, didn’t we in the press release. Didn’t we have a schedule? We just…

Jeremy S. Goldberg

An accusation we laid after that, we did.

Ryan Meliker – MLV & Co. LLC

I will take a look at that. Sorry for that, thanks guys.

Jeffrey I. Friedman

Lou, what are we thinking about there?

Lou Fatica

As I mentioned my portion of the script Ryan, we have three markets three assets currently listed. So we would expect those assets to close either late fourth quarter, first quarter with the balance of the assets going to market sometime between now and the second quarter of next year that is coinciding with the acquisitions that are coming online and being developed by our partner that we acquired the assets from in the portfolio sales.

Ryan Meliker – MLV & Co. LLC

Great, that is helpful. Thanks a lot.

Jeffrey I. Friedman

Thank you.

Operator

The next question is from Alex Goldfarb with Sandler O’Neil.

Alexander D. Goldfarb – Sandler O'Neill & Partners LP

Good afternoon. Just some quick questions here first. The national assets that you guys are selling. Is that in a TRS or there are issues with the REIT holding rule? I thought you have to hold an asset for four years or is it did you guys build it in TRS?

Lou Fatica

This is Lou. The holding period is two years. And we – the earliest we be able to sell that asset is February 1 because we began leasing February 1 of 2012.

Alexander D. Goldfarb – Sandler O'Neill & Partners LP

Okay, okay that is helpful. Second question is can you talk a little about Monrovia, California. You guys now have a development side out there and it’s – I mean certainly a far away from the Desmond and certainly a far away from Downtown. And I know EQR is looking to exit that area. It’s been hurt by housing and rental housing. So just sort of curious of all the development spots in California why Monrovia?

Jason A. Friedman

Alex this is Jason. Monrovia really is close to LA, it’s considered a suburb of LA just east of Pasadena. This is an alternative to Hollywood and downtown and our Desmond project. It’s really an attractive submarket to us. And the land that we bought has really attractive value in it at the price that we bought in. So we are encouraged by the market, rents have been strong and there are in the immediate area not a lot of competing supply. So, we have pretty high hopes for this submarket for this deal.

Alexander D. Goldfarb – Sandler O'Neill & Partners LP

Okay. And then just the final question, it really just goes to capital allocation. If we look at a few other recent decisions, you built Nashville, and now you’re selling it. The Midwest has been your strongest performing region for quite some time and again the strategy is to sort of dilute that exposure down. And then you’re doing this portfolio trade where you announced the acquisitions before you secured the financing and now you’ve identified publicly the properties you want to sell which could potentially pressure the operations there or pressure the cap rates as people know you have to sell.

So just sort of curious, as we think about capital allocation and the company, can you just walk through how we should think about it, because some of stuffs that seemed a little, I understand a lot of companies want to sell assets and recycle but usually it’s done, they announced it when it’s done as far as like dispositions and certainly investing in a market and then pulling right out, it’s a little confusing. So can you just help us understand this?

Jeffrey I. Friedman

Sure, Alex this is Jeff. Specifically with regard to Nashville, we continue to like the dynamics of the Nashville market, one of the things that we realized once we got into it a little more that, from a ownership standpoint we didn’t see the opportunity given the quick compression in cap rates and pricing in the market to be able to build a large enough portfolio there. At the time we entered on the development cap rates were much lighter. It hadn’t garnered the attention from the institutional investor base that it has today. When those cap rates compress we decided that it made more sense to be a seller in that market at the current bids and cap rates than a buyer. That’s not to say, we won’t circle back at another time, at another part of the cycle and be back in that market.

With regard to the other transaction the portfolio acquisition and to add on to what John Hinkle said, let me say, I see a little different. And I see a number of merchant builders today a little bit worried about the takeout loans, worried about Freddie and Fannie, worried about the lease up risk and we believe we bought at the right prices on this portfolio acquisition.

For us it’s a small company, a $324 million acquisition, it’s something we have to disclose. So it’s not like we can go buy at or tie it up and not disclose it. With regard to funding we believe that it was important for you and other interested parties certainly our shareholders to know how we plan to pay for it and we are going to pay for it with the sale of these properties, we are not concerned about the fact that the world knows that which properties we are selling because that doesn’t change the way we analyze them from a value perspective.

Given the large number of interested parties in these sites, the market is quite robust. As John said for, well maintained, well located properties and so this is all about capital allocation and this is about buying low and selling high and this is the third or fourth time cyclically that we have demonstrated our ability to do that.

Alexander D. Goldfarb – Sandler O'Neill & Partners LP

Okay. Thank you, Jeff.

Jeffrey I. Friedman

You’re welcome.

Operator

Your next question is from Jeff Donnelly with Wells Fargo.

Jeff J. Donnelly – Wells Fargo Securities LLC

Good afternoon guys. I hate to dwell on the assets that you are selling, but just curious for modeling purposes, can you talk about the sort of cap rates you expect to sell those assets for, I just didn’t catch you mentioning anything and I am curious, where you may be seen as the portfolio or maybe what the range is over the assets.

Jeffrey I. Friedman

I think just high level wise, we are using an 80 basis point negative barb on the trade, so we are buying for 80 basis points less than we are selling for.

Jeff J. Donnelly – Wells Fargo Securities LLC

Okay. I am just curious because I recall it, when you guys entered Germantown, I mean do you think you will be able to achieve the exit cap rate on Germantown that you kind of expected one or two years ago or do you think things are coming in better than your original expectations?

Jeffrey I. Friedman

It’s better than we could have ever imagine, better than the wildest assumptions in any pro forma we could have ever thought.

Jason A. Friedman

In level with 6.

Jeff J. Donnelly – Wells Fargo Securities LLC

Do you think you go below a 6?

Jeffrey I. Friedman

Well, most definitely.

Jeff J. Donnelly – Wells Fargo Securities LLC

Okay. And I might have missed this, when was the decision to sell the three properties in Maryland, is that just a function of the age of the property, because they are older or is that maybe a comment on your thoughts on Washington, D.C. or is it just something specific to those properties?

Jeffrey I. Friedman

Well, again it’s a – you make money when you buy. We bought them, right. We’ve owned them for 15 years, it’s in the life of a property, we had some decisions, we renovated two of them, we captured all of the pickup in the rents from having remodeled the kitchens and baths and we are going to take those dollars and we are going to reinvest them in newer properties with lower CapEx in markets that we think will prove out over a long period of time to also be good buys.

Jeff J. Donnelly – Wells Fargo Securities LLC

And is there any debt on any of these assets that you are selling that might kind of trip up the sale a little bit or affect pricing?

Jeffrey I. Friedman

No. There are no mortgages on any of the properties that we are planning to sell.

Jeff J. Donnelly – Wells Fargo Securities LLC

Okay. And just one last question, concerning the pushed out dates some of the adjustments, does that change just because it’s so slightly longer period to delivery, did that change your expectations around project cost at all, because maybe you are carrying into a little bit longer without income or is it, it looks like it holds pretty constant, but I was curious to think that will put a higher risk of higher construction cost?

Jeffrey I. Friedman

It does Jeff, we don’t move things during the process, in other words we don’t increase the rents during the construction period. We have a GMP contract, so from a cost perspective, we’re not concerned about the costs. As Jason mentioned, we’re hopeful that the general contractor brings it in, he is – they are incented to bring it in sooner. They make more money, if they complete it sooner. And so I guess two sides to that, there could be risk if we were concerned about the market or the supply in terms of having deliveries six months later than we originally thought about it. There could be some risks there.

We don’t believe in this Mid-Wilshire market on Wilshire Boulevard with our 175 units that we are concerned about, that this will be very special product. We will be in on a cost basis well below all of the new competition and we will be very competitive and attractive in that submarket.

Jeff J. Donnelly – Wells Fargo Securities LLC

Do you think that, I’m reading ahead but do you think that you might consider selling those assets after completion kind of as you have with Nashville, because you feel you have a very cost basis and I mean do you think those be combining all the assets?

Jeffrey I. Friedman

Well, Jeff California will be a part of our portfolio coastal California, northern California forever. And so we expect to have 20% to 30% of our assets in those coastal California markets that we have talked about. Now, will we tracing out of them, certainly to the extent that we are able to benefit from what’s happening with the cycles of the market, but we are designing these and building these and with the expectation that their long-term hold.

Having said that, there are many of the markets and submarkets that we are buying and then growing them to date. For example suburban Dallas, where some of the assets there clearly work, where assets that we did not necessarily see as long term holds, just because that's the type of markets that they are and based on when we bought them. But there are other deals that we bought like Rienzi, like Cantabria where we’re building, where we see them as long-term holds because in many respects they are irreplaceable assets.

Jeff J. Donnelly – Wells Fargo Securities LLC

Now I understood. I guess this might have been my mistake. But I guess when you guys have entered Nashville, I guess I thought you were looking at that market with the same kind of perspective you're talking about California now. I wasn't expecting you to sell Nashville so quickly. So you addressed that already, but thank you. It's helpful.

Jeffrey I. Friedman

Let me just add on to that, like I said what was important is that the expectation when we entered Nashville, that we would be able to build a portfolio at cap rates that we saw justify the investment in that market. When they compressed, we weren’t able to do that. We don't see that happening in California given the breadth of that coastal market and the submarkets we're focused in.

Jeff J. Donnelly – Wells Fargo Securities LLC

Okay. Thank you.

Operator

Your next question is from Dave Bragg with Green Street Advisors.

Dave Bragg – Green Street Advisors, Inc.

Thank you. Good afternoon. What was the cap rate on the Dallas acquisitions that you did during the quarter?

John P. Hinkle

This is John Hinkle. Rienzi was a 5.2% nominal cap rate and a 4.8% economic after fee and reverses.

Dave Bragg – Green Street Advisors, Inc.

And that’s on first year NOI, John?

John P. Hinkle

Correct.

Dave Bragg – Green Street Advisors, Inc.

And actually can you talk a little bit more about how you underwrote that? What unlevered IRR did you target?

John T. Shannon

Unlevered IRR is approximately 7.4% on that and levered assuming 50% leverage would be in the low 10% range and that’s what relatively conservative rent growth programmed in over the first five years.

Dave Bragg – Green Street Advisors, Inc.

What was the rent growth, John?

John T. Shannon

I believe it was 16.5%, little bit higher than that, but about an average of mid-threes per year.

Dave Bragg – Green Street Advisors, Inc.

Mid-three’s. Thank you. On the Monrovia development joint venture, what yield will that project have on today’s rents?

Jason A. Friedman

Well, hi, Dave. This is Jason. We’re really early in the process of designing the building that can be built there, the 154-units working with our joint venture partner. Based on the product site that we can build and the current market conditions, we would expect around a 6% return on cost.

Dave Bragg – Green Street Advisors, Inc.

And many of your peers have, when you talk about co-store account, many of your peers have really drawn a line in the sand between being on the coast and being half hour out in markets like Monrovia and have decided that they don’t want exposure to those markets. As yields remain quite low in the coastal part of the state, might we see you a team is 20% to 30% exposure by going a little further out in markets like Monrovia with higher yields?

Jeffrey I. Friedman

Well, this is Jeff. No. Coastal means coastal. Monrovia, this opportunity in Monrovia, you’re out there. You know that submarket dislocation. It’s a unique location and it’s just different, but for the most part coastal means coastal, we’re not going to be moving further out or we’re not going to be moving further east to chase yield.

Dave Bragg – Green Street Advisors, Inc.

Okay. Last question, can you just update us on the supply demand situation in the D.C. market?

Patrick Duffy

Sure. This is Patrick. For Associated Estates we operate five properties in the D.C. metro area and the five properties are located in four submarkets; Eastern Loudoun County, Vienna, Woodbridge and Silver Spring and in those four submarkets, our properties are continuing against one or two properties that are in lease up. And so for Associated Estates, the supply situation for our properties is very manageable and we’re able to maintain high occupancy levels at our five D.C. properties. There is some downward pressure on rents, but that’s minimal. So for Associated Estates in these four submarkets supply is absolutely manageable.

Dave Bragg – Green Street Advisors, Inc.

Okay. Thank you.

Operator

The next question is from Tayo with Jefferies.

Tayo T. Okusanya – Jefferies LLC

Yes. Good afternoon everyone. Most of my questions have been answered, but just in regards to development projects that completion times are being pushed out. I think the other one on the schedule is the 7,001 Bethesda and I was wondering if you could talk about why that was also pushed about a quarter or two?

Lou Fatica

Tayo, this is Lou. I’m not following. I don’t think that the timelines have changed for our Bethesda project.

Tayo T. Okusanya – Jefferies LLC

As the completion date now of Q2 2015, I wish that that going to get completed a quarter earlier than that or am I looking at that wrong?

Lou Fatica

Yes, you’re correct. Stabilization is still expected for Q3 of 2015.

Tayo T. Okusanya – Jefferies LLC

Okay. So the stabilization is still the same, but you’re pushing out that completion by a quarter?

Lou Fatica

Yes, I think it’s a matter of weeks, not months.

Tayo T. Okusanya – Jefferies LLC

Okay.

Lou Fatica

So it’s sort of, I think kind of particular about that like Desmond.

Jason A. Friedman

This is Jason, Tayo. We are moving along. We’re digging into the ground right now, have our permits and are on schedule. So we don’t expect anything to really affect that and change it with any significance.

Tayo T. Okusanya – Jefferies LLC

Okay. That’s all I had. Thank you very much.

Lou Fatica

Thanks, Tayo.

Operator

Your next question is from Nick Joseph with Citigroup.

Michael Bilerman – Citigroup

Yes, good morning. It’s Michael Bilerman here with Nick. Jeff, your son Matt owns the brokerage business in California. He advised you in certain deals last year over $100 million including this Desmond asset, which you now have a litigation, which made up almost 40% of that $100 million. You paid $1.6 million to him last year and seven years before that when he was at markets in [indiscernible], there was about $8.4 million, about $2.6 million went to him. Can you talk about sort of that conflict and sort of how you see that?

Jeffrey I. Friedman

Sure, I’ll be glad to. Broker community is very important to us and we work with brokers at every one of the brokerage firms, both on the buy and on the sell side. We rely on them to show us deals and we rely on their market presence to be able to attract buyers. We have a team of people here who made the decision with regard to which brokers and firms we work with on each property and they negotiate, they make the determination, they decide what the fee structure is on all of those.

In addition, anytime we do business with any related party, the independent members of the Board must approve a transaction related to related parties. So as it relates to my son Matthew who represented us some of those deals, first of all, the independent members of the Board approved that. Second of all, he probably feels like he didn’t get enough business from us. And he probably feels he didn’t get paid enough of the fee from us. As it relates to the three deals that are currently being marketed that we are selling now, he’s not the broker on either – on any of those deals. So really we have the best broker to represent us when we’re selling and when we’re buying. We work with who has the listing.

Michael Bilerman – Citigroup

That’s helpful color. Can you just dive a little bit into the Desmond asset? How much did you sort of know about the issues going into it? How much did Matt sort of tell you about what the issues were prior to getting the fee? And then, has there been any other fees in calendar year 2013 paid to this firm?

Jeffrey I. Friedman

With regard to Desmond, yes, Matthew was very up front. Matthew worked on this deal for over five years. It seems like longer, ingratiating themselves with the art dealer who controlled the property. It was a site that we had our eye on along with another site that he controlled for quite some time. He made it very clear that this was a very difficult tenant. This was someone we were going to be chasing for our rent based upon his historical performance. So we went into this with our eyes wide open.

As I said in my prepared remarks, Michael, we don’t comment on litigation which we’re still engaged in, but let me talk a little bit about our strategy and the rationale buying this property. Our objective was to acquire an entitled site and build apartments. We bought the property, which included the vacant land and a commercial building for a fraction of the market value.

We gave this art gallery a master lease on the commercial space at a below market rent. We knew that going in and we also gave them an option to buy the building at below market price. We gave them a $20 million option and we collect about $1.5 million to $1.6 million a year from them. We knew all along that approximately 80,000 square feet was worth more if we were to re-tenant it, reposition it, because our objective is to sell it and not to own it. And so we knew that going in.

The tenant had a reputation of being very difficult and we expected the tenant to pay timely and to live up to their obligation. When they didn’t, we defended our rights and we expect to be successful.

Now, with regard to what we paid Matthew this year, I don’t really know. I believe he was involved as a broker on the sale of the Columbus asset. Maybe there was another asset. I don’t really know that, but if you want to follow-up we’ll be happy to tell you. That’s something that we disclose on an annual basis, but…

Michael Bilerman – Citigroup

Yes, that’s helpful. And I guess, Jeff, you have been active at buying and selling and currently have more sales queued up. You are obviously frustrated with where the stock is relative to your perception of total asset value. When does it come to the realization that perhaps a sale of the entire portfolio or the company is the only way to get to that value that you perceived because the stock has traded at a meaningful discount to your perception of value for a long time?

So at some point don’t you just need to execute a transaction and sort of say, it’s not working for whatever reason. The public market is not just giving you the appropriate valuation that you believe it deserves that you just sell it.

Jeffrey I. Friedman

I guess, you’ll know it when you see it.

Michael Bilerman – Citigroup

Well, I guess at what point, I mean how long does it have to stay at precisely $15 and your belief is that it is likely meaningfully higher from a GAAP rate perspective. I mean how long do you let that sit for in a market where apartment assets today are highly sought after? I guess why wouldn’t you pursue that as a strategy? Are you just against the sale or is that ever on the table or I’m just trying to get a perspective of whether or not something that we should think about or not?

Jeffrey I. Friedman

Well, we’re building our business with a long-term perspective. We understand our obligations, our responsibility to all of our shareholders and every investment we make we look at it with that in mind. Our objective is to create as much value as we possibly can. That’s what we’re working hard to do everyday.

Michael Bilerman – Citigroup

All right. I mean you’re a large shareholder of the stock, so I mean wouldn’t you want to monetize at some point?

Jeffrey I. Friedman

Michael, I’ve answered your question.

Michael Bilerman – Citigroup

Okay, all right. Thank you.

Jeffrey I. Friedman

You’re welcome.

Operator

We have reached our allotted time for the Q&A session. I will turn the presentation back over to our presenters for any closing remarks.

Jeffrey I. Friedman

Thanks very much Victoria and to everyone for joining us. That will conclude our call today.

Operator

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

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