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Associated Estates Realty Corporation (NYSE:AEC)

Q2 2010 Earnings Call Transcript

July 27, 2010 2:00 pm ET

Executives

Jeremy Goldberg – Senior Director of Corporate Finance & IR

Jeff Friedman – Chairman, President & CEO

Lou Fatica – VP, CFO & Treasurer

John Shannon – SVP, Operations

Patrick Duffy – VP of Strategic Marketing

Analysts

David Toti – FBR Capital Markets

Buck Horne – Raymond James

Eric Wolfe – Citigroup

Lindsey Yao – Robert W. Baird

Andrew DiZio – Janney Montgomery Scott

William Acheson – Benchmark

Haendel St. Juste – KBW

Andrew McCulloch – Green Street Advisors

Operator

Welcome to the Associated Estates second quarter 2010 earnings conference call. My name is Linnaea and I will be the operator on your call today. At this time, all participants are in a listen-only mode. Following prepared remarks by the company, we will conduct a question-and-answer session. (Operator instructions)

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

Jeremy Goldberg

Thank you, Linnaea. Good afternoon, everyone and thank you for joining the Associated Estates second quarter 2010 conference call. I’d like to remind everyone that our call today is being webcast and will be archived on the Associated Estates website through August 10th.

On the call today, 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, Patrick Duffy, our Vice President of Strategic Marketing, and I will be available for the Q&A.

Before we begin our prepared comments, we would like to note that certain statements made during this call will be forward-looking statements that are based on 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 projection.

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' second quarter earnings release and the supplemental financial booklet are available on the Investor Relations section of our website at www.associatedestates.com and they include reconciliations to non-GAAP financial measures, which maybe discussed on this call.

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

Jeff Friedman

Thanks, Jeremy and thanks to everyone for joining us. The participation on our quarterly calls has increased significantly. We hope you continue to find them helpful and we always appreciate feedback.

As we prepared for 2010, we expected that operating fundamentals would improve for our portfolio. With the dust from 2009 not quite settled and I might say we were all still a little shell-shocked, we expected improving conditions, although we weren't sure how long it would take for a sense of normalcy to return.

We did establish several priorities for 2010, all of which took these optimistic expectations into account. Our focus on continuing to improve our balance sheet is at the top of the list. We also wanted to demonstrate our ability to continue to cover our dividend from FAD. And we wanted to grow. We've been able to do all of these.

We used the proceeds from our follow-on offering in January to pay down debt. As fundamentals and our stock price improved, we went back to the equity market in May with the largest follow-on offering in the company's history and used the proceeds to pay down high-coupon debt and preferred and to buy an irreplaceable asset 20 miles south of the District of Columbia.

These steps can be viewed two ways. First, to position the company to growth. As we will touch on today, there are many factors that indicate that the drivers of the apartment business are improving. However, the actions we took can also be looked upon as defensive measures in the event there is a double-dip or we are wrong about what's in store for our domestic economy and how that impacts the apartment business.

Certain facts and trends indisputably support improved apartment fundamentals. New households continued to grow at about 1% per year. Of these 1 million plus new households, we know that based on historical numbers, at least 35% or 350,000 will new renters.

According to a recent report published by John Burns Real Estate Consulting, 8 million homeowners are currently not paying their mortgage. Burns thinks 6 million of them will lose their home to the bank in the next two years. This will reduce the homeownership rate from 67% to 62%.

Burns continues that a recent study indicates another 5% of all households, which equals roughly 5 million additional homeowners, have no equity in their homes. This suggests that only 57% of U.S. households own a home with equity value. If you believe that many will strategically default, this will push the homeownership rate even lower. These households that were once homeowners will also be incremental additional renters.

There are other factors driving apartment demand; immigration trends, as more immigrants rent first before buying; financial flexibility, as even those who can afford to buy are waiting longer to pull the trigger; more stringent lending standards, making it more difficult to qualify for a loan.

And yes, there are a few factors helping homeownership such as the aging population, as older households tend to own versus rent; housing affordability, as home prices have fallen, the spread between the cost to own and the cost to rent is less.

So some of you may think I'm stating the obvious. But I believe it's important to point these things out to justify the very high occupancy we and probably the rest of the apartment companies will report this quarter. I would expect high occupancy to continue for some time to come. You will see from the numbers we just reported that occupancy is higher than we expected and expenses lower, driving better-than-expected same community NOI. But as we've said many times before, what's going on in the job market drives rents.

Let's look at a couple of our markets. Take the Midwest. When we look at May 2010 compared to May 2009 based on the Bureau of Labor Statistics, most Midwest markets where we have properties have lower unemployment than a year ago. Rents in our Midwest portfolio, Q2 over Q2, are down 0.4%. Conversely, when we look at the Southeast markets where unemployment has increased by approximately 1% May over May, our Q2 over Q2 net rents are down 3.2%.

Those are all facts. Now, a few opinions. I continue to believe that nationwide unemployment will reach 10% before it will reach 9%. Interest rates will remain low with little or no inflation for years, and top line growth will be hard to come by in any business until uncertainties in our domestic economy are clarified. I'm referring to tax policies, health care costs, and the political landscape following the November election.

Until we have clarity, businesses will be reluctant to expand domestically and there will be anemic job growth. In 2009, we were saying we expected to see the job growth in late 2010. Now, I don't see meaningful job growth before 2012 at the earliest. This isn't that bad for Associated Estates, but it's certainly not good for America.

Couple of more things before I turn the call over to Lou. The second quarter and really the first half of the year was truly transformational for Associated Estates. Our two follow-on offerings doubled the equity market cap of the company and the use of proceeds went a long way toward establishing a best-in-class balance sheet. And from a timing standpoint, it couldn't have been better, as we are seeing more deals that will create significant long-term value and steady and predictable cash flow.

We are also proud that we were recently recognized by the Cleveland Plain Dealer as one of the best places to work and we are one of four finalists for the National Association of Home Builders' Pillars of the Industry Award for Property Management Company of the Year. Although the demographic trends are favorable for our business, it's the people we have that continue to deliver sector-leading results.

Now, I'll turn the call over to Lou.

Lou Fatica

Thank you, Jeff. For the second quarter and year-to-date 2010, FFO as adjusted was $0.21 and $0.39 per share, respectively.

The FFO as adjusted for the quarter excludes a $1 million non-cash write-off of original issuance costs related to the Series B preferred share redemption on June 7th and a $700,000 non-cash write-off of unamortized costs related to the trust preferred securities, which were redeemed on June 30th.

The year-to-date FFO as adjusted excludes these non-cash charges, as well as a cash refund of approximately $550,000 received during the first quarter of 2010 related to previously defeased loans.

For the quarter, we saw a flat-to-positive revenue growth in most of our markets, driven by stable occupancy levels in the Midwest and Mid-Atlantic and improved occupancy in the Southeast. Total same community revenue was up 0.6%, property expenses were up 1.7%, resulting in an NOI decline of 0.2% when comparing the second quarter of 2010 to the second quarter of 2009. On a sequential basis, same community revenue was up 2.2% and NOI was up 3.2%. Year-to-date, same community revenue was flat and NOI is down 1%, both better than expected.

As Jeff mentioned, Q2 and the first half of the year were truly transformational for Associated Estates. We will begin to see the full impact of lower interest costs related to our debt repayments during the second half of the year. We ended the quarter with leverage as measured by debt plus preferred at 46.3% or nearly 15% lower than year-end 2009. 85% of our debt is fixed at an average interest rate of 6.3%. The average interest rate on all of our debt is 5.8% with a weighted average maturity of six years.

At quarter-end, we had $115 million of availability on our line. Our interest coverage and fixed charge ratios stand at 1.75 times and 1.55 times. These ratios will see significant improvements in the second half of the year as a result of the debt repayments in Q1 and Q2.

We have one remaining loan maturity in 2010, a $21 million loan maturing on December 1st that carries an interest rate of 4.75%. We have entered into a rate lock agreement with the current lender, a life company, to essentially extend the maturity for five years at a fixed rate of 4.55% with the closing expected to occur on the maturity date of the existing loan.

With regard to our line of credit, which matures in March 2011, we are in the process of finalizing the terms of a new facility with an expected closing towards the end of the third quarter. Unamortized costs relating to the line are $350,000 at quarter-end. Thus, to the extent we renew the line prior to March 2011, we will need to write off any remaining unamortized balance and recognize a non-cash charge for such write-offs. This non-cash charge is not currently reflected in our earnings guidance.

Given our year-to-date performance and our expectations for the balance of the year, we have updated our 2010 FFO as adjusted guidance to a range of $0.87 to $0.93 per share with a midpoint of $0.90. Based on our first half results and a property-by-property reforecast completed at the end of the second quarter, we have tightened our same community expectation as we now expect revenue to be flat at the midpoint, which is slightly better than originally projected.

Expenses are also expected to be lower than we had originally forecasted. When combined, our current revenue and expense expectations result in same community NOI declining by 1.75% at the midpoint of our guidance range.

As announced on June 2nd, we increased our acquisition guidance, which previously reflected no 2010 activity, to a range of $100 million to $150 million, which includes the Q2 Virginia acquisition. We now expect the balance of any acquisitions to occur later than originally forecasted. At the time we provided the updated guidance, we had two properties that we had every intention of acquiring and closing on in early Q3 that did not come together for various reasons.

Overall, deal flow continues to be elevated from 12 months ago and we expect to acquire additional properties that will take us closer to the high end of our 2010 acquisition guidance, albeit later than originally projected. Pushing the acquisitions to later in the year had a $0.02 to $0.03 per share negative impact to full-year expected results.

2010 G&A is expected to be a similar – at a similar level to 2009 at $14.2 million or approximately 11% of property revenue. Year-over-year comparisons are impacted by credits in the first half of 2009 of approximately $500,000 that were recorded relating to marking to market our deferred Directors' compensation.

Also, as it relates to the net contribution of our construction services, we continue to expect a nominal positive contribution for the full year. The year-to-date negative contribution is a result of the timing of new projects which did not commence until the third quarter or are not slated to begin until later in the year. We anticipate that our projected FAD will exceed our expected regular annual dividend of $0.68 per share. Further assumptions supporting our FFO as adjusted guidance can be found on Page 25 of our supplemental.

Before I turn the call over to John, let me take a minute to update you on our capital market activities. With the issuance of $175 million of common equity this year, we had less than $40 million available under our previous shelf.

We filed a new S-3 registration that became effective on June 23rd that allows for the issuance of up to $500 million of debt and equity securities. The shelf provides us with flexibility to issue securities when market conditions are favorable. It is our intention to maintain leverage as measured by debt plus preferred to undepreciated book value that has at a targeted range of 48% to 52%. Our 2010 earnings guidance does not take into account issuing any additional shares.

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

John Shannon

Thank you, Lou. In my prepared remarks, I will provide an overview of our second quarter same community operating performance and specific market details.

We are pleased with our second quarter performance as our results are ahead of our internal expectation. On a quarter-over-quarter basis, our same community NOI was down 20 basis points versus a budget of a negative 4%. This significant improvement is a result of an increase in physical occupancy and a reduction in real estate taxes and operating expense. On a same community sequential basis, revenue was up 2.2%, average physical occupancy was up 130 basis points, net rents were up 30 basis points, and NOI was up 3.2%.

When we released our annual revenue and NOI guidance in February, our expectations were second best when comparing us without – our apartment REIT peers. We also said that we would begin to see growth in the second half of the year. What actually happened is that we got growth a quarter early and we are starting the second half of 2010 right where we though we would be. We anticipate second half same community performance to be in line with our original budget of flat revenue and 3% expense growth at the midpoint.

Before I go into detail on our performance by region, I would like to provide some commentary on trends that we are seeing at the property level, that is, what has remained the same over the past 18 to 24 months, what has changed, and what we are forecasting for the balance of the year.

What has remained the same are the average age of applicants at 34 years and the average individual income level of approximately $55,000. Our average occupancy by unit type has consistently reflected no more than a 100-basis point spread between the one, two, and three-bedroom apartments. Year-to-date annualized turnover is held at about 58%. Net closing ratio has remained at approximately 40%. Our resident satisfaction scores from both external and internal sources remain high. And as a portfolio, our renewal increases have been positive every quarter during this recessionary period.

What has changed is that we are more highly occupied, prospect traffic is up, other income and fees are higher, and we have increased pricing on new leases from an average of a 6% decline in 2009 to down only 50 basis points in Q2. Month-to-date for July, new leases are up 1% and renewal leases are up 2%.

Much has been written and discussed as the reasons for the improvements in the apartment sector, and there are numerous opinions. It is our opinion that the reason we are seeing higher traffic and occupancy levels and new lease growth, albeit small, is that residents and prospects continue to be nervous about job security, they are uncertain to where housing values are going, and prefer the financial flexibility and physical mobility of renting. For the balance of the year, we anticipate that resident and prospect sentiment will be cautious and many will continue to rent. This will allow us to stay full and continue to push rents modestly.

Now, let me take a minute to discuss our markets and the specific quarter-over-quarter and sequential performance. In the Midwest, we finished the quarter at 97.3% physical occupancy. Quarter-over-quarter, revenue was flat and NOI was up 1.1%. Sequentially in the Midwest, total revenue was up 2.5%.

As I stated last quarter, the outlook for our submarkets in the Midwest is that we are at the bottom of the cycle. Over the past two years, the Midwest was our top performing region with average annual revenue growth of nearly 3%. Due to these tough comps and the fact that most of these markets did not peak until the first half of 2009, we anticipate flat to slightly down rental growth in the Midwest for the balance of the year.

In the Southeast, we closed the quarter at 95.1% physical occupancy. Quarter-over-quarter, revenue was up 2.8% and NOI was up 1.9%. Sequentially, total revenue was positive 2.4% as a result of an increase in physical occupancy. However, due to concessions, net rents in the Southeast were down 3.2%, offsetting much of the gains in occupancy as we expected.

In Florida, we have four communities that continue to perform in line with our internal expectation. In Orlando, we finished the quarter at 92.1% physical occupancy. Two months of free rent continues to be the norm. In South Florida where we have three properties, we expect occupancies to hold in the 93% to 95% range with concessions of one to two months.

In Atlanta, we finished the quarter at 94.5% physical occupancy, up 2.1% from Q1 and we are still offering concessions in the range to two to three months depending on availability and floor plan. For the balance of the year, we are forecasting that Atlanta will continue to be a concession-driven market and occupancy levels will remain in the 90% range.

In the Mid-Atlantic where we operate in Baltimore, Washington, and Virginia, we closed the quarter at 96.1% physical occupancy. Quarter-over-quarter, revenue was down 1% and NOI was down 6.3% due to increases in real estate taxes. Sequentially in the Mid-Atlantic, total revenue was up 70 basis points. Our three Baltimore/Washington properties performed in line with our internal expectations, finishing the quarter at 95.7% physical occupancy with revenue up 50 basis points. We anticipate that we will maintain occupancy in the 94% to 95% range with net rent growth due to the stability of the region.

In Virginia, on a same community basis, we operate in two markets, Norfolk and Richmond. We performed as expected with physical occupancy at 96.4% and revenue down 2.5%. We continue to see downward pressure on rent levels as new supply is being absorbed. We are forecasting that most of the new units will be absorbed in the second half of the year as all the new communities are nearing stabilization. As a quick update on our Woodbridge, Virginia acquisition, the property is performing in line with our underwriting and has been a great fit with our other Mid-Atlantic properties.

In closing and to reconcile to the midpoint of our revised guidance range, for the balance of the year, we are projecting year-over-year revenue to be flat and expenses to increase by 3%, resulting in full-year same community NOI declining by approximately 1.75%, a significant improvement from our original guidance of negative 3.25%.

I will now turn the call back over to Jeff.

Jeff Friedman

Thanks, John. Good quarter. Let me – why don't we go ahead and open up the call for questions?

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator instructions) At this time, we will pause momentarily to allow parties to join the question queue. Our first question is from David Toti of FBR Capital Markets. Please go ahead.

David Toti – FBR Capital Markets

Good morning, guys. Thank you. My first question, do you guys have any assets on the market today?

Jeff Friedman

No.

David Toti – FBR Capital Markets

Any that you are teeing up?

Jeff Friedman

I don't think so.

David Toti – FBR Capital Markets

For some time previously, you had discussed being a bit more aggressive on capital recycling relative to the acquisition pipeline that continues to grow. Do you have any thoughts about that or maybe can you just give us some indication of your strategy around that thought?

Jeff Friedman

David, this is Jeff. Capital recycling? Are you implying selling some properties and using those assets to buy others or are you talking – what are you specifically referring to?

David Toti – FBR Capital Markets

Well, I guess I'm thinking about your continued goal of transitioning into higher-growth markets and out of some of the more stable lower-yielding markets, even though there is a sort of a short-term dilution to that trade, it would seem to make sense to prune some of the portfolio in the light of your acquisition agenda.

Jeff Friedman

Yes. David, we really like all of the properties that we own in what some may refer to as the slower-growth markets, which actually over the last few years have been the fastest-growing markets and those are the Midwest markets. So the way we plan to transition our portfolio from the approximately 57% or so of NOI that today comes from the Midwest down to ultimately 35% from the Midwest, the balance from other markets, is by acquiring and building and growing in other markets.

And then depending on that additional acquisition or development activity, we will then make a decision on a market-by-market basis as we do practically every quarter, which properties we think we could then recycle where our return on equity would be greater from selling those properties into the market and reinvesting those dollars somewhere else. But I would expect most of the growth and most of the transition of our portfolio NOI to be from acquisition as opposed to disposition.

David Toti – FBR Capital Markets

Okay. And then along those lines, where do you see sort of target leverage level given that strategy?

Lou Fatica

David, this is Lou. We like to operate in the 48% to 52% range as measured by debt plus preferred to undepreciated book value.

David Toti – FBR Capital Markets

Okay. And then maybe if you could just give us a little bit of detail on the conditions of the Virginia acquisition, what was the bidding like, how did you come about the opportunity, and maybe some other pricing details as well?

Patrick Duffy

David, this is Patrick Duffy. We did purchase Riverside Station, which is a 304-unit property in Woodbridge, Virginia. The property was built in 2005. There was a high level of interest in this property, because it is part of – it's located in the greater Metro D.C. area. We – your nominal cap rate on the purchase was 6.1% and I think we use very reasonable revenue growth assumptions to arrive at our pricing of $54 million, which is approximately $178,000 a unit.

David Toti – FBR Capital Markets

Now, that's very helpful. Thank you very much.

Operator

The next question is from Buck Horne of Raymond James. Please go ahead.

Buck Horne – Raymond James

Thank you. Good afternoon, guys. I'm just – was a little confused maybe about the guidance. You are – just given the strong performance you all have demonstrated year-to-date and the continued improvement in same-store operating trends, I'm just wondering have you got same-store revenues already flat year-to-date and the same-store NOI is only down 1%.

So I just wanted to clarify if the guidance that you are giving for the rest of the year, does that indicate some recent signs of weakness in leasing or there is some higher expenses on the horizon or is it just that the crystal ball that you are using is just a little uncertain and you are opting for a little bit more conservatism right now?

John Shannon

Yes. Hi, Buck. It's John. What – with our forecast for the balance of the year, we are forecasting that occupancy will be down a little bit from where we performed in the first half of the year and that we are going to get a little bit of pricing power. So it's really a balance of those two.

Lou Fatica

And Buck, this is Lou. Maybe I can add a little color here as well. If we look at our year-to-date performance, if we want to talk about some round numbers, same-store NOI was probably $0.04 positive to where we expected. And as John mentioned, we expect the second half of the year to be in line with our forecast. Offsetting that 4% – or $0.04 positive impact is the impact of acquisitions now projected to happen later in the year and that takes away about $0.02 to $0.03 from that. So that gets us back to – within the guidance range that we provided of $0.87 to $0.93 a share.

Buck Horne – Raymond James

Okay. And maybe we can just talk a little bit about the acquisitions, maybe about – you had a Tennessee property, I think, under an agreement at some point. Is that deal now off the table at this point or might that close sometime soon? And maybe can you speak more broadly to the acquisition environment in general just kind of – are there more deals available? Is the pricing at a level that makes sense? Is there more or less competition for assets and kind of walk us through that scenario.

Jeff Friedman

Buck, this is Jeff. First, with regard to the Nashville asset, our policy is not really to talk about these until they close. What happened here is our management, our operations folks got a little bit ahead of themselves by posting for some positions in this market, a market that we've identified as a market that we wanted to grow in.

Specifically, with regard to the asset that we had under contract and, I believe, that was referred in our close-up relating to the follow-on offering, we uncovered some unknown physical conditions, some significant unknown conditions that were not apparent. And so we walked from that. It was something that the seller wasn't aware of either on that property.

With regard to the overall acquisition environment or sellers' appetite, Patrick, you want to talk about what you are seeing and what the guys in the field are bringing in?

Patrick Duffy

Sure. We are seeing an increased number of listings in the markets where we are looking at and that's generally in the Mid-Atlantic and Southeast. We are seeing cap rates in the 5% to 6% range on trailing 12-month NOI for Class A properties. We are currently working on a number of acquisitions in both the Mid-Atlantic and the Southeast.

Buck Horne – Raymond James

Okay. Thanks, gentlemen.

Lou Fatica

Thanks, Buck.

Operator

The next question is from Eric Wolfe of Citigroup. Please go ahead.

Eric Wolfe – Citigroup

Thanks, guys and Michael is on the line with me as well. Just staying with acquisitions and your guidance, how are you planning on financing the $50 million to $100 million additional acquisitions this year?

Lou Fatica

Eric, this is Lou. Currently, with our leverage at 46.3% and based on where our share price is today, we would expect to fund the balance of those acquisitions utilizing our line of credit.

Eric Wolfe – Citigroup

Okay. And then maybe I heard this wrong earlier then, I thought you said that you – the remaining acquisitions were going to actually be dilutive – $0.03 dilutive to FFO for the remainder of the year. But it would seem if you are using your line that it would be pretty accretive given that your line is at what, around 2% and obviously cap rate is going to be 6% or above. So I guess how much – what would FFO guidance be without the remaining acquisitions in guidance for the year?

Lou Fatica

Well, Eric, just to clarify, what I said was, as a result of those acquisitions happening later in the year than what we projected on June 2nd, because we had acquisitions that we thought we were going to close on in early Q3 –

Eric Wolfe – Citigroup

Right.

Lou Fatica

Moving those acquisitions to later in the year result in a $0.03 to $0.04 negative impact. Thus, if we did no additional acquisitions, it would impact guidance by $0.01 to $0.02 additionally, so within the range we provided of $0.87 to $0.93.

Eric Wolfe – Citigroup

Got you. Okay. And just I guess this relates – in terms of your interest expense guidance, it's going up marginally from where you were at in the first quarter. One would think it would go down, given that you are paying off $26 million of debt at about 7.9%. So I guess just doing the math and thinking about what would offset that, could we expect you are going to put $100 million on your line by the end of the year?

Lou Fatica

If we close on the acquisitions that we've provided guidance on, yes. And there is a couple of things that impact that as well in addition to that. And that's to the extent that we finalize our line of credit, we would expect pricing to change and that would add an additional impact to the line as well.

Eric Wolfe – Citigroup

Got you. All right. And then just lastly, looking at your occupancy right now, above 96%, you touched upon this in your early remarks that you were saying you are kind of looking for moderate increases in rent. But why do you think that you can't push tenants a little bit more right now? One would think at such high occupancy levels, you would have some pricing power.

John Shannon

Eric, this is John. We really have been pushing rents for the better part of the second quarter. When we look at our new leases and our renewal leases and combine those two as to what kind of increases we got, in Q1 of this year, all in, we were down 2.2% on those rents. And then when we look at the same data for Q2, the blended is we are up 0.6%. So if you kind of extrapolate that out, we effectively had 2.8% improvement in new lease and renewal rents.

Eric Wolfe – Citigroup

So I guess just for the renewals that you are sending out now, looking 60 to 90 days ahead, what kind of rate growth are you asking for there?

John Shannon

Yes, depending upon the market, we are at a 2% to 4% growth. And we are looking at those renewals when would – if it – we don't price renewals by saying everybody gets a 2% increase or everybody gets a 3% increase. We look at where everybody is currently priced and make a decision from there.

Eric Wolfe – Citigroup

Okay, great. Thank you for the detail.

Operator

The next question is from Lindsey Yao of Robert W. Baird. Please go ahead.

Lindsey Yao – Robert W. Baird

Yes. You gave some detail on July rent trends, renewals of about 2% and new rents of 1%. Do you have that on a market basis or regional basis?

John Shannon

I do not have that right now, but Lindsey, I certainly could provide that for you.

Lindsey Yao – Robert W. Baird

Okay, great. And then the 60 units that you constructed on the vacant land in Richmond, are there any other opportunities like that in the portfolio?

John Shannon

We do have excess land at a few of our communities in the Michigan market, as well as here in the Northeast Ohio market. It's just that we haven’t had the opportunity; it just doesn't make sense right now with what it costs to build and what kind of rents we can generate. So we are not planning any development on the existing sites right now.

Lindsey Yao – Robert W. Baird

What would have to change for you to want to start those developments?

John Shannon

We would have to see rents go up significantly to be able to support new construction in these markets.

Lindsey Yao – Robert W. Baird

Okay. Thank you.

Operator

Next question is from Andrew DiZio of Janney Montgomery Scott. Please go ahead.

Andrew DiZio – Janney Montgomery Scott

Yes, thanks. Hi, guys. Just a –

Jeff Friedman

Hi.

Andrew DiZio – Janney Montgomery Scott

Hi. Just a question on home purchases. Can you talk about what you are seeing as far as move-outs go by region?

John Shannon

For bought home, the reason for move-out, if we look at our same community total portfolio for the quarter, it was 17.6% as a blended number. The highest number would be in the Midwest where we were at 20%. And we think there were some home purchases because of the tax credits program in the Midwest, given that the homes are far more affordable in the Midwest market. So we think that as we move forward, that's going to pull back down to the high-teen range just like the other markets.

Andrew DiZio – Janney Montgomery Scott

Okay. And then looking at the River Forest addition that Lindsey just mentioned, can you talk at all about how lease-up gone on that through July?

Patrick Duffy

Sure. This is Patrick. River Forest phase two has 60 units, where currently 15 of the units are occupied and 24 of – a total of 24 are either leased or occupied. And construction is complete right now. So it's – the lease-up is going right as we anticipated.

Andrew DiZio – Janney Montgomery Scott

Okay. And then just one last question. In the press-up that you talked about earlier, you also mentioned having an agreement to potentially purchase some additional land in Ohio. Can you talk about if that's still on the table or if that's off the table?

Jeff Friedman

That is not on the table.

Andrew DiZio – Janney Montgomery Scott

Okay, thanks.

Operator

The next question is from William Acheson of Benchmark. Please go ahead.

William Acheson – Benchmark

Yes. Good afternoon, everyone. Are you guys getting any indication that the banks are about to open up their portfolios and perhaps put a little bit more product on the market? And would you be interested in general on what they have in their portfolios?

Jeff Friedman

Bill, this is Jeff. As most of us in the apartment business have said, there is not a whole lot of distress in the apartment sector for the type of assets that we are interested in buying. There maybe some distressed owners and as a result of their personal conditions, they may – or liquidity needs of the owners, they maybe faced with having to sell over on – that's on the individual side.

On the institutional side, I would say – and Patrick might add a little bit to this, from what we are seeing, it does seem like many of the institutional owners are coming to market with deals on a one-off basis and also willing to negotiate in off-market transactions, although there still seems to be a pretty wide gap between the expectations that some institutional owners have. And I wouldn't put the banks necessarily in that category and what buyers – what we are willing to pay. So that gap, that reality hasn't quite set in in some sellers' minds.

William Acheson – Benchmark

Okay. Switching gears, unbundling is a word that we have all heard an awful lot about lately. It's kind of a slippery thing to quantify. Is there any metric out there that you point to that really kind of verifies that trend like increased demand for one-bedroom units or interviews with tenants?

John Shannon

Bill, this is John. We – we've been trying to prove that up or quantify where we've been saying that we don't think that people bundled up. And the reason I say that is when – we constantly look at what our occupancy level is for our one-bedroom, two-bedroom, and three-bedroom apartments. And we have not seen more than a 100 basis points spread between the one, two, and three-bedroom apartments.

Additionally, we take a look at the number of occupants, adult occupants or leaseholders in each apartment and when we compare that this year versus last year, our numbers are unchanged. I mean, we are – where two people and a one bedroom, and a two bedroom, and two-and-a-quarter and a three bedroom, and those numbers have not changed at all over the past 18 months.

William Acheson – Benchmark

Okay. Let's see, lastly here, a lot of rates are pulling down developments from their shadow pipelines into the pipes. Do you get any sense whatsoever that the private developers are trying to pull the trigger on new deals? I mean, if a project pencils, it would seem to me that they would be able to get financing, assuming that they are not already in hock to the bank on another credit.

Lou Fatica

Bill, this is Lou. I mean, I think that you are right. If a sponsor is a credible sponsor, I think banks will do construction loans. It all really boils down to who is sponsor is and whether there is any issues with the rest of their portfolio. So we would agree.

William Acheson – Benchmark

Okay. Thank you, guys.

Operator

The next question is from Haendel St. Juste of KBW. Please go ahead.

Haendel St. Juste – KBW

Good afternoon, guys.

Lou Fatica

Hi, Haendel.

Haendel St. Juste – KBW

Hi. Just wanted to go back to a question on who you guys are talking to in the marketplace. I know you guys are looking at Mid-Atlantics and the Southeast. You mentioned institutional buyers. Are you in negotiation – are you in talks with institutional buyers? I'm trying to get a sense of who is in the marketplace right now putting out the assets. And also, can you give us some sense on what that bid-ask spread is in terms of what you might be willing to pay and what they might be willing to sell at?

Jeff Friedman

Insurance companies are sellers right now. There are some MEZ – holders of some MEZ pieces that really control the decision on selling, who really control the deals or willing to sell. And from where I sit – and Patrick, you would probably want to add to this, it seems like there are a number of other listings in the larger markets that seem to be hitting the services, certainly coming over on the e-mail and that's really in the last four or six weeks.

Patrick Duffy

Right. And Haendel, we find that – I guess our experience is that the spread between the ask-and-bid for the off-market deals that we've looked at, it tends to be in the 10% to 15% range.

Haendel St. Juste – KBW

Okay. Can you – Patrick, while I have you, you mentioned some – you gave some indication on Class A cap rates in some of your target markets? Do you have a sense – are you guys also looking at B type acquisition opportunities? And if so, do you have any idea of where those cap rates are?

Patrick Duffy

We do look at B opportunities in the Mid-Atlantic and Southeast and what we are seeing is between 6% to 7% cap rates when trailing –

Haendel St. Juste – KBW

Trailing LTM, NOI?

Patrick Duffy

I'm sorry.

Haendel St. Juste – KBW

You are basing that on trailing 12 months?

Patrick Duffy

Yes.

Haendel St. Juste – KBW

And last question I guess for you, Lou, just looking at the opportunity to redeem some of your upcoming CMBS', I guess there is two pieces in '11 and '12. Can you just remind me how far in advance can you prepay, what the current thought there is on redeeming that and if it's not too early, give us a sense of what the charges associated might look like.

Lou Fatica

Those are pre-payable at par three months prior to maturity. So the '11 and '12 maturities are pre-payable in two different tranches in February and March of each of those respective years. Based on where the low end of the curve is, the defeasance costs are in the 10% to 15% range. So you are talking about several million dollars on the $115 million outstanding balance there.

Haendel St. Juste – KBW

Okay, got you. Okay, guys. I appreciate it.

Jeff Friedman

Thanks, Haendel.

Operator

Our next question is from Andrew McCulloch of Green Street Advisors. Please go ahead.

Andrew McCulloch – Green Street Advisors

Hi, guys. Most of my questions have been answered. But I just want to get back to the guidance questions for a second. I guess the question is for John. I understand how NOI can trend worse through the end of the year due to expenses, expenses are what they are. But on the revenue side, I'm still having a hard time getting my arms around how that could either stay flat or trend worse. Are you saying that the top line revenue on a sequential basis is going to be flat in the next two quarters in kind of getting around this year-over-year comparison stuff? So can you talk about what you think same unit revenue do to you sequentially?

John Shannon

Well, on the – on a year-over-year basis, we are going to be – show a flat performance. But on a sequential basis, we should be up about 50 basis points. And again, that really is a net of occupancy being a little bit lower, 100 basis points, 75 basis points, and getting rent increases on the 2% to 3% range for the portfolio.

Andrew McCulloch – Green Street Advisors

Okay. So occupancy is probably a big chunk of why that was conservative?

John Shannon

Correct.

Andrew McCulloch – Green Street Advisors

Okay. I will follow up with you guys. Thanks.

Operator

And gentlemen, at this time, I show no other questions in the queue.

Jeff Friedman

Any other questions?

Operator

(Operator instructions)

Jeff Friedman

Okay. Thanks, everybody for joining us. That will conclude our call today. Thanks, Linnaea.

Operator

Thank you. That does conclude today's conference. You may – thank you for attending today's presentation. You may now disconnect.

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Source: Associated Estates Realty Corporation Q2 2010 Earnings Call Transcript
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