Mid-America Apartment Communities' (MAA) CEO Eric Bolton on Q2 2014 Results - Earnings Call Transcript

Aug. 2.14 | About: Mid-America Apartment (MAA)

Mid-America Apartment Communities, Inc. (NYSE:MAA)

Q2 2014 Earnings Conference Call

July 31, 2014 10:00 AM ET

Executives

Tim Argo – Senior Vice President, Director-Finance

H. Eric Bolton Jr. – Chairman and Chief Executive Officer

Albert M. Campbell III – Executive Vice President and Chief Financial Officer

Thomas L. Grimes Jr. – Executive Vice President and Chief Operating Officer

Analysts

David Toti – Cantor Fitzgerald & Co.

Ryan H. Bennett – Zelman & Associates, LLC

Michael J. Salinsky – RBC Capital Markets, LLC

Rich Anderson – Mizuho Securities Co., Ltd.

Haendel St. Juste – Morgan Stanley

Buck Horne – Raymond James & Associates, Inc.

Karin A. Ford – KeyBanc Capital Markets Inc.

Tayo Okusanya – Jefferies & Company, Inc.

David Bragg – Green Street Advisors, Inc.

Operator

Good morning, ladies and gentlemen. And thank you for participating in the MAA Second Quarter 2014 Earnings Conference Call.

At this time, we would like to turn the call over to Tim Argo, SVP of Finance. You may begin, Mr. Argo.

Tim Argo

Thank you, Aaron. Good morning. This is Tim Argo, SVP of Finance for MAA. With me are Eric Bolton, our CEO; Al Campbell, our CFO; and Tom Grimes, our COO.

Before we begin with our prepared comments this morning, I want to point out that as part of the discussion, Company management will be making forward-looking statements. Actual results may differ materially from our projections.

We encourage you to refer to the Safe Harbor language included in yesterday’s press release and our 34-Act filings with the SEC, which describe risk factors that may impact future results. These reports, along with a copy of today’s prepared comments, and an audio copy of this morning’s call will be available on our website.

During this call, we will also discuss certain non-GAAP financial measures. Reconciliations to comparable GAAP measures can be found in our earnings release and supplemental financial data.

I’ll now turn the call over to Eric.

H. Eric Bolton Jr.

Thanks, Tim. And appreciate everyone being on our call this morning. Second quarter results reflect good momentum on pricing, with same-store rents increasing 3.1% over the prior year. Revenue results largely reflect the impact of this pricing momentum with some offset from slightly higher vacancy losses compared against last year’s strong performance, as well as lower transaction fees resulting from reduced resident turnover during the quarter.

At the end of the quarter, physical occupancy was a solid 95.7% and slightly ahead of last year’s 95.6%. As a result of the strong occupancy position at quarter end in July, average daily occupancy within the same-store portfolio has run 35 to 40 basis points higher than last year.

And importantly, pricing momentum continued in July, with new lease rents increasing 4.1% year-over-year and renewal rents increasing an average of 5.8%. We’re encouraged with the pricing trends and the resulting revenue outlook for the back half of the year.

As expected, same-store operating expenses were under some pressure for the quarter due to timing differences versus prior year from landscaping expenses, as well as a continued rise in real estate taxes reflecting higher valuation trends.

Other expense line items during Q2 were generally in line to slightly better than we had forecast, with some favorability in performance capture due to lower resident turnover, which was down 7% as compared to last year.

Pricing and revenue performance in a few of our secondary markets lagged performance elsewhere across the portfolio, as a combination of weaker job growth trends and tough prior-year occupancy comparisons, pressured performance in Memphis, Birmingham, Jacksonville and San Antonio. Solid results were achieved in Charleston, Savannah and Greenville.

Generally, the secondary market segment of the portfolio continues to avoid the higher new supply trends that we see in a number of our larger markets. But we need to capture a stronger lift in the broader economy and employment conditions for several of these secondary markets to capture more robust rent growth.

Within our large-tier market segment of the portfolio, as expected, Raleigh was our weakest performer as the market their works through some new supply deliveries. We continue to feel good about the long-term prospects in Raleigh and expect we’ll see supply pressures peak this year and better pricing trends emerge in 2015. Strong revenue results from Nashville, Charlotte, and our Texas markets contributed to solid performance for the large-tier market segment of the portfolio.

As outlined in the earnings release, given the performance trends we saw in the second quarter and in July, we have adjusted our forecast assumptions for revenues and expenses, which are expected to generate a solid growth NOI in the 4% to 4.5% range for the full year.

Our team was very busy during the second quarter, wrapping up the consolidation of the MAA and Colonial operating systems platforms. We’re now fully operational on the same property management, asset management and management reporting systems.

After closing our merger in October, we felt the best opportunity for capturing the full benefit surrounding synergy and scale was to get both companies and back-office operations fully consolidated as quickly as possible and prior to the busy summer leasing season.

It took quite a bit of focus and a lot of extra hours during the second quarter. I’m proud of the work accomplished by our folks and really appreciate their hard work. With the vast majority of the integration work and risk now behind us, we’re fully focused on harvesting the various operational opportunities surrounding our merger.

Our new development pipeline continues to lease-up very well. During the second quarter, we wrapped up construction on the projects in Charlotte and in Orlando, leaving our projects in Nashville and Jacksonville as the only remaining construction actively underway. We expect to begin initial occupancy at these two properties later this year.

Leasing continues to go well on our lease-up portfolio, and we expect to achieve full stabilization of the majority of these units by the end of this year with full earnings production in 2015. We continued to make good progress on selling the remaining non-core properties that were acquired as part of our merger with Colonial. We’re in final due diligence with several buyers and expect to close on the sale of two more properties during the third quarter.

We’re also busy during the quarter with capital recycling, as planned dispositions for several of our older apartment properties were completed in the second quarter and in July. We currently have two additional apartment properties located in Mobile, Alabama under contract to sell and expect to complete those dispositions during the third quarter.

We continue to look at quite a bit of acquisition opportunity. But as discussed last quarter, a lot of investor interest and favorable interest rates makes the buying market very competitive. Properties involving pre-stabilized new development are where we’ve seen the greatest increase in deal flow, and I expect this area of the transaction market will remain fairly active for the next year or so. As noted in our earnings release, we closed on two such transactions during the second quarter and are currently looking at several other opportunities.

AI will recap for you the successful bond transaction that was executed during the quarter and summarize where we are with our balance sheet. We feel very good about where the balance sheet is at this point and expect that as the new development and lease-up pipelines become fully productive, we will continue to see strengthening coverage ratios and continued expansion of our unencumbered asset base.

In summary, we’re encouraged with the performance outlook for the balance of the year from the same-store portfolio and expect to deliver – we will continue to capture solid NOI growth for the full year.

Our new development and lease-up pipelines are becoming increasingly productive and we look for meaningful contribution from this component of the balance sheet in 2015. We’re making good progress on stock and capital from the non-core assets acquired in the Colonial acquisition, and are optimistic that we will capture attractive new investment opportunities for this capital.

With the heavy lifting of the merger and back-office integration now complete, we’re excited to be focused on harvesting the full value surrounding our merger. The balance sheet is in a strong position, and we expect to see further strengthening as the development pipeline and capital recycling from non-core assets continue.

Market conditions support our plans for a higher level of capital recycling within our stabilized portfolio of properties. And we expect to continue that over the next several quarters, mindful of maintaining coverage ratios and our strong balance sheet metrics.

That’s all the way I have in comments. And Al, I’ll turn it over to you.

Albert M. Campbell III

Okay. Thank you, Eric, and good morning, everyone. I’ll provide some additional commentary on the Company’s second quarter earnings performance, the balance sheet activity and finally on updated earnings guidance for the year.

FFO for the quarter was $95.5 million, or $1.20 per share. Core FFO, which excludes non-routine items, primarily the merger and integration costs and the fair market value adjustment for debt assumed, was $93.9 million or $1.18 per share, which was within our guidance range and $0.03 per share below the midpoint. About $0.02 per share of the variance is related to same-store NOI, with another penny per share related to earlier-than-expected timing of our bond issuance during the second quarter.

As Eric mentioned, rent pricing trends remained good and in line with our expectations during the second quarter. But we carried about 35 basis points lower effective occupancy than projected, generating about a penny per share variance to the midpoint of our guidance.

Fee revenue was also lower than expected for the quarter, as transaction and termination fees were below projections, generating another penny per share of variance.

We made a decision during the quarter to execute our planned bond financing almost a month earlier than initially projected in order to take advantage of the favorable market conditions and timing. The transaction proved very successful as we issued 10-year bonds at a 3.75% coupon and upsized the deal to $400 million from $350 million originally planned. But the earlier-than-planned timing cost about a penny per share in the second quarter as we carried more debt than forecasted in the short-term.

As Eric discussed, we were active both buying and selling assets during the second quarter. During the quarter, we purchased two new apartment communities in Charlottesville and Dallas for a total price of about $118 million and sold two older communities in Fort Worth for combined proceeds of 32 million.

Fund II, which is our joint venture, also sold one community in Macon, Georgia during the second quarter for gross proceeds of $25.8 million, one-third of which was owned by MAA.

Activity continued in July as we sold three additional communities located in Memphis, Birmingham and Charlotte for combined proceeds of $95.6 million and acquired the remaining two-thirds interest in the final Fund II property, closing Fund II.

Construction and lease-up of our development pipeline continues to progress well. We funded an additional $13.1 million of development costs during the second quarter and fully completed two communities, Colonial Reserve at South End in Charlotte and Colonial Grand at Lake Mary Phase 2 in Orlando.

We now have two communities remaining under construction, with a total remaining funding commitment of only $33.7 million.

Total construction costs and lease-up targets in the aggregate remain on track, and we expect stabilized yields in the 7.5% range for the current development and lease-up pipeline.

During the second quarter, we continued to strengthen our balance sheet by using the proceeds from the issuance of $400 million of 10-year unsecured notes mentioned earlier to repay $198 million of secured Freddie Mac debt and $192 million maturing bonds series acquired from Colonial. As mentioned, we executed the deal little earlier than planned, capitalizing on market demand to achieve a credit spread of 125 basis points above 10-year treasury, which exhibits the strength of our balance sheet.

The 10-year unsecured financing increased our unencumbered asset pool, our interest-rate protection and the duration of our debt maturities. At quarter end, over 66% of our gross assets were unencumbered. Over 98% of our debt is fixed or hedged against rising interest rates, with an average duration of about 5 years.

Also at the end of the quarter, company leverage based on market cap was 35.5% and our fixed charge coverage ratio was 3.6 times. Our total debt to Recurring EBITDA was 6.41 times and we had $488 million of cash and credit available under our unsecured line of credit at quarter end.

And finally, as expected, there are many crosscurrents included in our earnings guidance this year as we work through the integration and consolidation of Colonial, along with a related higher level of both non-core and core capital recycling transactions. Based on the second quarter performance and updated expectations for the remainder of the year, we are revising core FFO guidance for the full year to an expected range of $4.79 to $4.95 per share at the midpoint of the range, which is $0.47 per share. This represents a revision of $0.04 per share for the remainder of the year.

We are narrowing our NOI guidance for the full year to 4% to 4.5%, which translates into a penny per share revision to core FFO for the back half of the year. And additionally, we now expect $0.03 per share impact in the second half from transaction, timing and corporate items. Of these, we now expect to achieve our full year multi-payment disposition target by mid-third quarter, which is earlier than we originally projected, costing us about a penny per share versus the earlier forecast.

Also, we upsized our bond deal in the second quarter. We issued $400 million versus the $350 million planned, which increased our interest rate protection for the long-term, but cost us about a penny per share over the remainder of 2014.

And finally, after filing our franchise tax returns and extensions for 2013, we increased our franchise tax accrual rate primarily due to changes in our tax base from the Colonial merger, which will cost us an additional penny per share over the remainder of this year. And together, all of these items account for the $0.04 per share revision to the forecast for the back half of the year.

Also during the third quarter, we expect to record gains on the sale of several properties of around $34 million, along with a $2.5 million prepayment charge on a related loan, all of which are excluded from core FFO for the quarter, but maybe important for modeling purposes.

Quarterly core FFO per share is expected to be $1.15 to $1.27 per share for the third quarter and $1.21 to $1.33 for the fourth quarter. Core AFFO for the full year is expected to be $4.04 to $4.20 per share, which represents a 71% dividend payout at the midpoint.

We expect to end the year with our balance sheet in very good shape, leverage at the low end of the range, somewhere around 42% debt to gross assets, encumbered assets at historic levels, greater than 65% and with coverage ratios very strong greater than 3.5 times, position well to support 2015.

So that’s all we have in the way of comments. Aaron, I’ll turn the call over to you for questions.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions) We will first take a question from David Toti with Cantor Fitzgerald. Your line is now open.

David Toti – Cantor Fitzgerald & Co.

Good morning, guys.

H. Eric Bolton Jr.

Hi, David.

Albert M. Campbell III

Good morning.

David Toti – Cantor Fitzgerald & Co.

I’m still kind of struggling to understand the real mix of secondary market trouble, or I guess sort of why it fell a little bit shy of your expectations. And I know you, Eric, you mentioned employment and tough comps. But maybe if you could just provide a little bit of detail on the mix of rent at the new and renewal level, and also maybe comment on what you’re seeing in terms of move-outs to home purchases, and specifically where there’s troubling supply.

H. Eric Bolton Jr.

Okay. Well, let me start with it on some of this, and then Tom can give you some information on the pricing. But broadly speaking, David, I think, the secondary market segment story really centers around the employment issue. This segment of the portfolio continues to not see the level of new supply that we are seeing take place in some of larger markets.

The only areas where we’ve seen any sort of real supply issue – we have a submarket in Jacksonville where we’ve got a couple of properties that have seen a little supply and we’ve seen a little supply in San Antonio. But, broadly speaking for the segment as a whole, it really gets back to employment trends. And we know that when the economy starts to recover that the bigger markets, like Dallas and Houston, are going to really do quite well. But I think we have to see the economy lift at a more accelerated pace than what we’ve seen thus far to really get the job growth trends more favorable down at the secondary market level. And give you some perspective on it.

We use a lot of information from moodyseconomy.com in terms of job growth projections. And if you look at 2013 job growth year-over-year in the secondary market’s segment, we underperformed in that segment. Those markets underperformed national employment trends by about 70 basis points. And then, in 2014, we’re tailing by about 30 or 40 basis points.

But if you look at the projections for 2014 through 2016, which I know – assumes that we continue to see some acceleration in the employment markets. The secondary markets, they approach performing at a level consistent with sort of national trends. And of course the large-tier share markets are blowing away the national trends. They are doing much, much better.

So I really believe that – and then in particular, we had, Memphis is an example where we had some real tough comps. Last year, our occupancy – we carried roughly 97% occupancy in Q2 last year and we’re comparing against that this year.

So Memphis in particular had a tough comp, as an example. But I think really it gets back to the job growth trends and we just have not seen the growth take place in these markets up to this point. But at least the projections are assuming the economy continues to show some progress that we’ll see things get better as get into 2015 and 2016. But we still don’t see really the supply issues.

Before I turn it over to Tom, the other point I will tell you is move-outs to home buying and move-outs to renting a home are actually less in secondary markets than they are in the large markets. So it’s not a unique issue surrounding single-family in any way affecting the secondary markets. Tom?

Thomas L. Grimes Jr.

Sure. David, the new lease renewal blended trends follow what Eric laid out. We’ve got markets such as Little Rock and Memphis. During the quarter, Little Rock was up 0.2%, Memphis 2.2%. That’s on a blended year-over-year basis. And then places like Savannah, Charleston, they were 7%, 8.3%. It really just sort of depends on where they’re fitting in the spectrum of job growth. Limited new supply in Jacksonville in those pieces.

H. Eric Bolton Jr.

It is a mixed bag, because as I commented, Memphis, Birmingham, we saw weakness. Huntsville has been weak; Columbia, South Carolina has been weak for us, as has Columbus, Georgia. But Savannah has been strong, Chattanooga has been relatively strong, Charleston has been strong. Greenville has been strong.

David Toti – Cantor Fitzgerald & Co.

Okay, that’s helpful. And then, if we just think about – like, to take an asset in particular that may be a little bit weak from your perspective, what is the conversation like at the ground level, with tenants on renewals and incoming tenants? If it’s a market where there’s weak employment, our people just pushing back on rent? Are you sort of giving up a little bit of rent to keep occupancy, and keep the turn rates low? What’s the actual dynamic in an asset?

Albert M. Campbell III

No, David. And when you look back at our comp versus last year, we needed to carry our average physicals and we did. And of course, there’s the temptation to really tradeoff hard on pricing to get to that number. We feel like there’s good re-pricing in the portfolio and we feel like we have an opportunity to push that through. Move-outs to rent increases are actually down like 14%. So that dynamic is not occurring. We’re sticking to our guns on pricing and feel good about that long-term tradeoff. We have solid occupancy. We don’t have as good as what we planned on.

David Toti – Cantor Fitzgerald & Co.

Okay. That’s helpful. And my last question is just a detail, and I might have missed this. But did you comment on what your plans are for the Las Vegas assets?

H. Eric Bolton Jr.

We didn’t comment on it. I would tell you, David, we’re taking a hard look at that. We’ve got only two properties in that market. And we’re going to be looking at our plans over the next couple years as we talk about recycling, and we’ll have more to say about it then. But I think that we either need to bigger or out, one of the other. And we haven’t made a firm decision on that yet.

Thomas L. Grimes Jr.

And just a comment on Las Vegas, we closed July $96.4 million there with low exposure, 7% and rents were beginning to pick up. We feel like you’ll see better traction in Las Vegas in the second half of the year than you have in the first half.

David Toti – Cantor Fitzgerald & Co.

Okay, great. Thanks for the detail today.

Operator

And we’ll next go to the site of Ryan Bennett with Zelman & Associates. Your line is now open.

Ryan H. Bennett – Zelman & Associates, LLC

Hi, good morning, guys. Just to follow-up, just on your outlook for the full year, given the second quarter. You revised the core FFO guidance and walked through the detail there. Just curious, you’ve maintained this fourth quarter guidance, I believe, is why I’m just curious. If you could just walk us through kind of how you get back to that by the fourth quarter as we think about the run rate into 2015? And then, as part of that, the income contributions you’re thinking about from the redevelopments of Colonial assets later on this year?

Albert M. Campbell III

Hi, Ryan, this is Al. I can talk to you. Remember, there’s a lot of crosscurrents going on this year that affect the quarter-to-quarter and changes quarter-to-quarter. Let me just tell you how we approach looking at the back half and how our guidance has established large element. So if you look at what we’re expecting, we really expecting – rent trends have been good this year, first quarter and second quarter and continued to do so in July.

So we expect those to continue. And we expect, really to hold number one, those rent trends will continue to compound through effective rents as you move into third quarter, even more so in the fourth quarter, probably the biggest contribution in the fourth quarter. We expect to really hold the strong occupancy that we held at the end of the second quarter. We ended at 95.7%, and we expect to hold that strong for the year.

And as Tom mentioned, we didn’t capture quite as much effective occupancy during the second quarter as we wanted. Our plan is to hold that and to not have that happen again over the back half of the year and then to capture more fee performance. As we talked about, transaction fees were down a little bit, I think, for a couple of reasons. One is that we didn’t capture quite as much opportunity related to some of the programs on the Colonial side of the portfolio. We had hoped in the second quarter. We feel very good about that performance in the fourth quarter that is there. It’s a little bit later than we had thought. If you think about the revenue trends, that gives you the line.

And on expenses, as we had always talked about in our guidance, we did expect the biggest pressure point to be in the second quarter. Had we talked about that someone may read a couple of things. Real estate taxes for the year, they’re 6.5%. But just because the timing of the accruals last year and this year, the first half was higher. I think the first half average was 8.2%. So you can see it’s higher than the year. We expect some reprieve at the back half.

And then, we talked about our landscaping expenses. And we just had a pretty significant difference this year to last year in the landscaping expenses. They fall where the work – the time the work is done. So when we put the two, Colonial portfolio and our portfolio together, our practices changed a little bit. And we had a lot more of the expense problem in the second quarter as we did our [mulches] (ph) and annual things that we do. We expect to see that reprieve in the third quarter and the fourth quarter, primarily in third quarter.

So my point being, the back half of the year is largely based on continued rent trends, holding occupancy, capturing the other income of the fees that we talked about and lower expenses. And the final thing is, we have captured in the second quarter some favorable expenses from some of the synergy, probably some of the things that we had planned to do.

Our costs were low in personnel and R&M, and we look for that to continue in the back half of the year. And then, we also had an insurance renewal that will affect the back half of the year. We penciled it on July 1 and we get a 20% reduction – somewhere between a 15% and 20% reduction. So I’m just giving the color for all those things that combine both our income and our expense and make us feel good about the back half of the year, that performance.

Ryan H. Bennett – Zelman & Associates, LLC

Got it. I appreciate the color there. But just in terms of your comments about holding rents and seeing that positive trend, what’s kind of baked into your baseline economic assumptions for the secondary markets in the back half of the year? Are you modeling in pretty significant pickup? Or is it more stable, what we’ve seen? Have you kind of dialed that back a little bit?

Albert M. Campbell III

In secondary markets, as we talked about, we took the back the back half of the year down a penny per share primarily for secondary market performance that Eric talked about. Pretty consistent in trends, but we just soften it a little bit from the secondary markets. But still, we expect good trends going out.

Ryan H. Bennett – Zelman & Associates, LLC

Okay, got it. And then, just building on that, just on the transaction side doing the deals in Memphis and Birmingham, after the quarter here, just any indication give us on pricing, and how that came in relative to your expectations given the economic backdrop in those markets?

Albert M. Campbell III

They came in pretty good. I think the average of those that we sold in July was just south of 7%. I think the average of the two that we sold during the quarter was closer to 6.5%, 6.4% or something like that, and they were in Forth Worth. So I’ll say it this way. We’ve sold, I think, six of the eight assets that we had for the full year in the program to sell $140 million to $150 million in multifamily. We expect the cap rates to be just south of 7% on that and that’s what we captured so far. And we expect the remaining two that are about $20 million to be the same.

Ryan H. Bennett – Zelman & Associates, LLC

Okay, great.

Albert M. Campbell III

That’s on a $3.50 per unit CapEx, 4% of management fee, and in-place NOI.

Ryan H. Bennett – Zelman & Associates, LLC

Okay, got it. Thanks guys.

Operator

And we will next to the site of Michael Salinsky with RBC Capital. Your line is now open.

Michael J. Salinsky – RBC Capital Markets, LLC

Thanks. Just following up Ryan’s question there, in your presentation at NAREIT, you kind of walked through kind of what you expected in terms of same-store revenue and NOI there on a quarterly basis. Can you give us an update as to how you’re thinking in the third and fourth quarter, just in terms of trends and the contributions there?

H. Eric Bolton Jr.

Well, I mean, I’ll let Al give you the specifics, but broadly speaking, what we’ve done is we’ve pulled back a little bit on the revenue assumptions and improved a little bit, if you will, on the expense assumptions. So on a net basis, we still believe – our original guidance for the year was 4% to 5% NOI growth and we’ve dialed it back to 4% to 4.5%.

So still within the range, the bottom half of the range we originally started with. But we’re just going to get there a little bit differently with a little – based on what we’ve seen so far this year, a little weaker revenue growth, but better expense control frankly. And the net result is 4% to 4.5% NOI growth for the full year. And it really reflects all the things we’ve been saying in terms of what Al just walked through in terms the back half of the year and based on what we’re seeing thus far. I mean, Al, you want to…

Albert M. Campbell III

Yes, I’ll just give you – if you did the math on it, Mike, you’re going to need from our estimates about 3.6% revenue growth over the back half of the year. Okay? So third quarter, we expect somewhere in the 3% to 3.5% range. Fourth quarter, as we continue to compound those rents in and capture those fee opportunities, 3.5% to 4% range that shows you how we expect that to average out.

Michael J. Salinsky – RBC Capital Markets, LLC

Okay. That’s helpful there. Second of all, just given the comments about the secondary markets performance there being seemingly more job growth and supply-related. Does that make you rethink the mix of the portfolio a bit more? I know when you announced the Colonial portfolio, you said you had your target mix, but does that make you shift maybe a little bit more in favor of the primary markets?

H. Eric Bolton Jr.

I’ll tell you, Mike, not materially so. I think that we continue to believe very much in the notion that we want to deploy capital for a full cycle sort of performance profile. We always have understood that the secondary markets that don’t capture quite the level of robust job growth that you get in the bigger markets struggle at various points in the cycle. They don’t likewise get the supply pressures that you typically see in the larger markets as well.

While certainly there are some weaknesses that we saw this quarter, again this quarter, in Memphis, Birmingham and the others that I’ve mentioned, we’ve also seen some strength in some others. And so, I would tell you that in terms of a sort of overall long-term performance objective, we still feel very much that the right thing to do is continue to allocate roughly 60% to 65% of our capital to the large markets and 35% to 40% to the secondary markets.

Now, what you’re going to see as a consequence of our capital recycling effort, you’re going to see some recycling take place, and it will be more active within the secondary market segment of the portfolio. There are some secondary markets where we think the prospects are not nearly as strong as they are in some other secondary markets. We feel like we can still go into some of these higher growth secondary markets that – Charleston is an example and some others that we’ve been buying in. And we can still get the performance dynamics over the long haul, but I think put capital in a position where it’s going to create a little bit more robust long-term organic growth rate. And that’s what we’re really trying to do.

Michael J. Salinsky – RBC Capital Markets, LLC

Appreciate the color, guys. Thank you.

H. Eric Bolton Jr.

Thanks Mike.

Operator

And we will next go to the side of Rich Anderson with Mizuho. Your line is now open.

Rich Anderson – Mizuho Securities Co., Ltd.

Hey, good morning.

H. Eric Bolton Jr.

Good morning, Rich.

Albert M. Campbell III

Hi, Rich.

Rich Anderson – Mizuho Securities Co., Ltd.

Welcome to my site. You talked about capital recycling. Would you be willing in this market, with cap rates being where they are, to actually take on a little bit more dilution in the short-term if you found the right situation, even if you didn’t have a synonymous amount of redeployment opportunity, just to take advantage of the transaction market today to clean up the portfolio?

H. Eric Bolton Jr.

The answer is, within reason. I will tell you that this year in particular is a challenging year from a recycling perspective, in that not only are we eating dilution surrounding recycling multifamily capital, but we’re also eating dilution cycling out of some commercial assets, which is pretty darn dilutive, selling those at much higher cap rates. And we’re also eating dilution from the development lease-up pipeline, all of which does first – the development pipeline will largely be fully productive going into next year. And we certainly expect to be cycled out of a lot of the commercial assets by next year.

So those two areas of current earnings solutions kind of goes away. My guess is that you what will see is a higher level of recycling taking place within the apartment side of things, stabilized portfolio going into next year. But, again, we’re willing to – we’re eating about $0.14 of earnings this year. And I wouldn’t want to see that go up significantly from that, because we are committed to protecting the balance sheet and making sure that we don’t step back from all the work that we’ve done for the last five years, frankly, to get the balance sheet where it is. But our capacity for handling dilution improves in the sense we can cycle more multifamily next year, because we won’t have the dilution surrounding the lease-up and the commercial recycling.

Rich Anderson – Mizuho Securities Co., Ltd.

Okay. And in terms of cap rates, obviously, the multifamily side, you’ve probably seen some compression there. Maybe you can comment on that. But has there been any move at all on the commercial side from a cap rate perspective?

H. Eric Bolton Jr.

Not that I’m aware of, Rich. We’re not, I would say, particularly active in the commercial side of things. We just got two assets in the land asset that we’re rotating out of. So I can’t really comment a lot on the commercial side. These two operating commercial assets that we’ve got, we’ve had them under contract now for a while. So it’s not like we’re really active in the market. So I couldn’t tell you if there’s been any real compression or not.

Rich Anderson – Mizuho Securities Co., Ltd.

Okay. And then, just a quick one for Al. The mark-to-market, the $90 million, how quickly will that trend down? How long will that take?

Albert M. Campbell III

That is amortized over 4.5, almost five years, Rich. It’s a little bit frontend-loaded in that as individual pieces of debt in that mature, it comes down. So I would say it doesn’t come down quickly, but it will come down each quarter a portion until it’s very low by the end of the fourth year.

Rich Anderson – Mizuho Securities Co., Ltd.

Okay.

Albert M. Campbell III

So, I can probably offline give you a little more specific math, but it helps you give you the trend of it.

Rich Anderson – Mizuho Securities Co., Ltd.

Okay. That’s good. Thanks, guys, I appreciate it.

H. Eric Bolton Jr.

Thanks, Rick.

Operator

And we’ll now take a question from Haendel St. Juste with Morgan Stanley. Your line is now open.

Haendel St. Juste – Morgan Stanley

Hey, good morning guys.

H. Eric Bolton Jr.

Good morning.

Haendel St. Juste – Morgan Stanley

Eric, maybe Tom, can you take us behind the scenes of the last three or four weeks of the quarter? Trying to get a sense what the major change factor was between NAREIT, the first week of June where you had seemingly much rosier expectations for same-store revenue for the quarter, mid to maybe upper 3s than what you actually achieved. Trying to get a sense, more clarity, granularity on how the results came in so much lower than what we expected, when after all this is the apartment business; we have pretty good forecast ability, you have revenue management, which gives you the opportunity to assess upcoming lease expirations, absorption, competitive pricing, et cetera.

H. Eric Bolton Jr.

Haendel, this is Eric. And I’ll tell you that the pricing trends played out very much like we expected. The two things that surprised us a little bit was the effective occupancy point that we’ve mentioned, as well as the transaction fees. And I can tell you, if you will, behind the scenes, getting to your question, May was sort of the apex of work going on regarding back office, conversion and integration processes. We started the conversion over to Yardi in latter part of the first quarter, and really working it – taking a division at a time, if you will.

And May was a time where we had the greatest fog, if you will regard what was happening at the property levels. We knew that where occupancy was at the end of the quarter, or at the end of May into early June. We knew what sort of occupancy was at that point. What we didn’t have real clarity on at that point was the average daily occupancy that we had throughout the month of May. And when we got back and sort of got the two different sets of reports in two different systems, and got all the information compiled, it was obvious that we had given up roughly 35 basis points of effective occupancy during the course of the month of May, beyond what we had anticipated.

And so that was really where the difference came from. So, good news is in June we wrapped it all up. And at this point, we’re all in the same system. We’ve got great insight now into everything and feel very good about where we are.

Haendel St. Juste – Morgan Stanley

Would you be willing to share with us the new and renewal by month for April, May and June? And then what the month and occupancy numbers were for those months as well?

H. Eric Bolton Jr.

Tom got it.

Thomas L. Grimes Jr.

Sure, Haendel. All right. So April, May and June on year-over-year basis work for – April was 2.7% May for 4.3%, June 3.2% on new lease. And then renewal was 7.3%, 7.6%, 7.6% and 7.5% for the quarter.

Haendel St. Juste – Morgan Stanley

Okay. And then, the…

Thomas L. Grimes Jr.

We ended June at 95.7% and April and May were both 95.1%.

Haendel St. Juste – Morgan Stanley

Okay. So, you mentioned that your renewals for July here were 5.8%, so a little bit below what you were getting during the second quarter. What are you sending out today for August? And do you have an expectation of where you think that’ll be?

Thomas L. Grimes Jr.

We’ve got it. And on a year-over-year basis – actually I only have lease-over-lease for that right now, Haendel. So July, lease-over-lease was 8%, August 7.3%, September 6.4%, October 6.6%. We intentionally tail off. We don’t push on renewals as hard in fourth quarter moving into the summer season as we typically do during the busier season.

Haendel St. Juste – Morgan Stanley

Okay. And as far as occupancy at 95.7%, is this a level you feel comfortable sustaining here near-term, would you like to build that up a bit as we get the back half of the year end well?

Thomas L. Grimes Jr.

Our strategy is we’ve got the best re-pricing opportunity sort of late second, early third. And then we being to build our occupancy and lower our total exposure as we head into the slower winter months. We are looking like – we close July today, but expect that to be at 96% with exposure, which is total availability, close to 0.3%. That’s compared to 9.2% last year. And our average physical occupancy during the quarter or during the month looks like it’s going to be up about 30 basis points, as Eric mentioned in his comments.

Haendel St. Juste – Morgan Stanley

Thanks.

Thomas L. Grimes Jr.

So, yes, to answer your question, I would expect occupancy to run much closer, or slightly better, but much closer to last year’s numbers in the second half than in the first half.

Haendel St. Juste – Morgan Stanley

Thank you.

Operator

And we will next take a question from Buck Horne with Raymond James & Associates. Your line is now open.

Buck Horne – Raymond James & Associates, Inc.

Hey, good morning, guys. I was wondering if you could just give us an update on economic cap rates in your markets based on the levels of investments that you’re seeing out there in transactions. Just what are you seeing for A and B properties in the Sunbelt relative to the gap between large markets and some of the secondary markets?

H. Eric Bolton Jr.

Buck, this is Eric. I would tell you that broadly speaking, for the higher-end product, new product in some of the larger markets we’re seeing economic cap rates on a stabilized NOI level, sort of 4.8%, 4.9% to probably 5.25%. And in the secondary markets, it may be 5% to 5.5%, probably no more than 50-basis point spread, but broadly in that kind of range for the sort of more stabilized assets, frankly none of which we’ve been buying, because that’s in particular where the competition is pretty fierce. But we’re seeing stabilized assets, five, six, seven-year-old properties to some of the large markets, good locations, trading 5% to 5.5%, and in the secondary markets probably 5.5% to 5.75%. It’s rare to find anything at 6% today.

Buck Horne – Raymond James & Associates, Inc.

Okay. That’s helpful. And you mentioned how move-outs to single-family or – home buying and/or single-family rentals is down year-over-year. Could you quantify those numbers for us, and give us some perspective on what you’re seeing in those trends?

Thomas L. Grimes Jr.

Yes, sure. The turnover on home buying was, it dropped from about 20% to 19% on that. And then, on single-family rentals, I don’t we indicated were down. They were up modestly, but still running there in the 9% range, still a third of the level of our larger reasons for move-out, which are home buying and job transfer.

H. Eric Bolton Jr.

And the trends have been fairly consistent for awhile now. I mean, the move-outs to renting a home have ticked up just a tad. But it’s gone from roughly sort of 6% of our move-out to about 9% of our move-out. But as Tom said, it’s really not a meaningful impact overall. What really has been helpful in terms of driving turnover down is the continued low move-outs to buying a house. And we saw a drop again this quarter. So that’s an area that’s been very helpful.

Buck Horne – Raymond James & Associates, Inc.

Okay. Thanks, guys. Appreciate it.

H. Eric Bolton Jr.

Thanks Buck.

Operator

And we’ll now take a question from Karin Ford with KeyBanc Capital. Your line is open.

Karin A. Ford – KeyBanc Capital Markets Inc.

Hi, good morning. Question for Eric. The focus of your comments earlier regarding the revenue underperformance in the second quarter really were centered around the secondary markets. Should we infer from that that primary markets all performed as you had expected for the quarter, and that you expected the deceleration, I think, was 50 basis points that you saw from 1Q to 2Q in those markets including Atlanta, Austin, South Florida, all of those performed as you’d expected?

H. Eric Bolton Jr.

Yes, I would tell you broadly speaking that majority of the performance issue was in the secondary markets. Now, Atlanta as an example, we gave up, it looks to be, about 70 basis points. Austin we gave up a little more than that in terms of year-over-year effective occupancy, again just the quarter. And as I alluded to, the market that we saw the most pressure in was in Raleigh and fully expected that.

But broadly speaking, when you look at the revenue trends overall, I mean, Atlanta driving 3.7% year-over-year growth in revenues and Austin driving 4% year-over-year growth in revenues, despite the give-up and effective occupancy that we saw in both Atlanta and Austin, we still delivered pretty darn good revenue growth overall. And broadly speaking, the only market that really was weak per se was Raleigh.

And then, Tampa was a little bit weak there. But Tampa is a market that – frankly, we were just comparing against a little higher-occupancy variable there. And we gave up, it looks to be, about 60 or 70 basis points there in Tampa. But Tampa’s back. It’s hard to draw any broad conclusions from just three months to three months year-over-year. We still feel good about Tampa long-term, certainly. But largely, the large markets generally performed pretty much in line with what we were expecting.

Thomas L. Grimes Jr.

And, Karin, as we look forward to the second half, some of those markets that Eric mentioned are ones that we look to for further improvement over the first half of the year. Atlanta and Austin both trended very good in July. And we’re looking at 96.2% there on effective occupancy in Atlanta, and rents and renewals over – new lease rents at 5.5% and renewals 8.9%; supply and check in Atlanta. Austin is 96.7% now, below 7% exposure. There’s certainly some supply going on there. It’s much heavier in that central town like area than it is in the suburbs, though there is some. And then, Dallas, Fort Worth, Tampa and Las Vegas, we would expect those to perform better in the second half than they did in the first half.

Karin A. Ford – KeyBanc Capital Markets Inc.

Thanks for the color. My second question is on the merger and integration. You alluded to the focus on that in the second quarter causing sort of a lack of information for you guys for a period of time. Do you think it also – just because of the intense sort of nature of that transition, do you think that caused your team to take the eye off sort of the operational ball in 2Q? If so, do you expect that to reverse in the second half? Or is it just really that informational gap that you had and maybe a delay in the merger synergies that you saw in 2Q?

Thomas L. Grimes Jr.

Karin, I saw a lot of people really since October 1 with their eye on the ball and working incredibly hard with a lot going on. I will tell you going forward, we’re sort of ecstatic to be done with it. I think we have great insights. Our teams have gelled in terms of working together with each other. Our systems are in place. We’re no longer rolling out a new process, a new procedure, a new software. And I think you see some of the results of that in July, and I think we’ll continue to learn how to wring out the value of this merger as we move forward.

Karin A. Ford – KeyBanc Capital Markets Inc.

Okay. Thanks very much.

H. Eric Bolton Jr.

Thanks, Karin.

Operator

And we’ll now take a question from Tayo Okusanya with Jefferies. Your line is open

Tayo Okusanya – Jefferies & Company, Inc.

Yes, good morning. Just two questions. In regards to asset sales during the quarter and subsequent to the quarter, you did make sales in Fort Worth and as well as Charlotte, which are some of your larger markets. And I think you guys have always expressed most of your asset sales will come from the smaller markets. Just curious why in particular these assets were sold.

H. Eric Bolton Jr.

Tayo, in all cases, there were some legacy Colonial assets, pretty old. Some pretty significant CapEx requirements that we just concluded, that we’d be better off to cycle out of those. So they were just unique in the sense of – these are old, frankly, assets that come to Colonial through the Cornerstone merger that they executed well over 10 years ago. So there’s no change in strategy. It’s just unique situations pertaining to age and the CapEx requirements associated with those particular assets.

Tayo Okusanya – Jefferies & Company, Inc.

Got it. That’s helpful. And then, could you just talk a little bit – give a little bit more detail about the Austin, Texas market in particular? I know it’s one of these markets – you had a lot of exposure to it. And you had always mentioned rising supply in Austin was something you were on the lookout for on a going-forward basis.

Thomas L. Grimes Jr.

I’ll tell you, Tayo, I think Austin certainly has had a fair amount of supply. It seems like it is abating in the suburban submarkets. It’s still there. It’s heavier in the core. We’ve been encouraged honestly. We mentioned Raleigh and Austin as our worry beads at the beginning of the year. And Austin has held up, I think, a little better than we expected and is trending stronger for the second half of the year. And just encouraged with where it is right now, and where our assets are located.

Tayo Okusanya – Jefferies & Company, Inc.

Great. Thank you very much.

H. Eric Bolton Jr.

Thanks Tayo.

Operator

We’ll now take a question from Dave Bragg with Green Street Advisors. Your line is now open.

David Bragg – Green Street Advisors, Inc.

Thank you. Good morning. Can you please share the year-over-year revenue growth for the legacy MAA and CLP portfolios in 2Q?

Albert M. Campbell III

Yes. I can tell you, Dave, there was a about a 20 basis points difference. So, overall I believe, on legacy MAA was about 2.5%. I think legacy Colonial was about 2.7% for the second quarter. We have a little more larger markets, and there’s obviously some things we’re trying to do to capture.

H. Eric Bolton Jr.

Little more larger markets in CLP portfolio.

Albert M. Campbell III

Yes.

David Bragg – Green Street Advisors, Inc.

Okay. Thank you for that. And thanks for all the insight on the occupancy and secondary market issues that proved to be challenging in the second quarter. But what I’m kind of taking away from this conversation this morning is that there was also – what played a big role was a temporary challenge in your reporting and forecasting systems due to the integration. I’m just wondering if that’s a fair assessment when we think about the 3.4% to 4.4% second quarter revenue growth forecast you put out there at NAREIT in early June, versus where you ended up. Is that really a pretty big part of this that we’re not as focused on this morning?

H. Eric Bolton Jr.

I would tell you that it’s certainly part of it. I mean, just be honest with you, clearly there was a lot of work going on in the second quarter regarding systems integration and training and just, as you can imagine, putting together two $4 billion platforms and getting everybody sort of on the same page, and really hitting an apex, frankly, in the month of May. And there was some challenge to it, no doubt about it. But I would tell you – and so obviously, we came up short on revenues relative to what we had expected. Now, we actually did a bit better than we expected on expenses.

So while NOI still came up short because of the miss on the revenues, NOI miss was not a significant as based on what we were thinking going into NAREIT. But having said all that, as Tom alluded to a moment ago, it’s all done. We’re all on the same platform now. The teams are working very, very well together. The integration is complete. We’ve got great visibility into everything that’s happening at this point and feel very good about the outlook for the back half of the year.

David Bragg – Green Street Advisors, Inc.

Okay. Thanks for that. And could you just summarize for us the changes to your expense growth expectations specific to the second half of the year?

Albert M. Campbell III

Yes, Dave, this is Al. I’d tell you, as we talked about, we had always expected the best expense performance being the third quarter, you got several things going on. You got the favorable comparison from some of the [noise] (ph) in Colonial’s numbers last year in the third quarter that we always had forecasted. A couple changes though. We did have some favorable performance in our expenses, I mentioned personnel, R&M, in the second quarter and we expect some of that. That’s capturing some of the synergies and savings from the platform. We expect that to continue into the back half of the year.

And then also, we got very favorable insurance renewal, 20%, 15%, (indiscernible) that will take the back half of the year and the real estate tax comparisons get better. So my point being, third quarter will be by far the best expense performance and likely will be flat to negative, slightly negative. And the fourth quarter will be more of a modest, reasonable growth rate, averaging to much lower for the back half and the front half.

David Bragg – Green Street Advisors, Inc.

Okay, thank you. And one more for Eric. Eric, when you say that this integration is all done, do you also feel as though the organization is prepared for another sizeable portfolio opportunity should one present itself? Or is it too early?

H. Eric Bolton Jr.

We’re absolutely ready. We have learned so much over the past year, Dave, I can’t begin to tell you. And our team has done just a tremendous job. And we’ve learned a lot through the process. We’ve got, I think, a great platform in place. And there’s not many challenges that we’re not prepared to take on at this point.

David Bragg – Green Street Advisors, Inc.

Okay. And throughout this process, you’ve spoken a lot about your desires in terms of large and secondary market exposure. What are your broad thoughts on an opportunity that could make the portfolio meaningfully more urban and younger within your existing markets?

H. Eric Bolton Jr.

Younger is good. I’m not hung up on the idea that our asset base needs to become increasingly urban-oriented, particularly in this region of the country. This region of the country tends to support a lot of employment and entertainment and good places to live that are not in the urban areas, and more in the suburban locations. So younger is good. Newer is good. We would continue to like very much the large markets that we’re in. As I’ve alluded to, I think we need to cycle more into some better growth secondary markets, which we certainly are working to accomplish over the next couple of years. But we like a good mix of urban and suburban.

David Bragg – Green Street Advisors, Inc.

Okay. Thank you.

Operator

And I’m showing no further questions. I will now turn the call back over to Eric Bolton for any closing comments.

H. Eric Bolton Jr.

No comments from us. I appreciate everyone joining our call and I’m sure we’ll see everybody starting of September. So thanks.

Operator

Thank you, ladies and gentlemen. This concludes today’s conference. You may disconnect at any time.

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