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Executives

Jeremy Goldberg – VP, Corporate Finance and IR

Jeff Friedman – Chairman, President and CEO

Lou Fatica – VP, CFO and Chief Accounting Officer

John Shannon – SVP, Operations

John Hinkle – VP, Acquisitions

Analysts

Jana Galan – Bank of America/Merrill Lynch

David Toti – Cantor Fitzgerald

Eric Wolfe – Citi

Alex Goldfarb – Sandler O’Neill

Jeff Donnelly – Wells Fargo

Dan Donlan – Janney Capital Markets

Wilkes Graham – Compass Point

Paula Poskon – Robert W Baird

Associated Estates Realty Corporation (AEC) Q2 2012 Earnings Call July 25, 2012 2:00 PM ET

Operator

Good afternoon, and welcome to the Associated Estates Second Quarter 2012 Earnings Conference Call. My name is Amy, and I will be the operator for your call today. At this time, all participants are in listen-only mode. Following prepared remarks by the company, we will conduct a question-and-answer session, and instructions for asking questions will follow at that time. Please note this event is being recorded.

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

Jeremy Goldberg

Thank you, Amy. Good afternoon, everyone, and thank you for joining the Associated Estates’ second quarter 2012 conference call. I’d like to remind everyone that our call today is being webcast and will be archived on the Associated Estates’ website for 90 days.

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

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

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

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

Jeff Friedman

Thank you, Jeremy. We appreciate everyone taking the time to participate on our call. If in the long run the stock market is a weighing machine, why then do we continue to trade at such a discount? Is it because 40% of our NOI comes from the Midwest? Is it because we are a small cap company?

It can’t be, because we haven’t executed on our strategic objectives, we have, year in and year out. It can’t be because we haven’t been clear about how we plan to execute, we have, as demonstrated by our 2010 acquisitions, our 2010 equity raises, the limited use of our ATM and by allowing our internal growth from our 2010 and 2011 acquisitions to prove that we once again delivered on what we said we would do.

A long-term property level performance has led most of the publicly traded apartment REITs. Since 1998 when we decided to expand outside of the Midwest, we have repeatedly demonstrated our ability to recognize when to buy and when to sell. Our portfolio today is among the youngest of all of the apartment REITs. Our properties outside of the Midwest are in many of the strongest and fastest growing submarkets in the country. Our Midwest properties continue to produce strong results. Still, our stock trades at a discount.

We’ve repeatedly explained that we will not lever back up and that we need to raise $0.50 of equity for every dollar we spend. We said on our earnings calls in February and April that the midpoint of our acquisition guidance of $75 million could be accomplished while staying in our targeted debt-to-book value range of 48% to 52%, without needing to issue any additional equity.

In a very short period of time, we were able to tie up both marketed and off-market deals that we expect will generate strong returns for many years to come. These properties were under managed and we bought them below replacement cost. We are at a point in the cycle at these properties where we expect strong operating performance for quite some time.

Our re-entry into Raleigh-Durham is consistent with our objectives on all fronts. So why does our stock continue to trade at such a discount? We have delivered sector-leading results over multiple cycles. We have been clear about our strategy. In our case, the market has not been efficient and there is a major disconnect between our stock price, our multiple and the value per share.

Our job is to narrow that gap. We are confident that our continued execution will do just that. We are focused on the long term and every decision we make, every step we take is with that in mind. We have a strong experienced management team committed and focused on creating long-term value and sustainable and predictable earnings. We can’t be swayed by opinions about where we should buy or build and where we shouldn’t.

Would we have wanted our stock price to be higher when we did the follow-on last month? Absolutely. We expect our acquisitions to more than make up for the FFO and NAV dilution associated with our recent follow-on.

We will continue to execute our strategic objective of growing through acquisitions and development. We will allow the organic growth from our same-community properties and our recent acquisitions to drive results. This will position the company to deliver strong and sustainable earnings for years to come.

We urge you to visit our properties. We are confident that their high quality and sub-market-leading positioning will be obvious. We will not lever back up. That’s how we will expand the multiple, the old fashioned way, through continued hard work, focus and continuing to put up the numbers.

I’ll turn the call over to Lou.

Lou Fatica

Thank you, Jeff. For the second quarter, FFO was $0.32 per share, ahead of internal expectations as a result of better-than-budgeted same-community NOI. Q2 same-community NOI was approximately $500,000 or $0.01 per share higher than budget, driven entirely by greater-than-expected revenue. Year-to-date, same-community revenue is up 5.8% and expenses were up 4%, resulting in a 7.1% increase in NOI when comparing the first half of 2012 to the first half of 2011.

Based on our year-to-date performance, the equity issuances during the quarter and our expectations for the balance of the year, we have updated the midpoint of our 2012 FFO as adjusted guidance to $1.24 per share, a $0.01 decrease from our previous full-year FFO as adjusted midpoint. FFO as adjusted excludes the net $1.5 million pre-payment cost recorded during the first quarter of this year. The midpoint of our FFO as adjusted number represents a 20% FFO per share increase over 2011.

Based on our annualized dividend of $0.72 per share, our FAD payout ratio is one of the lowest of all the apartment companies, and is expected to be approximately 65%. Significant assumptions related to our revised full-year guidance are as follows; full-year same-community revenue up 5.25% at the midpoint or 75 basis points higher than our previous guidance. Full-year same-community NOI up 6.5% at the midpoint, or 100 basis points higher than our previous guidance.

Acquisition guidance of $180 million to $250 million, with the low end of the guidance reflecting completed transactions, plus the acquisition of Park at Crossroads in Cary, which is subject to a loan assumption that is expected to be completed in Q3. Property sales up $60 million to $75 million, with year-to-date dispositions totaling $60 million, and diluted weighted average shares outstanding of $49.9 million in Q3 and Q4, and $46.5 million for the full year.

Before I turn the call over to John, let me take a minute to discuss our equity capital raises during the quarter. We issued approximately 680,000 common shares under our existing ATM at an average gross price of $16.63 per share. These issuances completed our $25 million ATM program, with issuances under the program totaling slightly less than 1.5 million shares at an average price of $17 per share. In the normal course of business, we would expect to post a new $75 million ATM. Additionally, on June 27, we completed an overnight offering of 6.3 million shares at a price of $14.40.

Let me reiterate what Jeff said, we are focused and committed to creating long-term shareholder value. We are ever mindful of our NAV and the impact that issuing equity at these levels has on our NAV. We remain steadfast on our strategic plan of balancing the distribution of our NOI, continuing to improve the overall quality and age of our portfolio, and maintaining a conservative leverage structure, which will allow us to earn our investment grade ratings.

We believe the long-term benefits of issuing equity at these levels outweigh the 4% dilution to FFO in NAV. Our goal and objective is to continue to do the things that help bridge the gap between our share price and our NAV and the AFFO multiple that we trade at relative to the average multiple of our peers.

We have shown that we are prudent allocators of capital over multiple cycles and that operational performance has been sector leading over the long term.

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

John Shannon

Thank you, Lou. Our same-community NOI was up 5.5% over Q2 2011. We finished the quarter at 97% physical occupancy, in line with where we finished Q2 last year. Revenue was up 5.9% and expenses were up 6.4% as expected. The expense growth is the result of increased real estate tax expense due to $300,000 in real estate tax accrual adjustments recorded in Q2 last year, and increased tax accruals in Q2 this year.

On a sequential quarterly basis, same-community revenue was up 2.5% and physical occupancy remained at 97%. Apartment fundamentals continue to be solid and all performance metrics throughout our portfolio continued to improve. For the quarter, same-community new lease rents were up 5.4%, with renewal lease rents up 5.2%.

We are currently 96.3% occupied, and for July, new leases and renewals are up better than 5%. The August and September renewals are out at a 4% to 6% increase. Since May, we closed on three properties and completed due diligence on another, which is subject to a loan assumption. Two of the properties are in Cary, a suburb of Raleigh, one in Durham and one in Dallas. We expect all of these properties to generate returns that are accretive to our weighted average cost of capital.

Re-entering Raleigh-Durham has been on our radar for some time. We like the fundamentals of the region due to the strong employment and education foundation, highly skilled workforce and limited new supply as compared to historical levels. We have been very selective and focused on the west, northwest growth corridor, and we saw an opportunity to make a significant entry into the market.

The three Raleigh-Durham properties are terrific assets that are well-located relative to employment centers, offer excellent walkability and provide high-end amenities and finishes. We are buying below replacement cost. We are enhancing our NOI distribution and we are improving the average age and quality of our portfolio.

A younger portfolio has less CapEx, thus increasing cash flow. Further, we believe there’s a lot of low-hanging fruit to be picked through improved management. We also closed on 21 Forty Medical District in Dallas. A 396-unit class A community built in 2009. It is located in the southwestern medical district and is within walking distance of a DART rail station.

The community is a great complement to our Turtle Creek site and our two communities in North Dallas. As an update on our Vista Germantown development in Nashville, the lease-up continues to be ahead of schedule and rents are up over our original pro forma. We had our first move-ins in January and currently 77% of the units are occupied and 86% are leased. We are substantially complete with construction and should reach stabilized occupancy in early Q4. Our year one stabilized return on cost is expected to be 7.3% or slightly ahead of our original pro forma.

At the 99-unit expansion to our San Raphael property in Dallas, we have started the underground work and foundations for the garage. We anticipate that the first units will be delivered in Q3 of next year. Based on the current rents at our adjoining property, rents are up 4% over our original pro forma.

We will soon begin construction on three additional projects, in Bethesda, Maryland; Uptown Dallas; and Los Angeles on Wilshire Boulevard. These sites are irreplaceable. In Bethesda and Dallas, they complement our other properties in those submarkets. At all these locations, we will be building for less than we can buy stabilized assets, and we will earn significantly higher yields than the current going-in cap rates on acquisitions in these locations.

We have also been sellers. During the quarter, we sold an Atlanta property and four of our Western Michigan properties. The Falls, a 26-year-old, 520-unit property located in Duluth, was sold for $24 million or 5.2% economic cap rate based on 2012 budget. The four Western Michigan properties were sold as a portfolio for $36 million. These properties include 672 total units, with an average age of 24 years. The aggregate sale price represents a 7.6% economic cap rate based on 2012 budget.

Given the strong apartment fundamentals and low interest rates, we would expect additional sales, as we continue to improve the quality of our portfolio. Based on the strength of the first half and where we are today, we are well positioned as we move through the prime leasing season.

Q3 and the rest of the year are shaping up well. Our revised full-year guidance anticipates that in the second half of 2012, revenue growth at the midpoint will be up 4.75%. Full-year expense guidance at the midpoint is projected to be up 3.5%, which reflects our expectations for full-year real estate tax increases, resulting in full-year same-community NOI up 6.5% at the midpoint of our guidance range.

I will now turn the call back over to Jeff.

Jeff Friedman

Thanks, John. Good job to you and everybody in the field. Operations really did a great job. Amy, why don’t we open up the call for questions?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Jana Galan at the Bank of America/Merrill Lynch.

Jana Galan – Bank of America/Merrill Lynch

Thank you very much. Good afternoon. Can you please give us the acquisition prices and cap rates for the four assets that you purchased?

John Hinkle

Sure. This is John Hinkle, VP of Acquisitions. The apartments at Arboretum, it was $39.250 million at a nominal cap rate of 5.2%. Southpoint Village was $34.8 million at a nominal cap rate of 5.8%, and 2140, formerly known as Alexan Southwestern was $53.350 million at a nominal cap rate of 5.2%

Jana Galan – Bank of America/Merrill Lynch

Thank you. And then given the increased acquisition guidance for 2012, can you maybe talk about the size of the pipeline of deals that you’re reviewing? And then maybe – are they in current markets or are you continuing to look outside of your current markets?

John Hinkle

Still John Hinkle. Generally, we don’t comment on specific acquisitions that we are working on, but as usual, we are continuing to monitor every transaction that occurs both in our current markets, as well as the top 20 markets throughout the country. We’ll continue, as always, to take a disciplined measured approach towards future acquisitions. And that’s effectively what led us into our re-entry into the Raleigh-Durham market.

As John Shannon mentioned, we were looking to re-enter the market for some time and as we continued to monitor that market and available opportunities, we came across a very compelling opportunity to acquire immediately three irreplaceable assets in the best locations in Raleigh-Durham in three diverse locations.

Currently, we now own two of the best five or six deals in the entire marketplace. All three of the deals are submarket leaders in terms of location, amenities, and finishes, all are in close proximity, major employment centers, high-end retail. And actually, two of those deals are located within high-end mixed use centers, so those are true urban infill locations that are irreplaceable.

All three also are well-insulated from additional supply where purchase is below replacement cost and have an opportunity for us to improve on a leasing management and maintenance with these properties. In addition, The Park at Crossroads deal, which will close later this year, was on cover through a – one of our deep relationships in that market as an off-market opportunity and we’ll trade, although I can’t comment on the pricing, the cap rate will be significantly higher than the cap rates on the other two deals bringing up significantly our average cap rate cost to three.

Jana Galan – Bank of America/Merrill Lynch

Thank you very much, John.

Operator

Your next question comes from David Toti at Cantor Fitzgerald.

David Toti – Cantor Fitzgerald

Great, thank you. Jeff, the first question from you from a sort of strategy perspective, I know you’ve been very clear about how the company’s going to grow and how you’re going to fund that growth. Can you just sort of touch on one detail and that is relative to how you reconcile the equity issuance around where your stock is trading and its implied NAV? Obviously, you have to match fund, but how do you think about your net asset value in that context?

Jeff Friedman

Well, that is the question relating to the issuance of equity below NAV. We – look, we can manage risk, but we can’t manage uncertainty. And our responsibility is to make sure that we continue along this path of improving the quality of our cash flow, which we believe will translate to an expansion of our multiple.

If I go back in hindsight, look at what we were thinking and how we were feeling in April and May as the acquisition opportunities were available, and then correlate that spin to the need to have to pay for that, $0.50 of every dollar we spent with the issuance of equity, the markets felt like, the momentum felt like both in our name and in the apartment group as though we had some strong winds at our back. And so that when we actually put the properties under contract, we started to notice the fragileness of both our stock price and the broader market. That’s sort of the uncertainty.

Looking back in time, we had the Greek debt crisis, which seemed to be resolved, not much happened. And we also – they knew that we didn’t want to put ourselves in a position where we had to go to the equity markets.

And so we found ourselves making that decision about the long-term benefits of owning those properties at this point in the cycle, below replacement cost, big upside in terms of growth, the opportunity to improve the portfolio and expand our multiple, and then offset by diluting each one of our shareholders by 4% to both the NAV and our earnings – our 2012 earnings by approximately 4%. We made the decision to go forward with the acquisitions to -that we thought it outweighed the short-term dilution, and we continue to believe that’s in the long-term best interest of all of our shareholders.

David Toti – Cantor Fitzgerald

That’s helpful, Jeff. I appreciate the detail. My second question is for John. John, can you just give us a quick highlight of the increasing guidance at the revenue line, what changed in the last couple of months that drove you guys to be a little bit more optimistic? Most of the language from peers has been cautionary about the second half because of more difficult comps, and you guys seem to be taking a relatively more positive stance.

John Shannon

Sure, David. The – our guidance, when I say the second half of 2012, we will be – have revenue growth of 4.75% at the midpoint. That compares to 5.9% revenue growth in the first half of the year. So we are being a little bit more conservative as is compared to tougher comps. We’ve been running 97% physical occupancy, we think that, that may not be sustainable. We think it’s more of a 96% physical occupancy, but with continued rent growth in that or rent or new deals and renewals in the 5% range.

When you look at 2011, first half we were up 3.1% in revenue, the second half was 4.6%. So when you add the 4.6% to the 5.9%, excuse me, the – all-in we’re going to be better than 10% revenue growth on a two-year basis.

David Toti – Cantor Fitzgerald

Very helpful. Thanks for the detail today.

Operator

Your next question comes from Eric Wolfe at Citi.

Eric Wolfe – Citi

Hey, guys. Jeff, you asked a bunch of questions about why your stock is trading at such a large discount. So I guess what I just don’t understand about all this is, why you’re selling equity when it is trading at such an obvious discount? I don’t think anyone would argue that it’s trading at a discount, it’s very obvious on paper. So why issue a $100 million of your equity to purchase anything, to do anything?

Jeff Friedman

Well, we had this discussion, Eric, at least a couple of times and with Michael as well. And we take this very seriously, and although it was dilutive to our NAV and FFO, it was accretive in many ways, not only to the balance sheet by increasing the unencumbered pool of properties, improving the fixed charge coverage, it increases the liquidity, which has been an issue that we continue to hear from buy-side accounts in terms of why our stock may be trading at a discount. It’s one – we’re one step closer to investment grade ratings and so our goal as some – one of us said in our prepared remarks is to narrow that gap.

And we think in the totality of this execution, that this step, although a bitter pill to swallow, and by the way, we would have been having the same discussion if the stock would have been at $18. We’d still be having a discussion about selling stock below NAV. It’s unfortunate that we had this downdraft leading up to the pricing, but those are the decisions leading to it. And our goal is to slowly but surely, of course, we’d like to happen faster, is to bridge that gap so that we are trading at a multiple that is consistent with what the other publicly traded apartment companies are trading at.

Eric Wolfe – Citi

I understand that. I just – it seems to me if you keep selling equity at a discount to NAV, and I know you said 4%, other people’s math might be a little bit bigger, but if you keep doing that over and over, that’s what going to narrow the gap. I mean, that’s what’s going to bring your implied cap rate down. That’s what going to bring your multiple up.

It’s just diluting shareholders. And I guess I just – I mean, I understand your point about the company being small, but it seems like, I don’t know, the timing seems odd I think in terms of doing it in June at 14.50 or whatever it was at. And I guess I just don’t understand how buying assets at 5% implied cap rates and selling equity at 8% makes sense. I know they’re higher quality assets, but it can’t be value – I mean, is it value accretive for shareholders?

Jeff Friedman

Well, the returns – the returns that we expect on these with reasonable underwriting assumptions are accretive to our weighted average cost to capital on an unlevered basis, and hugely accretive to our weighted average cost to capital on a levered basis, assuming 50% leverage.

And we want to believe that we are going to get an expanded multiple, and that being the case, not even to the average of the other apartment groups, apartment companies, but getting an expansion and multiple, for example, from an 11.5 multiple to a 14.5 multiple really begins to narrow that discount to the cap rate between the FFO or AFFO yield and the cap rate we’re buying the properties at. And that’s what we’re expecting to accomplish.

Eric Wolfe – Citi

Okay. And on the acquisitions, I’m sorry if I missed this, but did you say what unlevered return you’re expecting on that?

John Hinkle

Yes, this is John Hinkle. All of those acquisitions unlevered will be north of an 8% return and levered assuming 50% would be well north of an 11%.

Eric Wolfe – Citi

Right. And so if I look at your stock, when you sold the equity, I would call it, say, 7.5% to 8% on people’s numbers, I mean, to get to an unlevered return of 8%, you have to be assuming almost 0% growth for your portfolio, right? I mean, I’m not sure I’m missing something there.

Jeff Friedman

Wait. We’re talking about buying a 5%, 5.5% cap property and getting an 8% unlevered return. I’m sorry, I didn’t follow...

Eric Wolfe – Citi

Right. I followed that math getting that. But then, if you look at your equity, right, which is trading around 7.5% to 8% on an implied cap rate. So, on an unlevered basis, it would seem to me that the unlevered return on that would be 11%, I don’t know, 12% if you just kind of take your 8% implied cap rate or yield and head on the growth for over the long term.

Jeff Friedman

That’s around about way of saying why won’t we buy in our stock instead of buying the properties?

Eric Wolfe – Citi

Yes.

Jeff Friedman

Yes, right.

Eric Wolfe – Citi

And so the answer is you just don’t want to – you want to deleverage and you don’t want to get any smaller, right?

Jeff Friedman

Well, we want to improve the balance sheet. We want to get back to investment grade rating. We believe that, that will be another arrow in the quiver and catalyst for the expansion of the multiple.

Eric Wolfe – Citi

Okay. All right. Thank you, guys.

Jeff Friedman

Thank you.

Operator

The next question comes from Alexander Goldfarb with Sandler O’Neill.

Alex Goldfarb – Sandler O’Neill

Hi. Good afternoon. Just continuing the dialog of the stock performance, I think we’ve seen in other companies, some of your peers have done portfolio repositionings where there’s been a period of stagnant earnings growth as people reposition assets. For some, it’s worked better than for some of the others as far as how long it takes.

But the question is, if it’s one step back and two steps forward, your stock performance is just really – the underperformance is just extreme and yet the portfolio performs well. So sort of curious if either at the management level or board level there’s been some discussion of maybe dial back the external, the outside investment and just let the existing portfolio do more of the talking and deliver the results that it has been delivering, but which seemed to be masked by a number of the external investment activities.

Jeff Friedman

Well, by the way, good job on CNBC yesterday. The – we talk about that all the time. We talk about it at the management level, multiple times a day, we talk about it at the board level on a regular basis. And when I think back to the financial dislocation that occurred in 2008, 2009, the impact that it had on our business, I come back to the fact that we had a well thought out plan and we stuck to it. And so, we continued to believe that the plan we are implementing to reposition the portfolio will ultimately result in significant enhanced shareholder value, but we’re constantly reviewing that strategy and that plan.

As John Shannon said in his prepared remarks, the strength of the submarkets right now were taken hard looks at selling core assets in certain submarkets because of the pricing. And of course, that would be a way to fund some additional growth as well. But I can assure you, Alex, we continue to reevaluate that plan, but we do have a plan and we’re continuing to follow.

Alex Goldfarb – Sandler O’Neill

But how – but at what point do you guys or just the board say, hey, we had a plan, but the stock market seems to be reacting differently, and maybe we should reassess the plan and alter it?

Jeff Friedman

We assess it on a regular basis. And if we can keep taking two steps forward and one step back, then we’re making progress.

Alex Goldfarb – Sandler O’Neill

I know. Unfortunately, it seems to be the inverse. But next is on guidance. Real estate taxes would seem to be something of unknown unless there is some recent assessment. So, just sort of curious why the guidance increase on the expenses occurred now versus last quarter, given, as I say, the – it would seem that real estate taxes is something of unknown, not something of a – something that just comes up.

Lou Fatica

Alex, this is Lou. In terms of real estate taxes and we make our best estimate based on our expectations of where the tax valuations will be, as well as the millage rates. Throughout the year, we receive periodic updates that we track and that we adjust our accruals accordingly. So in the second quarter, there were number of properties where we received additional information that resulted in higher real estate tax, accrual adjustments not only for the second quarter, but for the balance of the year.

That being said, we won’t know what the actual real estate tax expense are until the bills are received, the majority of which are received late fourth quarter, first part of January. So at this point, they are still estimates and we continue to use the best available information to make those estimates. Also, John did touch upon this one on his remarks, but the other thing driving the overall expense increases, slight increases on the personnel side is a result of that’s a double-edge sword there in a sense that we outperformed on the revenue side, and thus property level – performance incentives for our property level staff are higher than projected.

Alex Goldfarb – Sandler O’Neill

Okay. But, Lou, you did this real estate tax as your estimate for the rest of the year. Presumably, this incorporates every scenario, so it’s not like next quarter there’s going to be another increase because of real estate taxes. There’s been a thorough assessment?

Lou Fatica

Those come out at different times. When we operate in 10 states, the tax assessors and those assessments and valuations and millage rates come out at different times. So what we do is, our legal team in conjunction with third-party consultants are constantly monitoring that. I mean, at the same time where we have tax appeals at many of our community, so we can be surprised to the upside in terms of real estate tax refunds for prior year. So it’s a constant evaluation and our process is no different than anybody else’s process.

Alex Goldfarb – Sandler O’Neill

Okay. Thank you.

Operator

Your next question comes from Jeff Donnelly at Wells Fargo.

Jeff Donnelly – Wells Fargo

Good afternoon, guys. Jeff, if I can kind of comment some of other earlier questions differently. I don’t want to debate the merits of the Southern California development project or the buys that you guys have recently made. But as you know, I mean, I think you’re personally aware, or you’re painfully aware that since those developments were announced, the stock is underperforming its peers significantly, I think by about 20 percentage points, which is quite massive.

If those projects hypothetically do not pan out as you hope, so what will you learn from that? I mean, will that cause you to rethink your push outside of core markets and maybe will you take some of the feedback you’re getting about diluted issuance with a bit more concern? I’m just trying to think about what the next step is.

Jeff Friedman

Hi, Jeff. I heard you – you were coming in and out a little bit, but I heard the question clearly. There is one project, okay? They are not multiple projects yet in Southern California. We said that we would grow our platform in Southern California, Coastal Southern California primarily through development. Now, we continue to monitor what’s going on on the stabilized properties that come to market side, but based on where the properties that we’d be interested in owning or trading or expect to trade, we’re not going to be able to be competitive.

From a development perspective, as we – as with regard to the Desmond on Wilshire parcel, here’s an opportunity where we were able to buy entitled piece of property significantly below market. And we’re going to build a very competitive product in a very strong submarket.

Now, where that ends up in terms of – or how that ends up, we know we’re going to be able to build to return on cost, which is probably 150 basis points, maybe more, higher than what properties in those submarkets are currently traded at. And we will create significant value by doing that. And if we can do that slowly over a long period of time, we said this plan for Southern California was a three to five-year plan, and on a development basis that makes it a three to seven-year plan because that in the fifth year we’re doing something with sites they’re not coming online until the seventh year, this is a long-term plan.

So the jury is out on that, both from an execution standpoint, as well as a return standpoint. And if you’re suggesting, as I heard you say and as others have said, that since November NAREIT when we decided to get out in front of our Southern California strategy by discussing our plans to grow out there, the thought of that warrants this significant whooping, I just would say that that’s not correct, that’s not right, that’s not efficient. But it’s not changing our plans. It’s not changing what we plan to do on that Wilshire Boulevard site. We’re going to build a very competitive product and make a lot of money on that site.

Jeff Donnelly – Wells Fargo

That’s helpful. I mean, I guess to your point before, you were talking about some of the downdraft in the market. But I think some of it is – obviously it’s investors expressing their concern over the success or probability of success of that project. And I guess my question was maybe a little different. But if that does not pan out as you hope, does that change your thinking on that market?

Jeff Friedman

Well, certainly if it doesn’t pan out like we hope, we will evaluate that and figure out what that means, but I can assure you, if that means that spread is 50 or 75 basis points lower. I mean, if that’s what you’re – it’s not going to kill us. We think we have a well thought out strategy there and we have the right team in place to be able to implement it, and we’re confident that we’ll be able to do that.

Jeff Donnelly – Wells Fargo

And just a question or two, I guess for Lou, I just can’t remember, have you guys given us an estimate for the Desmond and the other future development pipeline projects? I just don’t recall if you’ve given us an estimate at this point.

Lou Fatica

I mean, I think we’ve talked about it at various meetings. I’m just trying to pull out my numbers here. Give me a second here.

Jeff Donnelly – Wells Fargo

Take your time.

Lou Fatica

In terms of Desmond, the range of return on cost there is expected to be in the 5% to 5.5% range. And then the Bethesda site, we would expect to build to a 5.75% to 6.25% cap rate.

John Shannon

Return on cost.

Lou Fatica

I’m sorry, return on cost, and Dwell Turtle Creek in the 6% to 6.5% range.

Jeff Donnelly – Wells Fargo

You don’t have a total dollar consideration for cost though?

Lou Fatica

We do. I mean, estimated cost for Desmond including the land is in the $77 million range, Dwell Turtle Creek in the $48 million range, and Bethesda in the $53 million, $54 million range.

Jeff Donnelly – Wells Fargo

Okay. And just one last question is...

Lou Fatica

I got to just qualify that by saying that we’re in the design phase on those projects and so these are obviously estimates that we make, those cost estimates just like – the only thing we know is what the current rents are there. And so this is clearly fluid until we actually let the contracts and start construction, Jeff.

Jeff Donnelly – Wells Fargo

No, that’s understood. I’m just – I’m curious so if you think for at least the remainder of the year because I think that ultimately some of these development will necessitate future equity issuance. And I’m wondering how you’re thinking about timing of future issuance given that your share price is little lower than where you’ve averaged over the issuance in the second quarter. Do you guys expect to issue more shares within the end of second quarter and year end either through your ATM or how are you thinking about it at this point?

Jeff Friedman

Well, Jeff as I indicated in my prepared remarks that in a normal course, sometime in third quarter we would expect to post a new $75 million ATM. Share issuances will be – one of the things that we look at as it relative to our cash needs and to the extent we’re able to sell additional properties, that will produce that, but we’re going to manage that process. In terms of development specifically, the requirements for development really don’t take place until 2013, as those projects really won’t begin in earnest until 2013.

Jeff Donnelly – Wells Fargo

No, understood. Thank you. I appreciate it.

Jeremy Goldberg

Thanks, Jeff.

Operator

The next question comes from Dan Donlan at Janney Capital Markets.

Dan Donlan – Janney Capital Markets

Thanks. I just have one question. Jeff, I’m a little bit new to the apartment space and one of the first things I did was take a look at CEOs and their tenure at companies. I think 2013 will mark your 20th year at AEC. I’m just curious if you could comment on kind of your outlook, your five-year plan, is there any type of succession plan that you may be discussed internally, or – and kind of what are your thoughts potentially towards retirement? And then obviously, it sounds like you still remain very passionate about the business, just I was curious given that 2013 will be your 20th year at AEC.

Jeff Friedman

Well, welcome, Dan. Actually, I bought the company from the founder in 1977. And so the 1993 date you’re talking about really is the date that we took the company public. So it’s even more years than that. Yes, succession planning is something that we talk about, both at the management level, as well as the board level. And as you would expect, when a company has a three or a five-year plan, they also have a plan with regard to the management team with regard to that period of time, and we continue to have those discussions.

I am fully committed to seeing through the current plans we have to transition the portfolio and to expand the multiple. And so there is no question about my commitment, and I would say that to you that I have no question about the management team’s commitment to seeing that through as well.

Dan Donlan – Janney Capital Markets

Excellent. Well, thank you very much.

Operator

The next question comes from Wilkes Graham at Compass Point.

Wilkes Graham – Compass Point

Hey, guys. Just a quick question. Do you mind just going over – I’m sure I can do it myself, but the different metrics that the rating agencies look at for the investment grade rating and where you stand relative to those?

Lou Fatica

Wilkes, this is Lou. I mean, there’s a whole scorecard in particular when dealing with Moody’s who’s very transparent in that process. But the things that we’re most focused on, our coverage ratio, which through the first half of this year, we were at 2.7 times or so, which is an investment grade metric because they’re at two times. Also, all the rating agencies are focusing on secured debt leverage, in terms of that individual metric, that’s something below 20%. We finished up Q2 at 29.1%.

Obviously, we talk about the five-asset cross collateralized pool that’s maturing in 2013. That will help drive that metric closer to 20% when we’re able to repay that with either unsecured bond issuances, term loans et cetera. Also, they’re looking at unencumbered NOI being in the 60% range. We finished the quarter at around 55%, and with the recent acquisitions that we’re funded on an unencumbered basis, dragging that number closer to 56% or 57%.

And then also, there are other metrics in terms of debt-to-EBITDA, just size, metrics and a various number of subjective measures that they’re focusing on. It’s our belief that many of our metrics warrant an investment grade rating in that we’re moving towards that path.

Wilkes Graham – Compass Point

That’s helpful. Thank you very much.

Jeff Friedman

Thanks.

Operator

Our next question comes from Paula Poskon of Robert W Baird.

Paula Poskon – Robert W Baird

Thank you. Good afternoon, everyone. I’d like to follow-up on a couple of topics that have been discussed in the call, one being Dan’s were I thought very thoughtful question about succession planning. So, Jeff, you’ve talked about that. What is it – what are you and the board do around career pathing and development for your management team and sort of the bench level, the next level down, if you will?

Jeff Friedman

Well, the board doesn’t get very involved at next level down. And – but we – this management team along with Dan Gold, our VP of Human Resources, through our AEC Academy put a lot of emphasis on career pathing, on education, goals and opportunities throughout the entire organization. And the benefit of having done what I do, as long as I have, is the ability to learn from some of those mistakes.

And when I think back, one of the mistakes that I made along the way, was believing that the existing management team at early years of being a public company were able to handle the exponential growth that we set out to accomplish. And I was wrong and played catch up building the management team, which fortunately for us, with Lou coming on board and John Shannon coming on board and others after them, we’ve been able to do quite successfully since about 2000.

So what I learned from that, Paula, is that, that won’t happen again. John has a very active program and recently promoted from within some long-term employees and some that haven’t been with us as long to very important positions. And so we’re building that depth and that succession from the regional manager, property manager, regional manager, regional Vice President level throughout the entire operations team.

And then all of the other officers are responsible for that same type of planning within their department. And we are well-positioned to handle the growth that we are going through and it was an important part of the strategic planning process where each of the participants basically signed on and committed that, that would be in place prior to the growth as opposed to the growth happening and then building the bench. The bench would be in place and the growth would follow.

Paula Poskon – Robert W Baird

Okay. So, keeping with that slot, do you think that – do you think investors believe that, that breadth exists, and in that context, what do you think the stock would do if you hypothetically announced that you were retiring? How would investors respond do you think?

Jeff Friedman

Well, I’m probably not the best person to having – having – I sort of feel like that Braveheart movie going out into the field with all the arrows about to be shot based on a few of the missives that have been written. And some of it is self-inflicted, but we continue to believe that what we’re doing to manage risk is absolutely vital. In terms of what would happen whether I resigned or I’ve got hit by the bus, I can’t really tell you what would happen. Most likely everybody would think that the company would be in play, but I don’t – I can’t really answer that.

Paula Poskon – Robert W Baird

All right, fair enough. Coming back to the discussion around the development strategy and in particular in Southern California, do you think that if you were doing, hypothetically, exactly the same kind of project in a market you were already in closer to your backyard, that the investor reaction would have been as negative? Is it the strategy or is it the location do you think?

Jeff Friedman

Well, I think it’s competition. I think this is an inertia thing. We got so many people. One, surprised how did we do it. Two, knowing as hard as we work that we’re going to be tough competition. And I think it’s a momentum issue in many respects. My grandfather used to say every knock is a boost. And so that really doesn’t bother us. The fact that the sentiment is that, oh, it’s going to be tough, how are you going to be able to do it without a platform there. But we’re not concerned by that.

Would someone think that if it was closer to home, it would not be looked upon? The way that this was, probably, they would think that there was less execution risk. And we’ve taken that into consideration. We are very comfortable with the location, the product that we plan to build, our ability to execute, and like I said, Paula, that Wilshire Boulevard deal will be a huge monetary success.

Paula Poskon – Robert W Baird

Thanks. I appreciate your candor, Jeff. And then just finally, I think investors understand in the REIT space that sometimes you take the short-term dilution hit for a longer-term value creation. But it certainly have a healthy fear of taking a big hit. At what point does the discount to NAV get to be so large that you can no longer make that short term, long term value trade work. Is it a 50% discount to NAV? Is it bigger than that? How do you think about that?

Jeff Friedman

Well, I believe that ultimately the markets are efficient. And I believe that the multiple that the apartment REITs are trading at will be applicable to Associated Estates on some relatively appropriate basis. So to answer your question you’d have to tell me where the multiple is going to be at the time. Will there be a reversion to the mean? I don’t really know. We expect an expansion of our multiple in the different environment with that kind of discount like you’re talking about, obviously we’re not going to be issuing equity to buy 5 cap properties.

If the cap rates are 9, it’s a different equation and we would have to look at it. But we are expecting to be able to narrow that gap and the discount by continuing to put up the numbers and demonstrate that the quality of our assets are equal to, if not better than perhaps most of the other publicly traded apartment companies.

Paula Poskon – Robert W Baird

Thank you, Jeff. I appreciate that. That’s all I have.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Jeff Friedman for any closing remarks.

Jeff Friedman

Well, thanks everyone for joining us today and Amy for your help. That concludes our call.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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