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AvalonBay Communities, Inc. (NYSE:AVB)

Q1 2008 Earnings Call Transcript

May 1, 2008 1:00 pm ET

Executives

John Christie – Director Investor Relations and Research

Bryce Blair – Chairman, Chief Executive Officer

Tim Naughton – President

Leo Horey – Executive Vice President Operations

Tom Sargeant – Chief Financial Officer

Analysts

Michael Billerman – Citi

Jonathan Habermann – Goldman Sachs

Louis Tayler – Deutsche Bank

Alex Goldfarb – UBS

Rich Anderson – BMO Capital Markets

Richard [Paley] – ATG Investments

Steve Radanovic – BB&T Capital Markets

Michael Salinsky – RBC Capital Markets

Jeff Donnelly – Wachovia

Ben [Lint] – [Vosale] Investments

David Cohen – Morgan Stanley

Andy McCulloch – Green Street Advisors

Operator

Welcome to the AvalonBay Communities first quarter 2008 earnings conference call. (Operator instructions) I would now like to introduce your host for today’s conference, Mr. John Christie, Director of Investor Relations and Research.

John Christie

Welcome to AvalonBay Communities first quarter 2008 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties are associated with forward-looking statements and actual results may differ materially.

There is a discussion of risks and uncertainties in yesterday afternoon’s press release as well as in the company’s form 10-K and form 10-Q filed with the SEC. As usual the press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms which may be used in today’s discussion.

The attachment is available on our website at www.avalonbay.com/earnings and we encourage you to refer to this information during your review of our operating results and financial performance.

And with that I’ll turn the call over to Bryce Blair, Chairman and CEO of AvalonBay Communities for his remarks.

Bryce Blair

With me on the call today are Tim Naughton, our President; Leo Horey, our Executive Vice President of Operations; and Tom Sargeant our Chief Financial Officer.

On the call I’ll summarize our results for the quarter and provide some comments on the economy, on the housing market and their impact on apartment fundamentals. I’ll then discuss our capital markets activity for the quarter and after that Tim will provide an update on our investment activity. After our comments we’ll all be available to answer any questions you may have.

Last evening we reported EPS of $0.60 and FFO per share of $1.24. The FFO per share of $1.24 represents an approximately 12% year over year growth rate which is driven by solid portfolio performance from contributions from new lease up activity and from the benefit of our opportunistic share repurchases during the quarter.

Our same store portfolio performer largely as expected with revenue growth of 4.4%, expense growth of 4.2%, resulting in NOI growth of 4.4%. Overall the portfolio remains well positioned with solid occupancy averaging 96.4% for the quarter. The strongest regions continue to be Northern California and Seattle, both posting double digit NOI growth.

In fact, if you look at the portfolio performance, it really is a tale of two coasts, with the West Coast reporting average revenue growth at twice the rate of the East Coast, 6.5% on the West Coast, 3.3% for the East Coast and the Midwest. We expect Northern California and Seattle to continue to show strength, while we would not be surprised to see increased weakness in the New York metropolitan area.

Overall we expect the rate of revenue growth will continue to moderate during the year, which is consistent with the original financial outlook that we provided last quarter. In terms of the economy, regardless of whether we call it a slowdown or a recession, events of the last three months have certainly weakened the near term economic outlook.

With job losses of almost 250,000 for the quarter, with oil prices above $100.00 a barrel, with the ongoing financial stress on Wall Street, these have all contributed to the business and consumer confidence falling to levels that haven’t been seen since the last recession earlier in the decade.

Although the nation experienced significant job losses during the first quarter, AvalonBay’s markets overall posted modest job growth. Seattle, Northern California and Boston all added jobs at an annualized rate of 1.5% or better during the quarter on a year over year basis, suggesting the economic slowdown hasn’t yet had a major impact in those markets.

Significant exposure to high tech industries which are showing healthy overseas demand and in the case of Seattle, Boeing’s backlog, are key reasons for this outperformance. Negative job growth in Southern California markets is driven in part by a continued deterioration in the housing market and New York and the surrounding tri-state area have continued to experience modest positive growth, but expectations are for weaker economic growth due to ongoing cutbacks in the financial services sector.

Now in terms of housing, there is no sign yet that the housing market has hit an inflection point. Single family home construction has dropped by two-thirds from its peak in 05 and is now at the lowest level since 1991. With the high level of housing oversupply, the homeownership rate has and will likely continue to decline, which obviously benefits rental demand.

As of the first quarter, the national homeownership rate has fallen by about 150 basis points to just under 68% from its peak in mid-05. And given the high cost of housing in AvalonBay’s markets, the homeownership rate in our markets is consistently lower than the nation overall, and for the first quarter this year has fallen to under 60%.

So while the economic outlook for ‘08 is likely to be weaker than projected in our financial outlook that we gave last quarter, AvalonBay’s portfolio is holding up well. The weak housing market and the limited supply of new apartments are helping to offset the impact of the slowing economy.

At this point we’re still comfortable with the revenue and NOI ranges that we gave at that time. In terms of capital markets, the volatility on the debt and the equity markets continue. It’s times like this that AvalonBay is rewarded for the strength and flexibility of our balance sheet.

While we have relatively large capital needs this year, we have multiple sources of liquidity and given our financial strength have been able to avoid the more costly unsecured debt and equity markets, in favor of more cost effective secured debt, a bank term loan and attractive dispositions.

Through April we’ve closed on three secured loans totaling $375 million at an average interest rate of 5%. The capital from these financings will be used to pay down a portion of the outstanding balance on a credit facility. In addition we’re pursuing a bank term loan in the amount of $250 million or possibly higher that would be in addition to our $1 billion line of credit and we expect this term loan to close within the next 30 days.

Now finally, during the quarter we repurchased approximately 480,000 shares of common stock at an average price of just over $87.00 per share, which brings the total amount we’ve repurchased in the last two quarters to 300 million. And in February we increased the repurchase program by an additional 200 million of capacity.

So with that I’ll turn it over to Tim to provide an update on our investment activity.

Tim Naughton

I’d like to touch on three areas related to investment activity. First, the existing development community performance; second, the status of the transaction markets and our disposition activity; and finally, our thinking regarding new commitments in terms of new starts, acquisitions and adding new development rights to the pipeline.

At the end of the first quarter we had $2.2 billion of development underway consisting of 22 communities and over 7,000 apartments. About 50% of the new developments are actively in lease up with the balance of the communities in earlier stages of construction. In addition we had another $4 billion in development rights in the design and entitlement phase.

Costs and schedule performance remains solid and in line with the original pro forma. In fact, current budgeted costs are within 0.1% of original budget on over $2 billion of activity. For recent buyouts, we have started to see some relief on the cost escalation experienced over the last few years. Depending upon the market, total costs have either flattened or declined moderately over the last couple of quarters.

As you’d expect, cost relief has been most pronounced in markets where for sale activity has fallen off the greatest, such as Southern California and the DC area. Clearly a slowing economy and housing market is resulting in greater availability of construction labor and materials. Based upon our outlook for the economy and housing market for the balance of the year, we expect costs to remain flat or decline further.

For those communities in lease up, the performance is generally in line with expectations. Absorption averaged over a 30 net leases per month per community during the quarter ranging between 25 to 40 across ten communities that were in lease up at some point. This pace is significantly higher than in the first quarter of the past three years, when absorption averaged 15 to 20 net leases per month per community.

Some of this absorption was stimulated by a greater use of concessions in Q1, particularly for communities with higher levels of inventory. We’ve recently found it more difficult to obtain phased occupancy in high density developments like Dublin Station in the Bay Area or at Maiden Bower in Seattle.

The net impact of this is that apartments are often delivered in large batches which in turn can result in higher standing inventory, where we need the use of concessions to help manage within acceptable ranges. In addition we have used more concessions in certain sub-markets that are experiencing some softness due to a slowing economy.

Shifting now to dispositions activity, given the state of the capital markets, we are relying on the use of dispositions to finance a good portion of our capital needs in 2008. In fact, our outlook calls for around $900 million in disposition activity this year. Currently we are in various stages of marketing on over $0.5 billion of assets.

I thought I’d spend a couple of minutes sharing some of our observations on the transaction market and its potential impact on our disposition plans. Overall we’re seeing a mixed level of investor appetite for transactions. Generally investors are gravitating towards stronger performing markets, higher quality locations and cleaner transactions.

We’re seeing signs of an unwinding of the cap rate compression we experienced over the last few years across markets and asset quality, when capital was plentiful. For example, we’ve marketed three assets recently in the Bay Area that were priced by the marketed cap rates that varied by over 100 basis point, based upon differences in the quality of the respective assets and sub-markets.

There still is a preference for value-add over core opportunity. However there is less tolerance of any structuring complexity. Underwriting assumptions by buyers and lenders are more conservative in terms of cash flow growth and debt service coverage ratios. The depth of the buyer pool varies dramatically from four to five to more than 20 depending on the opportunity.

Performance has been less predictable as some prospective buyers drop out during the qualification process and some terminate during due diligence, generally over financing related issues. Investment funds remain the predominant buyer, aided by the cost advantage of agency issued debt from Fannie Mae and Freddie Mac.

Given the reliance of many buyers on these agencies, we’re seeing some delays in closing transactions as the agencies are struggling to keep up with investor demand. Other buyers such as institutions, pension fund advisors and REITs are less predictable at the moment, as many of them are simply not competitive in terms of pricing or are choosing to wait on the sidelines until asset values stabilize.

Based upon assets that we’ve marketed and priced so far, cap rates appear to have increased on the order of 25 to 75 basis points from their trough levels, ranging from the mid to high 4’s on the West Coast to the low to mid 5’s on the East Coast.

Assets in the strike zone for investors or those assets in the better performing markets or stronger locations have experienced the least amount of cap rate reversion, on the order of 25 basis points, while weaker market more marginal locations have seen cap rate reversion of up to 75 basis points.

Overall we believe average cap rates are up around 50 basis points across the portfolio from the trough. Our current expectation is that we’ll sell around $200 million in the second quarter. We’re staying flexible with respect to total level of sales, weighing dispositions against other forms of capital available to us, including secured and unsecured debt.

And as Bryce mentioned earlier, so far this year, we’ve already financed $375 million in secured debt. Lastly I’d like to touch on our mindset toward making new investment commitments. Overall I’d characterize our attitude towards any new commitments, whether they be new start acquisitions or land contracts is cautious.

This is the result of a number of factors, including the liquidity needs of the current pipeline which are running at around $75 million per month. Second, having increased our target returns to a level which for the moment are still out of the market. And finally our believe that construction and land costs are still correcting and will likely continue to do so for some time.

All of these factors cause us to ask ourselves, why hurry, when considering new investments. We’re highly focused on liquidity and it is our sense that better opportunities will emerge in the back half of the year, as other owners of land and apartments are faced with fewer capital options and potentially some distress in funding their businesses.

As a result, for now, we believe that caution is the greater part of valor, which is reflected in our actions in the early part of ‘08. In Q1 we began construction on just one community in Long Island totaling under $50 million. We expect to start one or two more communities in Q2 and our total startups will be less than $150 million in the first half of the year.

Our original outlook called for around $1 billion in new starts of ‘08. But at this point we expect starts for the year will be more in the $700 to $800 million range, which is $0.5 billion less than last year. Most of these starts will occur in the second half of the year when we believe we’ll be able to buy out new construction on more favorable terms.

Similarly, we’ve been cautious and disciplined in adding new development rights, despite the increased deal flow we’re seeing. In our view, land prices have not yet adjusted to the higher return expectations of the marketplace. Undoubtedly some landowners will continue to hold out for last year’s values, but others will be forced to re-price in a changing return environment.

And finally we’re continuing to approach acquisitions very selectively. We have not bought any communities since September of last year and are focusing our transaction efforts largely in the area of dispositions. So in summary, performance remains solid in our development portfolio, although we are utilizing greater levels of concessions to clear standing inventory.

We’re actively pursuing dispositions while remaining flexible in terms of how much capital we raise through assets sales relative to other sources of capital. And finally we’re carefully evaluating any new commitments, considering both liquidity requirements and appropriate risk adjusted returns in a changing economic and capital environment.

With that, I’ll now turn it back to Bryce for some additional remarks before opening it up for questions.

Bryce Blair

While we’re pleased with our performance for the quarter, we do remain concerned about the economy and the volatility of the capital markets. And as these uncertainties play out, it may result in us adjusting our business plan to reflect the changing market environment.

As an example, we may end up doing, with fewer dispositions if the sales market continues to weaken. We may end up with less development starts as the capital markets remain volatile. We may end up doing more secured debt if the spreads on unsecured bonds remain historically wide.

So overall this period of uncertainty and volatility can be a competitive advantage for AvalonBay, given the strength of our balance sheet and our multiple platforms growth, with many opportunities to adjust our business plan in order to capitalize on the changing business environment.

And finally, I think there’s two key takeaways from our comments this afternoon. First, while we produce strong results for the quarter with revenue growth of 4.4% and FFO growth of 12%, the results were largely as we expected. As we stated last quarter, we do expect revenue growth to continue to moderate through the year and for the full year to be within the revenue guidance we gave last quarter.

Secondly, while capital markets remain volatile, given the strength of our balance sheet, we feel that we’ll comfortably meet our liquidity needs for the year, and the capital markets activity to date is evidence of multiple liquidity options that we have. With that, Vonda, we’d be pleased to take any questions.

Question-and-Answer Session

Operator

(Operator instructions) Your first question comes from Michael Billerman – Citi.

Michael Billerman – Citi

Craig Melcher is on the phone with me as well. Tim you went over talking about some of the increased concessions on the active lease up assets which took the average yield down about 10 basis points to 6.3% overall. How do you feel right now about your targeted rents on the assets you haven’t entered lease up yet given your backdrop of what you’re seeing and could you see increased concession activity there as well as you start to enter the lease up phase?

Tim Naughton

To date, well really this past quarter, the average effective rents were down about $40.00 across the entire portfolio which is about 2%. But given only about half the communities were under lease up that probably equates to more of a 4%, closer to 4% for those that are leasing. Typically we’re seeing concessions in the six week range right now. That is higher than we had anticipated, budgeted. To the extent markets continue more or less as is.

We may see some additional concession pressure. We may see concession pressure on other communities as they start their lease up as well. Having said that I would say that the communities that have started more recently have been, those pro formas reflect more current market environments. So we’d anticipate probably a little less pressure there overall.

Michael Billerman – Citi

Was there anything changed at least as you went through April leasing in terms of an increase or decrease in the amount of concessions to get some of the assets further leased up?

Tim Naughton

Not really, I think the quarterly trends are pretty reflective of what’s happening today. Again the velocity continues to be quite good. I think I mentioned were running over 30 net leases per month which actually equates to over 40 gross leases per month which is a historically high figure for us, on the order of 50% to 75% higher than we typically see. But as you might expect, as we moved into April, seasonal patterns emerge and the absorption is that level or strong.

Michael Billerman – Citi

In another one of your comments you talked about at least in the sales process and the sales market that the agencies are having a hard time keeping up. Can you just expand on that a little bit? The just don’t have enough resources or is there process taking longer in terms of underwriting?

Tim Naughton

I think it’s more of a function of volume. And we’re seeing closing schedule basically expand 30 to 60 days to accommodate financing related issues. It’s not always the agencies. It’s just in general I think the capital is moving a little bit slower to closing. So it’s on the order of 30 to 60 days.

Michael Billerman – Citi

Bryce in your opening remarks you talked about New York, you expect some increased weakness. Are you seeing that so far or are you expecting to see that as the year progresses?

Bryce Blair

We are not seeing that so far. Our New York portfolio is performing quite well. But certainly with concerns about the financial services industry, job losses to date, potentially accelerating job losses, it’s just something we’ll be very careful to watch. Obviously the financial services sector is a pretty significant component, about 10% of the total job base in New York and does have a multiplier effect. So it’s just something that we’re watchful for and we’ll continue to monitor.

Michael Billerman – Citi

How would Manhattan fare in your view relative to some of the suburbs of New York?

Tim Naughton

Certainly the financial services industry is not singularly focused in Manhattan, there’s a lot of back office jobs that spillover, whether it be in Queens or into Jersey City and the surrounding. So a slowdown in the financial services sector, it’ll be a broader hit than just Manhattan. In terms of what we’re seeing so far in our portfolio, Leo you might want to comment a bit.

Leo Horey

I’ll touch on a couple aspects. Just to make sure everyone’s clear, when you look at our same store results, the properties in the same store basket come from Westchester and Rockland counties. We do have properties in Manhattan and just to give you some perspective, the Chrystie Place the Bowery Place assets which are really multiple phases of one larger community have been performing quite well.

Occupancy is 98% and higher. So those assets have done well. But when you go outside the city to markets that might be impacted by New York City, you’re talking about Stamford, and Stamford while we’ve seen some occupancy pressure, it’s really come more from local employers and some corporate housing and we really see it as a short term issue, we don’t see it as a structural.

On the Jersey waterfront which would also be impacted by New York City, there’s a little supply coming there that Roseland’s delivered, but again we’re not seeing significant issues and we are seeing favorable traffic patterns, in other words people coming to the door is pretty positive. So while we are mindful that what happens in the financial sector in the second half of the year could provide some pressure, today we’re not seeing it in any of the adjacent sub-markets or in Manhattan itself, based on the performance of our portfolio.

Operator

Your next question comes from Jonathan Habermann – Goldman Sachs.

Jonathan Habermann – Goldman Sachs

Obviously the decision to reconsider investing in development, I’m just curious where you’re seeing yield today on new starts, obviously for those types of projects.

Tim Naughton

Well Jonathan we haven’t started much but the stuff that we have started mid-6s.

Jonathan Habermann – Goldman Sachs

And you talked about opportunities in the second half of the year, you mentioned obviously cap rates up 50 basis points from trough levels, can you give us a sense of how much of an increase are you looking to see before you become opportunistic?

Tim Naughton

Well in terms of hurdle rates, I would say at development we’re probably 50 basis points off of where the market is today. I think we’d want to see yields closer to the 7% range. As it relates to acquisitions, if the average cap rates today are closer to five, we’d probably need to be in the mid to upper 5’s in order to justify new investment.

Jonathan Habermann – Goldman Sachs

On the share repurchase, are you assuming any additional share repurchase in your full year guidance, the additional $200 million.

Tim Naughton

We do not comment on capital markets activity and the share repurchase would be a capital markets activity.

Operator

Your next question comes from Louis Taylor – Deutsche Bank.

Louis Tayler – Deutsche Bank

On the capital markets side and Bryce maybe you could provide a little bit of color, in terms of the term loan that you’re contemplating, how wedded are you to that? If the corporate bond market which is starting to show a little bit of life shows some further life in the next couple of weeks, would you still do the term loan? What’s your rationale?

Tom Sargeant

The term loan that we’re working on is pretty far down the runway. It’s really too far for us to pull back on that. It is pretty favorable financing. It’s basically LIBOR plus 1.25. LIBOR today is at about 272. So it’s pretty attractive financing. We have room in our capital structure for more floating rate debt and we think it’s a pretty good piece of business. So we’re going to proceed with that. That will close in the next couple of weeks.

Louis Tayler – Deutsche Bank

In terms of the concessions on the development leasing, do you think you’ve got it priced right now or do you think the concessions will either dissipate because you’re going into the strength of the leasing season or do you have more bulk delivery units where you think the concessions might increase from here?

Leo Horey

I’d say there’s two responses to that. One is, in certain places where we’ve used more concessions or where rents have come under more pressure, it really is because we are trying to stimulate the absorption. So for instance if you looked at Avalon Sound in New Rochelle, we had slow leasing in November, December and January and we’ve made adjustments and accelerated that leasing to take some of the standing inventory off the market as Tim had suggested.

With respect to going forward, we are catching up and getting into a place with which we feel comfortable and if traffic continues to come, things remain stable; my hope would clearly be to be able to pull some of those concessions back. But I don’t see a bulk of units coming that’s going to put further pressure on those at this time.

Operator

Your next question comes from Alex Goldfarb – UBS.

Alex Goldfarb – UBS

Can you just comment on what you’re seeing across your different floor plans, the studios, the ones and twos, including in the New York area.

Leo Horey

In general we obviously price our apartment homes across all different floor plans to keep our absorption stable and occupancy stable across the different types. There’s no specific pattern that would suggest ones or studios are more occupied than twos. It’s really pretty balanced across the portfolio.

Alex Goldfarb – UBS

What’s the message that you’re telling your field for this leasing season? Is it more focused on occupancy, more focused on rent?

Leo Horey

The focus is to operate the portfolio between 96.5% and get the maximum rent increases we can get from that occupancy platform. So the emphasis right now is making sure that the portfolio is well positioned. I believe that we came through the first quarter in a very good place. As you can see, in comparison to the previous year, our occupancy was up and it was stable at 96.4%.

I’ll tell you April is running about the same rate, if not slightly higher. So it’s get the properties to that stable occupancy platform and then push rents as aggressively as we can from there.

Alex Goldfarb – UBS

It seems like there’s a lot of people trying to sell properties in the market, including from some of your former brethren, how concerned are you that the market is going to be flooded with properties and that could depress values.

Tim Naughton

I think we actually anticipate volume is going to be down pretty dramatically this year over the prior couple of years. So I think the question is just how many buyers are there on the other side. I think the sellers are actually, I don’t think there are as many sellers. The investment funds are generally buying right now, they’re not selling.

And so in terms of the market being flooded, there’s a lot more product in the market today than there was three or four months ago. But it hasn’t risen to the level which we think it’s close to having been flooded.

Operator

Your next question comes from Rich Anderson – BMO Capital Markets.

Rich Anderson – BMO Capital Markets

We have in our model and maybe we shouldn’t, redemption series H, [inaudible], the capital markets event you can’t tell me right?

Tom Sargeant

We’ve actually given an outlook on that and we’ve said that our current plans are to redeem it.

Rich Anderson – BMO Capital Markets

So is there a charge associated with that?

Tom Sargeant

Yes and that’s also factored into our outlook for the year.

Rich Anderson – BMO Capital Markets

And that charge is what? Did you give that?

Tom Sargeant

A little over $3 million.

Rich Anderson – BMO Capital Markets

One thing that’s not in the press release this time around is comments on the accounting revision; can you give us the status of that? Having to book a land lease, revised accounting interpretation from previous quarters of about $0.13 in 2007.

Tom Sargeant

That land lease stays out, it’s outstanding today, it continues to have the same terms and there’s no resolution of the land lease in terms of the accounting for it. It’s basically status quo at this point.

Rich Anderson – BMO Capital Markets

In terms of your potentially being more cautious on development, might there be some pursuit cost issues in the future, in terms of abandoning deals.

Tim Naughton

Well at this point we certainly think everything we’ve got in the pipeline is something we’re going to move forward with. Having said that, we are pushing our target hurdles up and we’re looking to get some cost out of the construction side of the equation to bring those yields up more in line with what we think are appropriate risk adjusted returns.

So for the most part, the land basis of the deals that we have that we own or are under contract we feel comfortable with. I think on average it represents 16% to 17% of the total projected development budget. So I don’t sense a lot of risk in that side of the business.

Rich Anderson – BMO Capital Markets

You mentioned higher concessions, would you be able to give an absolute number in terms of how much higher your concessions that you’re using to fill up development properties?

Tim Naughton

I think I mentioned earlier, they’re running I believe around 6 weeks on average for the ones that are in lease up currently. So I think they’re running a little over $2,000 a unit, $2,500 a unit, something like that on an average lease of a couple thousand.

Rich Anderson – BMO Capital Markets

In terms of the acquisition environment and the fact that the fund is now fully committed, would you consider another fund?

Tom Sargeant

We are in discussions with investors about raising capital to continue with our acquisition program. What form that takes, we’re not really ready to provide any information on that. I would say just stay tuned and hopefully we’ll be able to share more with you in the second quarter.

Rich Anderson – BMO Capital Markets

This is conceptual, when you have homeownership going up, that’s obviously good, job loss going up, that’s obviously bad. Comparing the two, the magnitude of the two, which one do you think has a bigger impact on the fundamentals, all else being equal for multi-family and your business?

Bryce Blair

I think in the last quarter I gave a little color on that because I think it’s an important point and it’s a good question. Historically job growth accounted for frankly more than 100% of the increase in rental household demand. Because over the past few years, the homeownership rate was working against us and demographics were working against us in the sense of the Baby Boom bust if you will.

Today if we look at 2008 with job growth essentially zero, all of renter household demand is coming from the change in the homeownership rate and the improved demographics that the sector is seeing with the benefit of the echo boomers. So we are blessed by two positives, not just one, two positives being demographics and household formation which are offsetting, not in total, but are offsetting the impact of having a very weak economic environment and essentially no job growth.

Operator

Your next question comes from Richard [Paley] – ATG Investments.

Richard [Paley] – ATG Investments

The $10 million of the unsecured debt that you bought back, There was some language in there that there’s going to be some recognition of the deferred financing charges on those and the premium over part. What’s the deferred amount, the $287,500 is the amount over par that you recognized.

Tom Sargeant

In total the charge we’ll take in the second quarter for buying that back is about $300,000. So the deferred financing cost wasn’t really material.

Richard [Paley] – ATG Investments

On the development pipeline and specifically to Long Island city asset, it looks like concessions bumped up a little bit but then the stabilization date of a project moved up I think from the fourth to the second quarter. In terms of trade off, do you look at that in terms of velocity and so how much does the yield change from just maybe giving an extra two weeks rather than having it stay out leasing up a little longer?

Tim Naughton

It’s always a trade off, rent for absorption. It’s something we’re managing all the way through lease up. At the end of the day we’re really looking to maximize IRR and so to have a lot of vacant standing inventory, particularly like the Long Island city assets that you’ve mentioned, $2,900.00 a month of a wasting asset potentially sitting there empty, you need to factor that in.

And if you can stimulate absorption by throwing another two or three weeks of concession, often times you’re maximizing cash flow and ultimately IRR by doing that. But it’s a tradeoff we are constantly managing, it’s a function of where you are in the season and sometimes in a case like Long Island city where you’re finishing up lease ups, sometimes you are left at the end of the day with units that are just tougher to lease and therefore may not have had them priced right to begin with. So it’s a function of a lot of different things but it’s something we’re totally focused on.

Richard [Paley] – ATG Investments

I noticed that this quarter your rent growth on a cash basis peaked over the rent growth on a GAAP basis and at least, I waded through some of the supplementals and at least from my data, it hasn’t been that way in quite a while. Do you take that, do you use that as any way of a leading indicator to say that things aren’t rapidly decelerating?

Leo Horey

In the middle part of last year I actually indicated that I expect the flip-flop to occur in December which is when it did occur. I don’t take it as specifically a leading indicator. It’s measured over such a long period of time, when you’re amortizing the concessions in. I’m looking more toward a situation, some of the discussion that we’ve had previously, of where is the portfolio occupancy, where is availability, how is traffic trending. Things along those lines than I am the cash versus GAAP.

Bryce Blair

Rich you mentioned flip but you did say it’s a minor point. We’d say they’re essentially equal; they’re within one-tenth of a basis point.

Operator

Your next question comes from Steve Radanovic – BB&T Capital Markets.

Steve Radanovic – BB&T Capital Markets

Do you have the break out of rent growth on renewals versus on new move ins?

Tim Naughton

We don’t have that information, we don’t typically parse it that way Steve.

Steve Radanovic – BB&T Capital Markets

On same store portfolio, looked like there was a net, call it 3,000 units that fell out this quarter, is that held for sale or is that under contract?

Tom Sargeant

Yes. Same store pool changes every year once a year. And there’s two things going on there. One is redevelopment, we redevelop an asset, and we take that asset out of the same store pool. Leaving a redevelopment asset in the pool could distort operating results for the same store pool and we generally want to pull that out. If you were to leave it in, it would distort things positively and that is, you’re applying new capital you’ll get a rent spike.

And you’ll also get an expense decline, solely related to the improvements and not related to the market. Sometimes this is referred to in the industry as buying NOI from capital investments. So when we do redevelopment, we take it out of the same store pool until it’s re-stabilized and it’s comparable between periods.

Second point would be yes we do have a large disposition program and those assets are taken out of the pool, the assets that we identify for sale at the beginning of the year are taken out of the pool for the year.

Steve Radanovic – BB&T Capital Markets

Can you comment if you have anything currently under contract?

Tim Naughton

I think we have around ten assets that we’re anticipating going into redevelopment this year and of the disposition pool I think there around 14 to 15 assets just to give you a sense. So that’s 25 assets right there essentially come out and then obviously the ones that had stabilized from the year prior would be coming in and that would explain the difference.

In terms of the current dispositions, as I mentioned we have a little over $0.5 billion out in the market, it’s roughly about $600 million. $150 million of that is actually through due diligence and subject to a firm contract. About $100 million of that, the deals have actually been awarded, so they’ve been priced and awarded.

The purchases would either be in due diligence or just starting due diligence. Another $100 million are in the pricing negotiation phase. And then there’s about $200 to $250 million that we’re currently marketing which makes up the $600 million that are in one form of marketing or another.

Operator

Your next question comes from Michael Salinksy – RBC Capital Markets.

Michael Salinsky – RBC Capital Markets

First on the operating side, rental revenues came in higher than your forecast for the full year. Operating expenses also came in, do you expect a similar moderation to operating expenses as the year goes?

Bryce Blair

As I stated in my comments, our projections have always been based on revenues continuing to decline throughout 2008 and that’s just consistent with the economic environment that we plan for and we budgeted for. So I just want to be clear that the revenue performance of 4.4%, while it is higher than our range, it does not mean it’s higher than we expected. If you look at it declining throughout the year, we still expect revenue for the full year to be within the revenue guidance that we gave, in terms of expenses, largely seasonal.

Leo Horey

The 4.2% was higher than our plan but the truth is it’s basically timing related. If you adjusted out the timing related issues, we would have been just slightly above 3% which would have been largely consistent with the plan. And as Bryce has indicated, we still feel comfortable with the ranges that we put out last quarter.

Michael Salinsky – RBC Capital Markets

So for clarification purposes, the timing differences, you could see it drop pretty significantly here in the second quarter going through the rest of the year?

Leo Horey

Yes, we expect the expenses that we expected in future periods will go away now, so yes we should see some benefit in future periods.

Michael Salinsky – RBC Capital Markets

Secondly given your conservative underwriting practices for development, if you look at the developments that are going to be completed in the second quarter, third quarter, how are those performing versus your initial underwriting expectations right now in terms of NOI growth?

You don’t trend rents beyond a certain point and over the past year we have had positive rent growth so I’m trying to understand, you show a 6.3% target yield there but in theory if you hadn’t trended rents there you could have some upside beyond the 6.3% essentially.

Tim Naughton

Yes you could. The reality is over the last couple years we’ve seen very modest, I think last couple years the deals that stabilized, they were on the order of 20 basis points higher at stabilization than original pro forma, just to put a perspective.

Michael Salinsky – RBC Capital Markets

Third, in terms of your development yields of 6.3% right now, how does that compare versus the spread to what you’re looking at to comparable properties in the market right now?

Tim Naughton

I think I mentioned earlier, if we were out in the market today, pricing land, on this basket of communities, we’d be looking for something probably in the higher 6’s.

Michael Salinsky – RBC Capital Markets

With the rebalancing of the same store portfolio there in the first quarter, are you exiting the Baltimore market?

Tim Naughton

No, we just classified Baltimore as part of the Washington DC market.

Operator

Your next question comes from Jeff Donnelly – Wachovia.

Jeff Donnelly – Wachovia

Bryce, with the GSCs out there tightening credit terms that we’ve heard about, can you talk about what impact you think we’ll see there as a result, if it’s going to be in the volume side initially or cap rate. And then drilling a little deeper, are there segments of the apartment market that you think maybe will see more of an impact. Is it more the value-add deals or maybe more stabilized A quality assets in second tier markets that might be impacted by a tightening of credit?

Tom Sargeant

First, I’d say that the GSCs, the main area that they’re tightening up on is they’re actually increasing their spreads or at least have been increasing their spreads. When we started out on our secured programs, spreads were in the 175 range. The latest quotes are more in the 225 range, so that would be one area where you’ve seen some tightening. The second would be terms. You’re seeing it more difficult to get interest only.

And there’s a movement toward amortization and I would say that the good news there is if you do an amortizing loan, you will see a better spread than if you were to do interest only. So those are the two main areas. There seems to be plenty of capacity left. It’s taking a little longer to get things done but that’s only because volume as Tim mentioned, it’s not their reluctance to do business. So I think those are the important points to make.

Bryce Blair

Given that spreads are up and debt service coverage ratios have moved up as well, that ultimately means there’s got to be more equity in the deals. That for a leveraged buyer puts them under greater pressure and ultimately as Tim indicated puts upward pressure on cap rates.

So there has been this bifurcation in cap rates or decompression in cap rates and again Tim commented on in his opening comments, where those second tier assets either by asset quality or sub-market location are seeing a disproportionate lift in cap rates versus the better located assets or newer assets.

Tom Sargeant

One final thought on the GSCs, we have been using more secured debt because of the historically wide spread we saw in the first quarter between secured debt and unsecured debt. Those two spreads have come back into alignment somewhat. Current quotes that we’re receiving from the investment banks suggest that we could get an unsecured debt deal done at 275 basis points over five or ten year treasuries.

And that compares to our, a little bit dated quote at 225 with the agencies. So that number was more like 150, 175 basis points, it’s now down to 50 and that’s only in 60 days. So I would say there is some pressure building with the GSCs to abate their rate of spread expansion, because there’s markets opening up on the unsecured side.

Jeff Donnelly – Wachovia

Generally speaking, they’re not, obviously it’s dynamic because they’re adjusting their rates as you’ll see Wall Street, do you think there’s any sign at all though that we should expect additional tightening in coming quarters at all?

Tom Sargeant

We don’t anticipate any more than what we described in terms of change to date.

Operator

Your next question comes from Ben [Lint] – [Vosale] Investments.

Ben [Lint] – [Vosale] Investments

Can you give me the sequential growth rate on your same store NOI this quarter since you changed the pool? I just want to match my estimates and my model to your guidance. It’s hard to do without the sequential growth rate.

Tom Sargeant

We don’t have that recast in the former presentation style Ben, I’m sorry.

Operator

Your next question comes from David Cohen – Morgan Stanley.

David Cohen – Morgan Stanley

On the development starts this year, you talked about raising your hurdle rates but your growth and rent assumptions have to come down because of the economy. So can you just talk about which markets are actually going to meet your IRR thresholds and maybe can you just talk about do you expect to see, how much of the development starts would you expect to see through broken deals in which you’re able to step in, there’s some type of equity partner. And what you’re seeing across those different markets.

Tim Naughton

Currently we’re not anticipating we’d be picking up any broken deals that would start before the end of the year. The additional $500 to $600 million that we would anticipate starting in the second half of the year would be coming from our development rights pipeline and would largely come from the development rights source top of the page on attachment 10. I think Bryce mentioned we’re going to continue to be flexible with respect to how much we start.

It’s a function of the capital markets, it’s a function of target yields at the time, it’s a function of how much construction costs have corrected by the time we start. So at this time it’s really an estimate. And recognize we’re going to continue to be flexible with respect to how we execute the business plan.

Operator

Your next question comes from Andy McCulloch – Green Street Advisors.

Andy McCulloch – Green Street Advisors

One your three secured financings during the quarter, can you give the LTVs on those deals?

Tom Sargeant

They’re in the 60% range, 60% to 65%.

Andy McCulloch – Green Street Advisors

On your expense growth, can you give a little bit more color on why the expense growth varied so much across your different regions?

Leo Horey

There were three regions where it was the highest and in two of those three regions, it was really driven by property taxes, a little bit by some maintenance related costs. And in Southern California which would be the third region where it was up quite a bit, that was more in the maintenance related cost area.

Pacific Northwest was down largely because of some administration and payroll costs that came in that were offset by insurance and some utility benefits that were offsetting costs. Northern California was favorable again because we had some benefits on the insurance side and the office administration side that was offset by property taxes a little bit. But the property tax growth in California is constrained, so that was what caused those type of results.

From market to market, expenses can be lumpy but that’s what was driving the issues.

Operator

Your final question comes from Michael Billerman – Citi.

Michael Billerman – Citi

I want to come back to the same store pool for a second. The difference between 4Q and 1Q, those 3,000 units, that’s what you now identified for sale?

Tom Sargeant

It’s either for sale or assets that were pulled out of the pool for redevelopment. And those assets wouldn’t be sold, they’d just come back into the pool once we complete redevelopment.

Tim Naughton

And there’s some additions to the same store pool from one year to the next that come out of the other stabilized pool after they’ve been stabilized for a full year.

Michael Billerman – Citi

The redev’s is a pretty low number, you only have 112 units pulled out in the first quarter, and did you pull them all out though?

Tim Naughton

It’s everything you anticipate selling or starting in a calendar year.

Michael Billerman – Citi

And what you pulled out for sale is that $600 million, even though you only have $100 million held for sale on the balance sheet, you’re pulling out everything that you are anticipating to sell?

Tim Naughton

Yes, more than $600 million, in this case it was $900 million in the case of disposition.

Bryce Blair

There’s been a couple questions on this, just to be totally perfectly clear, as Tom mentioned we really try to be extraordinarily diligent to ensure that our same store basket changes only once, not each quarter and that there are no assets in that same store portfolio that positively or negatively could skew the performance of that portfolio. So there’s three things, one, two that would come out and one that would go in.

The two that would go out would be redevelopment, not just what’s on the redevelopment, it’s everything that’s planned to be under redevelopment during the year and that’s a substantial number, I think Tim mentioned that’s ten properties. Then it’s everything that could plan to be sold which is around 15 properties. So that’s a total of 25 properties. So those come out and what goes in are the properties that were fully stabilized last year and so we have a full year of comparison.

We have 25 properties coming out, you have X properties going in, the next effect is the difference in the same store portfolio. That’s the same way we’ve always done it and we feel very comfortable and confident that that’s the best way to present data without any biases built into it.

Michael Billerman – Citi

But I’m just trying to think about from a perspective of the dispositions, generally these are probably weaker growth assets and weaker performers?

Tim Naughton

I wouldn’t characterize them that way Michael, particularly in this market. As I mentioned in my opening remarks, those are the assets that have suffered the greatest value diminution and so we’re actually, we’re selling a basket of assets that are pretty representative across different markets and asset quality of the overall portfolio.

Michael Billerman – Citi

Would you say those have the same 4.4% revenue growth year over year of the basket?

Tim Naughton

I don’t know because it’s so dependent upon, if anything it’s probably a little bit higher because, a little bit more of it’s in the Pacific Northwest and Northern California.

Operator

At this time there are no further questions.

Bryce Blair

Thank you Vonda and thank you all for your time and we look forward to seeing many of you at NEREIT in early June. So thank you.

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Source: AvalonBay Communities, Inc. Q1 2008 Earnings Call Transcript

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