Associated Estates Realty's CEO Discusses Q3 2012 Results - Earnings Call Transcript

Oct.24.12 | About: Associated Estates (AEC)

Associated Estates Realty Corporation (NYSE:AEC)

Q3 2012 Earnings Call

October 24, 2012, 02:00 pm ET

Executives

Jeremy Goldberg - VP, Corporate Finance & Investor Relations

Jeff Friedman - Chairman, President & CEO

Lou Fatica - Vice President, CFO & Treasurer

John Shannon - SVP, Operations

Jason Friedman - VP, Construction and Development

Patrick Duffy - VP Strategic Marketing

Analysts

Eric Wolfe - Citi

Gaurav Mehta - Cantor Fitzgerald

Jana Galan - Bank of America Merrill Lynch

Alex Goldfarb - Sandler O’Neill

Bruce Garrison - Chilton Capital Management

Tayo Okusanya - Jefferies

Paula Poskon - Robert W Baird

Andrew McCulloch - Green Street Advisors

Wilkes Graham - Compass Point Research

Buck Horne - Raymond James

David Toti - Cantor Fitzgerald

Operator

Good afternoon and welcome to the Associated Estates Third Quarter 2012 Earnings Conference Call. My name is Rocco 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, sir.

Jeremy Goldberg

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

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

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

As a reminder, Associated Estates’ third quarter earnings release and supplemental 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 will turn the call over to Jeff Friedman.

Jeff Friedman

Thank you, Jeremy. Our business is very solid. Fundamentals remain strong. The prime winner cohort continues to determine that renting an apartment versus buying a home maximizes financial flexibility and in many cases allows one to live in a location they would otherwise not be able to afford.

Year-over-year and sequential results support that even in a weak economy, highly amenitized, well located and professionally managed apartments are able to raise rents. In addition, higher occupancy and relatively flat controllable expenses have contributed to improved margins.

From a supply standpoint, very little new product has been delivered or started in our competitive submarkets over the last three years. This shortage, combined with the increase in household formations has added to our pricing power.

The decision we made to focus on continued improvement to our balance sheet not only positioned us to weather the financial storm of 2008 and 2009, but enabled us to be in a position to buy properties at attractive prices that will generate solid returns for many years to come. Our recent investment grade rating adds another arrow to our quiver by enhancing our financial flexibility and reducing our borrowing cost.

Before I turn the call over to Lou and John, let me comment on acquisitions, dispositions and our preliminary thoughts about 2013. We will continue to be extremely disciplined in our underwriting analysis for acquisitions. Based on current market conditions, we expect that next year what we spend on one-off acquisitions will be less than what we spend this year.

If we do find deals on our own, it is our intent to fund acquisitions with disposition proceeds. We would expect 2013 dispositions to be equal to or greater than what we sell this year. This focus and approach will minimize the need for external funding and at the same time allow us to continue to improve the competitiveness of our portfolio.

With regard to expected 2013 property performance, we are deep in to the property level budget process. Based on current market conditions and what we are hearing from our teams in the field, we expect 2013 to be another strong year; continued rent growth combined with historically high occupancy; our plan is to provide 2013 guidance when we report Q4 results at the beginning of February.

Lou?

Lou Fatica

Thank you, Jeff. We are thrilled with our third quarter and year-to-date 2012 results. Our teams in the field have done a great job harvesting renewal and new lease increases that will benefit us into 2013.

For the third quarter, FFO was $0.32 per share, a $0.02 better than internal expectations as a result of higher same-community NOI and lower interest expense. Q3 same-community NOI was approximately $300,000 or a penny per share higher than forecast. The increase was driven by better than anticipated revenue. Year-to-date, same-community revenue was up 5.8% and expenses were up 4.5% resulting in an increase of 6.7% in same-community NOI when comparing 2012 to 2011.

Based on our year-to-date performance and our expectations for the balance of the year, we have increased the midpoint of our 2012 FFO as adjusted guidance for $1.25 per share. FFO as adjusted excludes any loan prepayment costs or defeasance refunds. The midpoint of our full year FFO as adjusted number represents a 21% increase in FFO per share when compared to 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% for the full year. This conservative payout ratio provides ample room to increase the dividend in 2013 if the Board decides to do so.

Significant assumptions related to our revised full year 2012 guidance are as follows: Full year same-community revenue up 5.9% at the midpoint or 65 basis points higher. Full year same-community expense up 4.5% at the midpoint, or 125 basis points higher. Full year same-community NOI up 6.8% at the midpoint or 30 basis points higher.

Acquisitions of $183 million which represents completed year-to-date acquisitions. We do not expect to close on any additional acquisitions by the end of the year. And property sales of $67 million which represents an year-to-date completed dispositions totaling $60 million, and one additional sale that is expected to close in Q4, that is reflected as held-for-sale on the balance sheet at the end of Q3.

With regard to our balance sheet, we continue to execute on our objectives as evidenced by the recent upgrade from Moody’s. Our improved metrics will allow us to continue to reduce our secured borrowings and tap the unsecured bond market. Our leverage is measured by debt to undepreciated book value stood that 48% at quarter end.

With the closing of the amendment to our term loan last Friday, we are able to increase the size of the loan from $125 million to $150 million; extend the term 19 months, improve the borrowing spread and add an investment great pricing grid. The additional proceeds were used to repay a property specific loan increased unencumbered pool. Unencumbered assets now account for 58% of Q3 NOI and have a market value of approximately $1 billion.

Our year-to-date fixed charge coverage ratio stood at 2.85 times. Our leverage profile and balance sheet are as strong as they had ever been, and we continue to focus on incremental improvements to maximize financial flexibility.

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

John Shannon

Thank you, Lou. Our same-community NOI was up 6% over Q3 2011. We finished the quarter at 97.3% physical occupancy, up significantly from 94.8% a year ago. Total revenue was up 5.9% with 30% of the growth coming from occupancy gains and 70% from rents and other income. Same community revenue was up 4.7% in the Mid Atlantic, up 5.3% at our Southeast Properties and revenue up a very strong 7.1% at our Midwest properties.

For Q3, same community new lease rents were up 3.3% and renewal lease rents were up 5.8% across the portfolio. Expenses were up 5.8%, advertising, utilities, repairs and maintenance and other operating expenses combined were up 1.3% for the quarter. Payroll was up 8.1% for the quarter, primarily associated with performance driven incentive compensation. Real estate taxes and insurance were up 9.8% due to increased values and rates.

On a sequential basis, same community revenue was up 2.2% over Q2, as we continue to push rents and physical occupancy remained better than 97%. Apartment fundamentals remained strong. When comparing Q3 2012 versus Q3 2011 annualized resident turnover is down 10% and prospect traffic is up better than 10%. The average length of stay is 20 months. These trends drive increased occupancy, increased rents and improved same community NOI.

Year-to-date we have acquired four properties, three in the Raleigh-Durham and one in Dallas. The properties are performing well and collectively finished the quarter at 96% physical occupancy. As an update on our Vista Germantown development in Nashville we've completed construction and are currently 91% occupied. At the 99 unit expansion of our San Raphael property in Dallas, the structured garage is 90% complete and we anticipate that the first units will be delivered in Q3 of next year.

Our current development pipeline is on track and will add significant value, design and approvals continue to move forward as anticipated. We are positioned to have another good quarter as we finish the year. When comparing one year leases, October new leases are up 1% and renewal leases are up 5%. November and December renewal letters have been sent out with increases between 4% and 5%.

From a reconciliation standpoint, NOI for the first nine months is up 6.7% and our guidance reflects full year NOI up 6.8% at the midpoint. To get to the 6.8%, we anticipate year-end physical occupancy of 96% to 97% and revenue and expense growth tracking to year-to-date performance resulting in fourth quarter NOI of approximately 7% at the midpoint.

In closing I want to thank all of our employees for another terrific quarter and for positioning us for a strong 2013. I will now turn the call back over to Jeff.

Jeff Friedman

Thanks John. Our operations team has really done a great job. Our results continue to demonstrate the competitiveness of our portfolio. This is an exciting time in associated states. Our debt service metrics are at historic highs as evidenced by our three times plus coverage for Q3. The value of unencumbered properties is at an historic high, greater than $1 billion. Our operating margins are at historic high. Over 60% portfolio wide. Our average rent is over $1,100 per unit and occupancy better than 97%, both at historic highs. These results are a testament to the great job our teams are doing and the fact that apartment fundamentals in the most basic and unbiased analysis are also at historically strong levels.

Rocco, why don’t we open up the call for questions.

Question-and-Answer Session

Operator

We will now begin the question-and-answer session. (Operator Instructions) Our first question comes from Eric Wolfe of Citi. Please go ahead.

Eric Wolfe - Citi

Jeff, you mentioned in your remarks that you plan to fund all your acquisitions next year with disposition proceeds. Could you just talk about why are you pursuing this strategy versus choosing to issue, incremental capital to fund your growth?

Jeff Friedman

Given the different ways to fund that growth, a combination of increasing borrowings, albeit at very low spreads to LIBOR or issuing stock at significantly low prices in relationship to our NAV, issuing shares is sort of a lowest on the total (inaudible). And with the increase in pricing and the low cap rates, the opportunities that we saw over the last two years are fewer than what we see today buying stabilized acquisition properties.

At the same time we want to take advantage of these high prices and low cap rates, and we think by selling certain assets into this market that will be a good way to fund not only acquisitions to the extent that we find them but also a portion of our development stand on those properties that we have committed.

Eric Wolfe - Citi

And I guess if we were to think about sort of the properties that you would be willing to part with I guess is a sort of percentage of portfolio I mean would you see that kind of like 10% of your portfolio and what markets would that include is that primarily the Midwest sort of older assets which you are looking to sell.

Jeff Friedman

Eric we do a top down and a bottom up analysis at least twice a year, where we rank every property based on return on equity. And so those with the highest return on equity are holds those with the lowest returns on equity come to the top and identify for potential sale. What drives that primarily are two things, one anticipated capital expenditures over as far out as we can reasonably predict and the cap rates in the respective markets for these properties and so we only own one what I would call legacy asset of small some house development on the west side of suburban Cleveland on only legacy asset, but Midwest portfolio as you can see is performing quite well.

So we are agnostic as it relates to where, if I had been going for that a little further, I would say in the markets where we have a smaller presence and want to growth, if would be unlikely that we would sell in that markets. So for example we probably wouldn’t sell in Dallas today that’s the market where we would want to grow.

On the other hand the market where we don't have the significant presence or don't anticipate growing, we may identify that as a market where we would want to sell, but we are agnostic as to the geographic location, its all about a pricing and return on equity.

Eric Wolfe - Citi

Last question along the same line, when you go to this analysis of essentially pre-underwriting all of your assets and thinking about return equity you will get from holding them and where does that sort of shake out and when we think about the assets to sell, I mean what return on equity, what base would imply that sort of some 7% would be the assets you sell, just trying to understand how you’ll make that determination?

Jeff Friedman

Well, it’s on the relative basis to the other properties. When we look at funding our growth form dispositions of proceeds it really is relative to the returns that we would get from one of the other properties and that will depend obviously on where we are any point in the cycle. I don't know that we disclose Lou, John, I am not sure we disclose what those returns on equity because think about it, Eric that in order to do that. We are looking out a couple of three years for example in terms of capital expenditures what do we think is going to happen, what do we think is going to happen with regard to our inflows in those markets and then we take all that into consideration against those same underwriting assumptions with the other properties.

So a newer property would have less capital needs and older property greater capital needs, property currently at a low ebb of the cycle would have greater future rent growth, and then as you know the further we get out the more cloudy those assumptions become. But I can't tell you that that relates to a certain weighted average return on equity. It’s on a relative basis to the entire portfolio.

Operator

Our next question comes from Gaurav Mehta of Cantor Fitzgerald.

Gaurav Mehta - Cantor Fitzgerald

Thank you. You mentioned in your prepared remarks that turnover was down 10%, can you provide a breakdown in terms of what you saw for rent increases and house purchases?

Jeff Friedman

As it relates to turnover the reasons for move out?

Gaurav Mehta - Cantor Fitzgerald

Yes.

Jeff Friedman

Yeah, we really didn't see anything meaningfully change over the past year. Our top three reasons for move out continue to be relocation, buying homes and rent too high, just giving an example of those percentages, rent too high as a reason for move out was right around 12% of our move outs, buying home about 15% and relocating about 16%. And those numbers have been holding up around those levels for the past year.

Gaurav Mehta - Cantor Fitzgerald

Okay, that's helpful and in your remarks you mentioned that you saw a lot of strength in the Midwest markets, can you perhaps provide some color as to what is driving that?

Jeff Friedman

I think the Midwest we've said many, many times, its certainly a sub market story and we are in some of the prime and submarkets in the Midwest and I think the other big key component is there’s virtually been absolutely no new supply in our market, both Ohio, Michigan, Indiana and that has helped us to really stay full and drive rents.

Gaurav Mehta - Cantor Fitzgerald

Okay and lastly can you provide the spread on your new term loan. You mentioned that the amendment of the term loan and there was an improvement in the spread, I am not sure, what was the new pricing?

Lou Fatica

We had a 20 basis points decrease across the leverage bid. So where we were at 180, we are currently at 160 over 30 day LIBOR. So in oil and rig they call it 181 on the term loan. As you know, we swapped a portion of that to fix beginning in June of 2013. So that will price it at the 160 plus, the swap spread which is 126 at that time. The other important thing to recognize there is that we added an investment grade, pricing grade as well that will go into effect once we meet that hurdle.

Gaurav Mehta - Cantor Fitzgerald

So that would bring the rates lower on the term loan or?

Lou Fatica

Well, the spreads vary depending on the rating and so it varies from 125 to 220 over.

Operator

Our next question comes from Jana Galan of Bank of America Merrill Lynch. Please go ahead.

Jana Galan - Bank of America Merrill Lynch

Jeff, I was a little surprised with the lowered acquisition guidance. It sounded like during the summer, you are seeing a lot of attractive acquisition opportunities. I am just curious if pricing was getting too aggressive or if you are lowering rental assumptions in your underwriting or what cause the change?

Jeff Friedman

All of the above. Yes, we are lowering rent growth assumptions beginning in 2013 going out five years. In most markets, there are some exceptions than we were at the beginning of the year. Sellers expectations are seem to continue to be high, pushing, asking cap rates, lower. Haven't really seen enough transactional volume to support that cap rates are really higher. Some might say it sort of feels like in some markets, they are moving it a little higher but haven't seen enough of the core product, core plus product transferring or trading to support that yet.

And so given those factors, we're still looking; we're still trying to uncover those opportunities like the team has done so well with the properties that we have acquired over the last 18 months or 24 months. I think John touched on it. Even the properties that we just acquired in the third quarter are exceeding our wildest expectations and performing quite well. So, yeah, I would say, it's changed in the last three months, four months in terms of our expectations. Therefore, we reduced our acquisition expectation

Jana Galan - Bank of America Merrill Lynch

Thank you. And then may be Lou if you could just comment on what you are seeing in terms of real estate tax increases, are those mostly all received or you still expecting to get additional assessments and may be which regions are they much higher?

Lou Fatica

Sure. First off, we haven’t received all the tax bills. We still we need to receive the Ohio tax bills and the Michigan tax bills. Those will be received in the fourth quarter of this year. The regions where we are seeing the significant increases in 2012 are Virginia, Georgia and Florida, and Georgia and Florida tax bills were received during the third quarter.

Operator

Our next question comes from Alex Goldfarb of Sandler O’Neill. Please go ahead.

Alex Goldfarb - Sandler O’Neill

Just going back to your uses of capital certainly based on the comments that you said about you are having encumbered pool it sounds like from an unencumbered base folks are rallying around 6.5 and you guys are trading in eight so certainly makes sense to dial back some of the acquisition activity and focus on using internal capital dispositions, but just sort of curious you guys mentioned the low dividend payout and as you think about maximizing your cheapest cost to capital, how do you weigh increasing the dividend above and beyond what you need to do versus using versus paying a higher yield or using that cash flow internally to fund your development and the acquisitions?

Jeff Friedman

Hi Alex this is Jeff. But first of all, the board will decide what to do with the dividend. They will typically review that after we have presented the final budgets up to the board for approval. We understand that in a perfect world where pricing was perfect and multiples were the same and the amount of the dividend didn't necessarily relate to stock price or investor expectations that would what you said would be correct.

We look at it a little bit differently. I was a very outspoken about this a few years back when some were thinking about paying dividends and stock and others had to cut the dividend and our plan and we see it as the basic contract with the investor is to have a dividend policy that is predictable, sustainable and the investors expects summary, particularly a person read that a large portion of the total return come from the dividends payout.

And so our policy is to continue to grow that dividend in a very measured way, keep our payout within the 60% to 70% range and yet that is our cheapest form of capital to retain that but when we take that and although very little bit helps for us with approximately 50 million shares outstanding, a penny is $500,000. So we look at it on that basis, this year we have raised the dividend on an annualized basis, for pennies that's $2 million, yes we think that using that money internally is a great source of capital, but also the message that we send to our shareholders and are confident in our future expectations, we feel is important and in the long run we will get the benefit of that policy.

Alex Goldfarb - Sandler O’Neill

And then speaking of future expectation, what is S&P telling you, like where do you guys stand, they seem to have reviewed you I guess about a year or so ago and just given that you got about a $152 million or so of secured coming due next year and $167 million on your line of credit, certainly an unsecured offering would be attractive if the ratings make sense or alternatively presumably you can get pretty good pricing on the term loan. So if you can one up data from S&P and then two, Lou tell us what we should be thinking as far as how you are going to refi the $167 million and the $152 million?

Jeff Friedman

Sure. Lou will touch on that. We are dealing with and have ratings from both the Fitch and S&P. So Lou why don't you touch on where we are with both of them?

Lou Fatica

We work closely with both Fitch and S&P in each of the criteria from our perspective. We believe we are there from a metric standpoint, there's no bright line task when it comes to whether you are investment grade or not below investment grade, so we continue to work closely with them. We think we have a number of alternatives as you mentioned, the term loan, of that $150 million that was maturing in 2013, $21 million of that was paid off with the additional $25 million proceeds that we closed down on Friday leaving the $130 million Freddie cross collateralized pool. And we think if for some reason either the unsecured bond market were to close back up or not be as attractive that there is plenty of appetite we think in lenders to do another unsecured term loan and we have the unencumbered pool to support that.

Alex Goldfarb - Sandler O’Neill

And then just finally, as you guys think about assets to sell, the Midwest has been an area that you had mentioned producing, you have a large concentration. At the same time, its producing phenomenal NOI growth for you over the past few years, how do you weigh, trading any of that NOI growth for also selling from there, just given it is a large pool of assets?

Jeff Friedman

We are agnostic. Its about keeping the highest what we expect return on equity and so on what we expect be the lowest.

Operator

Our next question comes from Bruce Garrison of Chilton Capital Management. Pleas go ahead.

Bruce Garrison - Chilton Capital Management

With respect to the development pipeline on your page 13 on the supplemental, could you elaborate a little bit particularly on the projects that you have entitled under future development, details that would be somewhat similar in terms of total estimated capital costs and timing?

Jeff Friedman

Sure; Jason you want to take that?

Jason Friedman

This is Jason. Looking at the supplemental, the first property developed Turtle Creek is located in Dallas. This property is currently in the design and approval stages and we are working through that process with the City of Dallas and we expect to start that project in first quarter of 2013. The second property is Dwell Bethesda and that is a 140 units. That is currently also going to the approval process and we expect to start construction before the end of this year. And the third property is The Desmond on Wilshire, which is our property, 175 units and we expect to start construction by summer of next year.

Bruce Garrison - Chilton Capital Management

In terms of capital cost, can you give kind of rough estimate of where you spend?

Jason Friedman

Sure, on Dwell Turtle Creek, our estimated costs are approximately $50 million; on Dwell Bethesda, our estimated costs are $53 million and on The Desmond on Wilshire, are approximately $75 million.

Bruce Garrison - Chilton Capital Management

And in terms of your proforma, would you say that the expected yields are about the same or better or worse than when you initially announced those projects?

Jason Friedman

Our return expectations have really not changed since we started those projects. The returns have probably only gotten better based on the rent expectations and the improvement in all of those markets, but our returns have stayed the same based on our cost, stayed the same.

Operator

Our next question comes from Tayo from Jefferies. Please go ahead.

Tayo Okusanya - Jefferies

Most of my questions have been asked, but I was just hoping you could give me some insight into Metro DC and as well as the Southeast and Central Florida markets and kind of what you are seeing there in regards to your overall portfolio and performance in those markets?

Patrick Duffy

Tayo, this is Patrick Duffy. We have 10 properties in the Mid-Atlantic; Mid-Atlantic for us is else where south to Southern Virginia and most owners have apartments in the Mid-Atlantic are concerned about new supply and government job cuts. In terms of new supply of the 10 properties that we have in the Mid-Atlantic only four properties have new supply in their target, in their competitive submarket and each of those four competitors only have one or two new properties. So we are not looking at oversupply situation for our portfolio. And then in terms of government job cuts, only two of the 10 properties have more than 15% of their residents employed by the government or by government contractors, so I don’t think that what we are going to see significantly impact and job cuts occur in the government.

Tayo Okusanya - Jefferies

Okay. But does that put any pressure on you though in regards to kind of rent in that market or anything of that nature; just on a whole concerned about of government job cuts?

Patrick Duffy

No, we have had strong revenue growth in the Mid-Atlantic and we expect it to continue; year-to-date in the Mid-Atlantic we have increased revenue by 4.7% in Northern Virginia which is where we have the most units; we have increased revenue by 5.7% year-to-date. So strong revenue growth. In terms of Florida, we are starting to see rents increased we’ve had a high level of occupancy in both Central Florida and Southeast Florida for the last two years and we are now starting to see rents increased in south Florida and in Central Florida.

Jeff Friedman

Tayo, this is Jeff, but I would say just one more thing. I think that Florida, we would all say has been slowest to see job growth coming back. We would be more surprised with what we haven't seen in those Florida markets from a job standpoint.

Operator

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

Paula Poskon - Robert W Baird

I wanted to the follow up on the tenant metrics that you discussed earlier in the call. Can you tell us what your average rent income ratio is right now and how that compares to a year ago?

John Shannon

Paula, this is John. Our average household income is $66,500, that’s on our current rent and about a $1,050 puts the ratio with 19% that has stayed about the same as we’ve seen rents grow, we have seen household incomes in our communities grow. So it really stayed at around 18%, 19%, 20%.

Paula Poskon - Robert W Baird

And Jason you had mentioned your yield expectations on the future development projects haven't changed since their costs appear the same, are you not underwriting any increase in construction costs, particularly around the labor market.

Jason Friedman

No we actually do when we underwrite our projects we assume construction pricing expectations when we anticipate to start up the deal. So we have already factored in on our price increases over the period of time that we are going through the pre-development stages and the design stages but currently we are really not seeing in the projects we are working on as well as the bidding process for these deals. We are not seeing a whole lot of increase in construction pricing.

Paula Poskon - Robert W Baird

And then just finally, I noted that the occupancy at San Raphael dropped year-over-year and sequentially as well, is that a function of Phase 2 getting underway or is there something else going on there.

Patrick Duffy

This is Patrick. Phase 2 is not impacting Phase 1. We went from fiscal occupancy of 98.6% for the nine months in 2011 to 97% in 2012 and I would argue that 97% is a very strong occupancy. We are going to have to talk about that guidance. We are going to have to look into that.

John Shannon

Paula and I think this is John the other important thing when you look at not only San Raphael but some of the other markets that we are in but specific to San Raphael yes occupancy maybe down a 150 basis points, but for the quarter total revenue is up 5.8% so we are effectively staying pretty full and pushing rents hard.

Paula Poskon - Robert W Baird

And that's your point John you know clearly in the second quarter earnings Paul as we heard a lot from your apartment peers that they were creating their own turnover essentially because they were continuing to backfill exiting tenants with higher income, higher credit quality tenants. Is that a fair assessment for what you are still seeing in the third quarter across the portfolio or do you see some diversions across the markets?

John Shannon

I would not say that we are trying to force turnover because with keeping folks in the apartments, for the quarter we had renewal increases of 5.8%. So we want to keep people in our apartments because that's where we are seeing a significant pricing power.

Paula Poskon - Robert W Baird

So as the credit metrics improved then of your tenants you would say the household incomes were up etcetera. Do you think your tenants are seeing wage growth or is it the backfilling of higher income of new tenants.

John Shannon

I think it’s a combination of yes and some folks are seeing some wage growth but I think really fundamentally the high occupancy is really a result of having well located, well managed properties in very strong sub markets, and as I said earlier the sub markets have virtually no new supply so its really a double benefit for us. We are staying full and we continue to push rent.

Paula Poskon - Robert W Baird

Are you guys surprised at all of that new supply hasn't come more quickly in so many of their markets.

John Shannon

No, I mean when you look at the Midwest, its still difficult to make the numbers work on a development basis, even though your land costs are a little bit less here in the Midwest, but your construction costs you are still at $100 a foot let's say and if we really can’t get the big rents to support, you know, $125,000 - $150,000 unit.

Operator

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

Andrew McCulloch - Green Street Advisors

Just coming back to your comments on external growth and capital recycling, I want to make sure I understand. Do you plan to grow the company next year or will dispositions roughly match acquisition and development spending?

Jeff Friedman

Hi Andrews. This is Jeff. We’ll provide the guidance with our fourth quarter earnings. I would say, overall we do plan to grow the company. We will grow it both through our development pipeline, coming online the organic growth from our core and on a select basis, acquisitions. And so what I tried to message, I tried to leave with everyone is that we do expect the growth next year to be less through acquisitions, less than the growth from acquisitions this year. And that we do plan to try to fund that growth as much of that growth as possible from property sales, but we do expect to continue to grow the company.

Andrew McCulloch - Green Street Advisors

Because if I knew my math, you got 150 million roughly, spend on development alone, right? I mean that require you selling 10% of your company. So I know you said equity issuance are pretty far down the total pull but don’t you have to issue equity?

Jeff Friedman

Well, Andy, with regard to the development spend, the construction would be 24 to 30 months out now what we are talking about that if we looked at 2013 development spend if I had to estimate it I would say about $75 million in 2013 and so yeah we have that we have to generate that 75 million to pay for that on a new neutral basis and then any growth on top of that. The balance of the spend would come in the second year of the development of those three properties.

Andrew McCulloch - Green Street Advisors

Okay. One more question and switching gears bit on your rent income metrics do you guys quote rents using incomes from your end play tenant in your rentals or incomes from the market just market average?

Jeff Friedman

From our rentals it’s actual residence.

Operator

Our next question comes from Wilkes Graham of Compass Point Research. Please go ahead.

Wilkes Graham - Compass Point Research

Hey guys most of my questions have been answered (inaudible) other one I had was if you could talk may be about how seasonal trends third quarter over second quarter this year looked relative to either the past few years or even the sort of three to five timeframe. .

Jeff Friedman

Sure. Let me if you look at what we did on total rent let me just talk you the combination of renewals as well as the new deals on a combined basis for all of our leases we were up 2.5% in Q3 of this year, and when you look at 2011 we were up 5% but again we were up 5% but again we were back then we were 91% occupancy excuse me, 95% occupy versus the 97%. So really I think on the total revenue basis we really have seen growth from the occupancy as well as we are getting the rent from the first quarter and the second quarter that are compounding and growing into the third quarter and the fourth quarter.

Operator

Thank you. Our next question comes from Buck Horne with Raymond James. Please go ahead.

Buck Horne - Raymond James

Hey, good afternoon guys. Hate to be the one to bring this up, because I know it’s a topic that’s beaten to death for you guys daily but I do think its worthwhile just to revisited on a public forum. Investors have clearly someone noted with their feet in terms and what they think will be growth strategy, I still find to hard the believe with the quality of your assets putting up the numbers is good as you are putting up this trading close to at 30% NAV.

So I mean, it appears there is a real feel of significant dilution among the investors down the road and I just want to ask you again what your current thoughts are and just to give an opportunity to be explicit about your growth strategy plans, would you consider re-evaluating those plans or exploring in strategic options. And what your investors are telling you in terms of what they want associated to state to be as it fits into the board apartment really-landscape?

Jeff Friedman

I am so glad you ask that question Buck, look we are focused on what we can control and that’s the stream of earnings the quality of our portfolio and we believe that the portfolio that we built has demonstrated over a very long period of time that it is competitive with all of the other publicly traded apartment companies. Now, certainly our actions as interpreted by the market impact what happens to the stock price and to that extent clearly trading at the significant discounts NAV that we are would indicate that people have voted by not buying our stock or in some cases by selling our stock. We continue to be focused on those things that we can control.

We constantly evaluate our strategy and how we spend the precious capital that we have and we believe that based on our long-term basis we are making the decisions that will maximize shareholder value over a long period of time. Someone that I trusted some may know him, his name was (inaudible) he is no longer with us. He once said to me when I asked him about how he ran one of his businesses. He told me that when things are good that he has the throttles pegged all the way down and when things aren't so good he backed off on the throttles. Well, at where our stock price is we are backing off on the throttles but its not changing from a strategic standpoint how we go about operating our business.

Buck Horne - Raymond James

And maybe just one quick one for John. I just noticed the southeast region for you, did you drop rent recently in some of those properties to rebuild your occupancy there and kind of have you reset the decks in like Atlanta and I guess Florida in those other markets, what kind of rent growth do you think you can get going forward there?

John Shannon

Yeah, but as you can see from the supplement, it really was an occupancy issue down in the Atlanta specific to the Duluth property, the 843-unit property that we have there. We've now got occupancy back and we are throttling the rents up both on new deals and on renewals. So we feel pretty good about that market and some of the stabilization that's really happening in the whole Duluth submarket.

Operator

Thank you sir. Our next question comes from Rob (inaudible) of Wells Fargo Securities.

Unidentified Analyst

Just a quick question on expenses, I'm not sure if you have mentioned this but could you just address what's driving the creep up in your expectations for the year. There seem to have [rise] in each of the last few quarters from 2% to 3% down to 3.5% now above 4% and I guess to put it differently what specifically has changed since your original guidance was given?

John Shannon

Sure. Rob, this is John and I think Lou hit on the real estate expenses and the insurance why we are seeing growth there. When we look at our payroll expense and our real estate tax expense it makes up about 55% of our total operating expenses. So when I peel out the real estate taxes where we had the valuation increases and middle trade increases that explains some of it and we've also seen some increases in our payroll line item and the expenses being up in payroll is really a good thing for us. Our property employees receives revenue and NOI bonuses for out performance as compared to the budget and as we've seen, we've really outperformed for the quarter and for the year. So those incentive bonuses have been paid out and we think it's a terrific thing because it means our revenue and our NOI has really outperformed the expectations.

Operator

Thank you. Our next question comes from David Toti of Cantor Fitzgerald. Please go ahead.

David Toti - Cantor Fitzgerald

Very quick two sort of just random questions. Jeff, can you talk a little bit about what you’re seeing in your Midwestern markets relative to I don’t think any optimistic in the employment base. There's been a lot of writing done recently on manufacturing resurgence. Are there any specifics you can point to that might be supportive of a stronger employment case for your core Midwestern markets?

Jeff Friedman

David, the Midwest markets have been performing well. We look at the unemployment numbers in our Midwest markets and when we look at the year-over-year change, the velocity of that change, the fewer unemployed. Now this is if you believe the numbers the way they were reported, we are just going period to period, same numbers are reported, are actually better than the percentage if you look either nationally or even portfolio wide. For example, if we look at our total portfolio, unemployment in our total portfolio on an average is 7.7% unemployed compared to a year ago at 8.8% unemployed.

If we look at Washington for example, we are down a half of percentage point from our Washington, Arlington, Alexandria were down from six to 6.5. So that’s only 50 basis points, if we look at Baltimore we are down from 7.8 to 7.7. Conversely, if we look up in Western Michigan we have anywhere from 150 from a 100 to a 150 basis points improvement in year-over-year less unemployment. So we see the Midwest resilience and strength even though those numbers in many cases are equal to or in some cases greater than the numbers in other markets that velocity of change the improvement has been better.

David Toti - Cantor Fitzgerald

Okay, that’s helpful. And then again sort of randomly what’s happening in LA relative to the entitlement process, the design process on the new project Desmond?

Jason Friedman

This is Jason, David. We are currently working with the City of Los Angeles to receive approvals to start construction where at the same time working with our architects to complete the design and redesign the buildings that was originally planned for that site to a five storey wood frame podium product. And so we are pleased with the process so far with the way it’s going with the city, they have worked with us very well and we expect to start construction next summer.

Operator

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

Jeff Friedman

Thanks everyone for joining us today that will conclude our call.

Operator

The conference is now concluded. We thank you for attending today’s presentation. You may now disconnect and have a wonderful day.

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