Apartment Income REIT Corp
NYSE:AIRC
Earnings Call Analysis
Q3-2023 Analysis
Apartment Income REIT Corp
The company strategically executed acquisitions where the implementation of their proprietary system, the AIR Edge, is contributing significantly to high Net Operating Income (NOI) growth rates, close to 17%. This resulted in an overall boost to the portfolio's NOI growth, bringing it up by 170 basis points to a robust 7.2%. These acquisitions, along with economies of scale from Joint Ventures (JVs) valued over $2.2 billion and organic growth endeavors, have fortified the company's financial performance and diversification.
Even as the transactions market faces headwinds with a reported 72% decrease in national volume due to high debt costs and supply concerns, the company remains resilient. Their adeptness at sourcing acquisitions that enhance both financial results and portfolio quality is attributable to their strong operational capabilities and access to capital through partnerships with top-tier global investors.
In the current economic climate, marked by rising interest rates, the company has strategically managed its balance sheet. They refinanced significant debt into fixed rate property debt, which is conservatively levered, limiting near-term exposure to rising rates. With no debt maturities until the second quarter of 2025 and substantial liquidity available, their leverage ratio is expected to be prudently maintained below 6.0:1 by the year's end.
The third quarter showcased a Funds From Operations (FFO) per share that slightly exceeded guidance, underpinned by both recurring and nonrecurring streams. A year-over-year increase of 7.3% in run rate FFO was reported, indicative of the company's underlying strength. Impressively, Adjusted FFO (AFFO) exceeded dividends by $56 million year-to-date and is projected to reach about $80 million for the full year. The forward outlook for the fourth quarter includes a narrowed FFO per share guidance and anticipates sustained growth.
The Board of Directors' affirmation of shareholder value is evident through the declaration of a quarterly cash dividend of $0.45 per share. This translates into an attractive annualized yield of approximately 5.8% based on the current share price, signaling a strong commitment to delivering shareholder returns.
The company implemented three enhancements to its earnings supplement to bolster transparency. These enhancements include a detailed computation of Net Asset Value (NAV), a comparison of actual results to guidance, and a reconciliation of FFO to AFFO. These measures allow investors a more granular view of the company's financial performance and projections.
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Welcome, and thank you for attending today's AIR Communities Third Quarter 2023 Earnings Conference Call. My name is John, and I will be your moderator for today's call. [Operator Instructions] I would now like to pass the conference over to Lisa Cohn, President and General Counsel of AIR Communities. You may proceed.
Thank you, John, and good day, everyone. My name is Lisa Cohn, and I am President and General Counsel of AIR Communities. During this conference call, the forward-looking statements we make are based on management's judgment, including projections related to 2023 expectations. These statements are subject to certain risks and uncertainties, a description of which can be found in our SEC filings. Actual results may differ materially from what may be discussed today.
We will also discuss certain non-GAAP financial measures such as FFO. These are defined and are reconciled to the most comparable GAAP measures in the supplemental information that is part of the full earnings release published on AIR's website. Prepared remarks today come from Terry Considine, our CEO; Keith Kimmel, President of Property Operations; Josh Minix, our Chief Investment Officer; and Paul Beldin, our CFO. Other members of management are also present and all of us will be available during the question-and-answer session will follow our prepared remarks.
I will now turn the call to Terry Considine. Terry?
Thank you, Lisa, and my thanks to everyone on this call for your interest in AIR. AIR had a solid third quarter and business is good. I start with 3 observations. The first operations matter. Keith and his talented team continued to outperform. Second, portfolio composition matters. At a national level, there's a tremendous amount of competitive new supply, but there is no national market for apartment renters, only local markets, submarkets and neighborhoods.
AIR is diversified by markets and price points. And as we look to 2024, our regular review of new supply property-by-property shows a range that's been typical over the past several years. Third, interest rates matter. The increase in the 10-year rate has disrupted property pricing and created opportunities for profitable acquisitions. In the third quarter, AIR made successful Paired Trades that upgraded our portfolio and increased the expected growth rate in recurring cash flow.
In the quarter, Keith and his team again confirmed our decision to organize AIR around comparative advantage in operations. In the third quarter, AIR enjoyed the highest customer retention, lease rate growth, same-store net operating income growth, free cash flow growth and operating margins. AIR's emphasis on customer selection results in more stable communities with residents, who are more financially capable and stay with us longer. AIR operations and the deep pockets of our venture partners make possible accretive acquisitions. Over the past 3 years, we've invested more than $2 billion of AIR Capital in properties, whose financial results are improving at rates well above AIR's peer-leading same-store portfolio.
Speaking of transactions, I want to introduce Joshua Minix, our Chief Investment Officer to the call. Many of you will have met Josh, who have been co-CIO at AIR for more than 2 decades. His transition to CIO was Seamless. And I also want to tip my hat to John McGrath, a dear friend for his many contributions to AIR and wish him well in his entrepreneurial pursuits. Through joint ventures and a property sale, AIR raised more than $600 million of new capital and as Josh will report, reinvested the proceeds and property purchases, share buybacks and debt reduction, both accretive to FFO and AFFO and improving the quality and growth rate of the portfolio.
Paul kept the balance sheet bulletproof. AIR will end the year with leverage below 6x EBITDA, abundant liquidity and limited exposure to higher interest rates. We price the AIR culture, the foundation for all we do and is well described in the corporate responsibility report published last month by our colleague Patti Shwayder, and posted on our website.
Now I'll turn the call to Keith Kimmel, President of Property Operations. Keith?
Thanks, Terry. The third quarter was good. As expected, with strong demand and leasing pace 25% ahead of 2022, high retention with only 38% turnover in the past year, accelerating occupancy as we put peak season frictional vacancy behind us. Slower rent growth as inflation ebbs, impactful supply in pockets muted overall by AIR's diversified portfolio and significant gains from acquisitions, whose growth rate outpaces our same-store communities.
The third quarter solid leasing translated into good financial results. AIR transacted new lease rates up 3.6%, renewals up 6% and blended lease-to-lease rates up 4.7%. Occupancy increased throughout the quarter from 94.6% in July to 96% in September. Revenue was up 6.8% year-over-year. Expenses were up 8%, largely due to timing. And for the full year, expenses are on plan with controllable expenses up less than 1%.
Net operating income increased 6.3% and AIR's operating margin was 73.4%. Growth was even stronger in our acquisition portfolio. Now 20% of our business, thanks to Josh and his team. Our 5 acquisitions from 2021 now owned for approximately 2 years and included in our same-store portfolio and revenue up 10.3%, net operating income up 15.2% and added 40 basis points to same-store revenue growth and 80 basis points to same-store net operating income growth.
Our class of 2022 acquisitions not yet included in same-store had revenue up 9.9%, expenses down 6% and net operating income up 20.1%. Their rate of increase in profitability is more than triple our same-store result. Southgate bought earlier this year had sequential revenue growth in the third quarter that also outpaced our same-store communities. We see a steady close to the year and setting us up for a solid start to 2024.
October average daily occupancy was 96.9%, up 1.6% from the third quarter. Physical occupancy is in the mid- 97% range today, which we expect to hold throughout the rest of the year. These rates are easing seasonally with our October transacted due lease rates up 1.3%, renewals up 3.8% and blended lease rates up 2.1%.
We are well positioned for further revenue growth in 2024 with earn-in in the low 2% range, occupancy that will start the year in a strong position, bad debt that continues to show improvement in a diversified portfolio in which strong markets are expected to offset those pressured by new supply. We talk regularly about the AIR Edge, a distinct approach that delivers consistent results. The AIR Edge begins with quality residents with an average 725 FICO score and rent-to-income below 20%.
Our resident stay longer, thanks to world-class customer service delivered by our experienced and stable on-site teams, who build communities and relationships, differentiating AIR in a commoditized marketplace. We add technology selectively, where it improves team productivity or the resident experience. These factors combined to reduce AIR's controllable operating expenses to nearly flat for the past 13 years. We approach our business differently. We use analytics to fundamentally rethink operations, delivering results in lease-to-lease metrics, turnover, occupancy, bad debt, income growth and margin. My thanks to all AIR team members for your ongoing passion to provide world-class customer service and create communities our residents value. You are the foundation of the AIR edge.
I'll now turn the call over to Josh Minix, our Chief Investment Officer. Josh?
Thank you, Keith. We are open for business and closed 5 transactions this quarter. We've increased our allocation to faster-growing acquisition properties and further improve the portfolio. The core JV announced on the Q2 call, provided AIR with $505 million of capital and grew by over $100 million with the acquisition of The Elm in Bethesda, Maryland. The sale of Tempo provided $21 million, finishing our planned exit from New York City. These fund our share of The Elm and our entry to the North Carolina market, where we bought Brizo in the Research Triangle and Old Town in Raleigh. The balance was used to delever and buy back stock. Taken together, these parent trades are expected to be neutral to 24 NOI and accretive to free cash flow by $0.02 per share.
Our investment philosophy remains the same. We focus on generating a positive spread to our cost of capital and on improving portfolio quality. The properties acquired this quarter compared to the properties sold half. average ages of less than 2 years versus effective ages of over 26 years, resulting in a reduction of capital replacement spending of $4 million per year. Expected stabilized free cash flow that is cash flow after capital replacement is 20% higher, rents, 11% higher, better locations and expected 10-year IRRs 230 basis points higher driven by the combination of the Air Edge and higher growth markets.
We also used retained cash flow to fund property upgrades of $24 million in Q3 and $64 million year-to-date with double-digit yields on IRRs. New result, a portfolio with a 20% allocation to acquisitions, where the implementation of the AIR Edge is driving NOI growth rates of around 17%, lifting the total portfolio NOI growth by 170 basis points to 7.2%. Higher recurring cash flow from these and economies of scale generated by our JVs with AUM of over $2.2 billion.
Organic growth from property upgrades, exceptional high credit quality customers and broad diversification with roughly equal weighting across the following 3 categories: East and West Coast, Class A and Class B apartments in urban and suburban locations. This portfolio has proven resilient even during periods of elevated national supply. The impact of supply depends upon price point and micro location. We track the percent of NOI from properties facing new supply pressure, which historically has ranged from 20% to 30%.
We estimated at 26% for '24. More details can be found in the appendix to our release. At the moment, the transactions market is filled with national volume down to reported 72% due to the high cost of debt, limited available equity and supply concerns. However, AIR benefits from access to capital via our partnerships with some of the largest and most sophisticated global investors and sovereign well funds. Superior operations from the AIR Edge and the ability to source acquisitions accretive to both financial results and portfolio quality. I note it is a great advantage as an investor that we count on Keith and his talented team to improve our returns.
With that, I'll turn the call over to Paul Beldin, our Chief Financial Officer. Paul?
Thank you, Josh. Today, I will discuss AIR's balance sheet, report third quarter results and our expectations for the full year highlight 3 enhancements made to our earnings supplement and concluded with a brief comment on our dividend. Their balance sheet is well positioned. During the quarter, AIR refinanced a $154 million of borrowings on our revolving credit facility and $325 million in 2023 and 2024 term loans with new fixed rate property debt with a weighted average life of 5.3 years and a weighted average interest rate of 5.2%, 30 basis points above the short-term debt repaid, but happily by the 100 basis points below borrowing costs today.
As a result, AIR has near-term exposure to rising interest rates that is limited to $79 million in our share of the Virginia joint venture debt plus $26 million on our revolving credit facility. We have no debt maturities until the second quarter of 2025 and abundant liquidity with $2.1 billion available, sufficient to refinance all maturing debt through 2027. Leveraged EBITDA is anticipated to be below 6.02:1 at year-end. It is temporarily elevated today due to the timing $365 million of NOI and free cash flow accretive acquisitions and share repurchases.
Turning to third quarter results. FFO of $0.64 per share was $0.01 above the midpoint of guidance. As previously discussed, 2022 and 2023 FFO include income not expected to recur in future periods. In the third quarter, we had $0.05 as such nonrecurring income compared to $0.03 in the third quarter of 2022. Run rate FFO, which excludes this nonrecurring income was $0.59 per share in the third quarter, up 7.3% year-over-year and up 8.2% year-to-date.
Run rate AFFO was $0.52 per share, up 4% year-over-year and up 6.3% year-to-date. AIR AFFO has been calculable from our disclosures. We publish it now to provide greater visibility of the capital spending required to maintain our properties, a proxy for depreciation, which we call capital replacements. AFFO in excess of dividends about $56 million year-to-date and expected to be about $80 million for the full year is retained to fund organic growth, such as investment and property upgrades, which we call capital enhancements.
Looking forward to the fourth quarter, we have narrowed our guidance for full year pro forma FFO to be between $2.39 and $2.43 per share. For the quarter, we anticipate pro forma FFO doing $0.63 and $0.67 per share, with $0.05 higher property NOI, offsetting the sequential decline in nonrecurring income. The fourth quarter is usually AIR's most profitable due to the earn-in of peak leasing season rents and seasonally lower expenses.
Next, I'd like to discuss 3 enhancements made to our earnings release. The close of the core joint venture increased the percentage of FFO and AFFO derived from unconsolidated properties and from services provided to the third parties to allow for more efficient and effective modeling, we enhanced Supplemental Schedule 2. We've separately disclosed third-party services subject to long-term contract and those generally in support of transaction activities. To walk the consolidated drivers of FFO to AIR's proportionate share. And additionally, we added to our glossary a walk of our GAAP income statement to this schedule.
We trust these changes will be beneficial, please reach out with any questions. Last, the AIR Board of Directors declared a quarterly cash dividend of $0.45 per share. On an annualized basis, the dividend reflects a yield of approximately 5.8% based on the current share price. With that, we will now open the call for questions. Please limit your questions to 2 for time in the queue. John, I'll turn over to you for the first question.
[Operator Instructions] Your first question comes from the line of Eric Wolfe from Citi Group.
On Page 6 of Joshua, I think, gave a breakdown of your NOI growth by properties based on when you acquired them. Just curious, can I take from that disclosure that 89% of your GAV will be in the same-store pool next year? So basically just excluding the other real estate in Class A 2023 and so that remaining 11%, any early sense for the growth potential for those paid properties?
Eric, this is Paul. Thank you for the question. I hope you're well. Thank you for pointing out the additional disclosure we provided in our supplement. And to answer your particular question, next year in same store, we will be adding we'll be adding the class of 2022 to same-store. But also what's included in other real estate, those 4 properties are the properties that we reacquired from Aimco, a little less than a year ago now. And then so that will be part of our same-store pool in 2024 as well. And so the only items that will be outside of same-store will be our acquisitions made in 2023.
Got it. And then this quarter, you saw a 120 bps contribution to your same-store revenue from other residential income, which has been growing over the last couple of quarters, presumably as you receive more late fees. Can we see that be a little bit of a headwind to growth next year, just given that your bad debt has come down substantially. So I would think you'd see less late fees? Or are there other sort of initiatives to offset that?
Eric, it's Keith. There's some other initiatives to offset that. We have lots of focus on parking and storage and other resident type of very particular amenity opportunities. So while I acknowledge your point about whether late fees or other things that could come with previous delinquencies, we have other ideas and things that are in play that actually, we've been working on a lot of the year, and we'll start earning into next year.
Your next question comes from the line of Rich Anderson from Wedbush.
So on the deployment of joint venture funds and sort of bringing in partners and so on, I understand the line of thinking behind it. What concerns me is sort of a return to more complicated sort of structures, the very thing that you sold AIR on is simplified strategy and all that sort of stuff. So do you expect to expand joint venture activities from here, formation of new ones? Or do you feel like what you've got is enough to feed your growth needs for the coming few years?
Rich, it's Terry. And good afternoon, where you may be, I think, and it's good to hear your voice, You're absolutely correct that the addition of joint ventures adds an element of complexity to the AIR plan. I would note that it was included in the AIR separation. At that point, we had a single joint venture. But there's been a change in facts, since then a dramatic change in the capital markets. And when the facts change, we need to incorporate that in our thinking. And we want very much for AIR to be transparent. And that's why by Paul and his team spent so much time on same-store Schedule II to provide a walk so that analysts and the market would be able to track the proportionate contribution and not be too undone by the increased complexity.
Okay. Great. And as far as the opportunity set that may lie ahead, you sort of you and your peers are kind of teeing yourself up for some dislocation related to debt maturities and all that. Do you have a an idea of how this could look? Do you have a sort of a pipeline number in mind today? And would it be mostly one-off deals in your pair trade scenario. Could you see yourself doing something larger portfolio-wise or even some sort of these entity level type situations. Like what's out there that you see now and how might it grow as we go?
Rich, you followed both the industry and [ AIR ] for a long time. And so you know that we will be comfortable doing one-off acquisitions and entity acquisitions. I think it really depends on what opportunities the market brings. I think that the impact of higher interest rates and for how long is still reverberating and I don't think the market's found a clearing place. But I'm delighted to see the 10-year back down a little bit, but I don't think it's going back to where it was. And I think that's not yet fully reflected or understood by the market.
Your next question comes from the line of John Kim from BMO Capital Markets.
I had a question on your guidance, which you maintained on same-store revenue at the midpoint. The last quarter, in an answer to your question, you guys have mentioned that the assumptions to reach midpoint would be to get blended rent in the mid-4s to 5% in the second half of the year, which you achieved in the third quarter. But since then, it has decelerated in October. So can we take from that the midpoint of your guidance is a stretch goal at this point?
John, I disagree with that articulation. I think the midpoint of guidance is right in line with where we expect to land. And so when we talked last quarter about our expectations for blended lease rate growth for the year, our expectations are the same today as they were at the end of July. And in a deck that we put out in September, we talked about our expectations for full year blended lease rate growth to be between 5.5% and 6%.
I think year-to-date through September, I think we're up 6.1% in that ballpark. So we're doing well in that regard. And then when you think about the impact of fourth quarter leasing, you just have to remember for our business, it's not that impactful because we don't have that many transactions during the quarter. Another point on guidance that I would just speak to that you didn't explicitly ask, but I think it's an area of interest relates to the implied acceleration for fourth quarter revenue relative to the third quarter.
And if you look at that, you can see that in the third quarter, our revenue growth was affected by a headwind in the form of lower occupancy. Occupancy during the quarter was 60 basis points lower than a year ago. But conversely, in October, our ADO is already 30 basis points ahead of where we were a year ago and growing. So we feel very comfortable about our guidance and we still have 2 months to go to hit it, but we view it as a likely outcome.
Okay. That's great color. Your leasing metrics and same-store revenue have been sector leading. It looks like you're on track to repeat that feet next year. This year, it hasn't translated FFO growth for various reasons, including the separation from Aimco. But next year, you do have that $0.05 headwind on nonrecurring items in FFO. Do you foresee any other headwinds to earnings that will impact your ability to match earnings with internal NOI?
John, I'll start and if Terry might want to jump in or anybody else. But you're right to call out that we do have $0.05 of nonrecurring income in our expectations for the current year. And so that's why we have pointed you and others to our run rate FFO growth, which is up at a rate that is during the quarter, up about 6%, 7%. I should do a better job of remembering my own script, but it's bailing me now. But more importantly, for next year, we're going to have a benefit of continued strong same-store NOI growth. We have the benefit from our portfolio composition changing and evolving in a higher growth rate of the AIR edge properties growing quicker. One headwind, which is apparent, if you look at our earnings supplement is that our weighted average interest cost will be higher next year than this year because of the balance sheet restructuring that I spoke about in my prepared remarks and just other changes.
And so if you look at our weighted average interest rate as of the third quarter, that should give you a pretty good proxy as to what to expect for next year with one caveat that I'd call out, and that's the $79 million of debt that's associated with our Virginia joint venture that's currently capped at 5.4%. That cap expires in January. So we'll be subject to higher rates next year on that $80 million of debt.
Just one quick follow-up. How should we be thinking about run rate FFO? Is that just FFO less onetime items? Or is it like an earn-in concept? How do we read this?
John, a run rate of FFO, we think it would be recurring normalized items that would be relatively consistent year-over-year. There's always some volatility in the year because the business changes and evolves. And so there's some volatility in nonrecurring type items. We just wanted to draw attention to what's recurring and enduring.
John, I want -- it's Terry. I want to just underline what Paul just said. The focus of AIR and the whole team here is on free cash flow and recurring free cash flow. And that's what we think is the most important driver of value. That said, the business gives rise to nonrecurring income and all cash income, even if nonrecurring is worth having. And so we're going to keep getting it and reporting it, but we're also going to keep directing to you towards the recurring free cash flow, which we think is the more fundamental.
Your next question comes from the line of Haendel St. Juste from Mizuho.
So I guess you guys touched on my -- the acceleration question in the 4Q and your response to John. So maybe, Keith, can you talk about the pricing power and expectations into next year for some of your better performing markets here? Boston [indiscernible] versus some of your weaker markets, Chile and San Fran. And where are you offering contestants in the portfolio today?
Haendel, I missed the last part. You said where my offering? What was the last question?
Are you offering contestants in the portfolio today?
Okay. Yes. So I think Haendel, the first thing is that they talk about the seasonal deceleration. And what I really want to emphasize is that we're returning back to a normal seasonal pattern. And what we're seeing -- let me point you to 2018 and 2019, which was pre-COVID. And when we look at the fourth -- the third quarter to the fourth quarter in those periods, we saw somewhere between 200 and 280 basis points of deceleration in new lease rates.
And so when we look at where we're at today, we're inside that window of a very similar deceleration that we would have seen Pre-COVID. So we've had this period of time, where going from the third quarter to the fourth quarter had, had this acceleration for a lot of different factors. But what we're seeing is much more akin to what is typical. So that's the first thing I'd point to. The second thing I'd say is, is that Paul pointed this out, which is, in the fourth quarter, we do a lot less business in our model.
The majority of our business happens between May and September, which is really our peak leasing season. That's where the majority of that activity happens and we get the best earning from that. And so the deceleration is not something that I want to have a lot of exercise around because it's really about making peak season and then building into next year. As we look into next year, I want to get ahead of myself about, who's going to do what. But one of the markets you pointed out that has been a tough one is Northern California. Listen, I think Northern California has the most on the bone to come back.
And what I'd point you to today is in Northern California for us, that's the Peninsula to be particular, San Jose and Marin County. We're at 97.7% occupied today. What that tells me is demand exists. And at some point, we're going to get that pricing power back, and we're going to earn it back in. So we'll see. I called it at the beginning of this year. I thought it was could be the winner in turn out to be true and else, but that one could be back. San Diego continues to be a great market for us.
Of course, Miami continues to be a great market for us. Philadelphia will be a tough market, I would call the first half of the year as we work through the balance of supply, but then we're going to be in blue skies and clear sailing once we get past that because that supply will be behind us. So we'll get into the more particulars, when we get to January, but that's the way I'd have you think about it.
Great. Appreciate that color. And then some question on the JV. How much capital has led to deploy there? I guess I assume that will be the first source of potential acquisitions other than maybe dispositions as you match fund. But clearly, I think where your cost of capital isn't buying back shares, it's more like that you use JVs. And then maybe on Raleigh as a market, you guys entered this quarter curious what you saw there, what kind of exposure you're looking to build there?
I would say, Handel, it's Terry. But I'm going to call on Matt O'Grady, who's our primary person responsible for the joint ventures, and then I'll call on Josh for Raleigh. So Matt?
Haendel, just on the -- our joint venture partners each have committed follow-on amounts to invest alongside us. And so those amounts are in aggregate about $600 million, $700 million. And -- but I would say that the objective is we're doing right by our partners. We'll continue to do those. And I don't think there's a meaning -- we partnered with folks with deep pockets, so we should be able to continue to draw on that in the future.
Josh?
Thank you, Terry. Raleigh has been a target market for air, and we're excited to be able to execute on multiple deals there this quarter to give us immediate scale in the market. We believe in the long-term outlook of Raleigh based on the favorable business environment, skilled labor force driven by the proximity to research universities and science of technology companies we think these factors will generate durable long-term job growth and population growth in the market.
And now, I hate to have to amend what Josh said, but in various attractive feature there, he overlook at the college basketball team. So I just [indiscernible]...
I assume you mean North Carolina?
I assume that will get worked out over the course of the season.
Your next question comes from the line of [ Robin Lu ] from Green Street.
I just want to go back on the prior question around the Bay Area. I noticed in the stop that in the 2024 table, you did actually mention that you expect sluggish leasing in peninsula and San Jose. Are you signing, do you expect it to be tougher to track I guess, new demand on new tenants are your price point? Or are you expecting broader demand softening next year in that area?
Robin, it's Keith. I would just say that, look, it's been a tough 4 years there. So it's hard to believe. But in March of this coming year, we will be in 4 years of sort of navigating the remote work and all the different types of things that happen with the technology environment there. Mostly, what I want to say is that we're cautious about it. But pointing back to the occupancy that I just had referred to, our portfolio being at 97.7% in our Bay Area portfolio rises to the point that gives me confidence that the demand continues to exist and be there. It will be really about, when we can really recapture some of the rates that have been on the table for a period of time.
That's helpful. And then just one for Josh. And then just touching on the Maryland acquisition. Given the [ price to ] is 500,000 thereabouts and the rents are a little bit higher than what is usual for the top of that market. How are you underwriting affordability? And I guess, your ability to push rent growth over the near-to-medium term.
Yes. That -- you're absolutely right. It is a higher-end property. That particular one has market-leading finishes in quality and attracts the top end of the renter base there. Affordability in the building is excellent with income to rate ratios of less than 20%, and we think that will be durable demand.
Your next question comes from the line of Michael Goldsmith from UBS.
The same-store revenue buildup for 2024 is really helpful. It seems like some of the components are probably more certain than others. So can you provide a little bit more detail into your visibility and the increase in the average daily occupancy and bad debt improving next year?
You bet, Mike. Thanks for the question. This is Paul. On the first point around our optimism around higher average daily occupancy in 2024 versus 2023. We provided a range, where we expect to do maybe 10 to 20 bps better than in 2023. A portion of that is really just due to the noise that we had during the second quarter in Los Angeles on the eviction process as we evicted those residents that had been living in our communities, but not paying rent.
And so just the elimination of that reoccurring next year gives us 10 basis points. And then on the -- on the operate at that range on the 20 basis points, that's really being driven by how we have operated this year versus 2022. So far year-to-date, we're trailing our 2022 occupancy and part of that is due to L.A., but part of it is just due to the changes in end markets. And as we're doing our budgets plan, we see the upside to do better than we did this year. And so that gets us to the high end of the range.
On bad debt, we have done well this year in bad debt. Our year-to-date bad debt on a net basis is 80 basis points of revenue. If you exclude collections from prior periods, our bad debt is 120 basis points of revenue on a gross basis. But that's still above where we've been on a pre-COVID basis, although we're getting closer in the third quarter, our bad debt on a gross basis with 80 bps and 25 of that of those basis points is just elevated due to eviction-related move-out costs and fees. So if you pull that out, our bad debt expense on a gross basis, again, is about 55 bps. And so, if we do know better than what we did in the third quarter, you would get that improvement that we are outlining in the outlook for '24.
Got it. And then my second question is on the ability to sustain and control expenses that's built into your expectations for next year, well controlled again in the third quarter here. I guess just given some of the investments you're making, like is there continued ability to keep expenses moderate over the long term? Or is this I'm just trying to understand like how much more cost savings you can kind of drive and keep it controlled or are we kind of getting to the end of that component?
Michael, it's Terry. And we're a bunch of hands go up in the room. There we have people are eager to answer that question. The short answer is, we don't know how long it will continue. 13 years has been a long time, but we see continuing opportunities to do better. And so we're not calling pause. We expect to have that kind of discipline next year, and we'll see what happens thereafter.
Good luck in the fourth quarter.
John, do we have any additional questions?
Next question is from Rich Anderson at Wedbush.
The anticipation was killing me. Quick follow-up on the topic of bad debt because it is -- it does stand out as an outlier for you guys. What about Essex said something like $120 million of rent that they have not received through the pandemic and subsequent because of delinquencies and people walking in the dark of night, perhaps growing a mustache changing their hair color and moving the Tijuana. But I'm just wondering if there is any expectation to go after those people that are no longer residents of yours? And if it's just too much work to do, you have to say, put your hands up and say we're not going to get that back? I'm just curious if there is an additive component to 2024 from those sources.
Rich, it's Keith. Thanks for the question. First, I just want to start, why I think our result is different, which is we spend a lot of time on the resident's quality. And when we look at MICO scores at 725. What that means is people live up through their obligations, and they fulfill them. And so we haven't had the experience that you just referred to with somebody else. What we have found is that we have the majority of residence, while they may have had a disruption at some point, found a way to get back on track.
As it relates to, is it worth the time I will tell you that I am personally involved with seeking out those who have done this wrong. And to the extent of actually going after them in small claims court. And one of the things that's interesting is that in California, they had lifted the actual maximum small claims amount that you could sue somebody for if it was actually related to COVID rent. And so I'll just give you a one anecdotal example is there was an individual, who had left us for about $85,000. We knew that they were somebody that actually could pay the rent. We had a proof of a guarantor that was a multimillionaire. We sued them in small claims court we won. We then pursued them and they wrote us a check for the amount of money that they owe us to make it go away.
So it's one out of a few hundred that exist that are in that kind of a situation. But I will tell you, I'll be relentless to go after people that have done is wrong. But the more important point is the majority of our residents did is right by paying as -- because we have such an emphasis on the quality of our resident.
Well, Rich, thank you. John, if we don't have another caller pending, I would like to thank everyone on the call I can't think of a better note to end on the Keith's emphasis on our customer selection. And for many of you, I look forward to being together in Los Angeles in a couple of weeks. Thank you so much. Have a great weekend.
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