Apartment Income REIT Corp
NYSE:AIRC
Earnings Call Analysis
Q4-2023 Analysis
Apartment Income REIT Corp
Good morning. Amid the shaking markets, AIR's leadership has recalibrated their strategy, emphasizing transparency and long-term shareholder value. They are implementing accretive property upgrades to improve their portfolio quality. Though this means higher expected interest expenses by approximately $11 million due to increased borrowings and refinancing activities, they assert this cost as the price for faster cash flow growth expected in 2025 and beyond. The company anticipates a robust 2024 revenue growth of 3.8%, based on strong 2023 leasing activity, a blend of occupancy growth, and community upgrades, with promising signs already seen in early 2024.
In 2023, AIR enjoyed operational success, reflected by a revenue increase of 6.2% year-over-year. Occupancy surged to 97.3% while net operating income grew by 8.1%. This performance was attributed to the 'AIR Edge,' a strategy yielding superior results with expense growth being exceptionally controlled and below market trends. The company achieved the year’s highest operating margin of 76.7%, showcasing efficient portfolio management that yielded significantly higher revenue and declining controllable expenses in recently acquired portfolios.
AIR foresees positive growth in all markets for 2024, with South Florida, Austin, Washington D.C., and San Diego pegged as top performers. The Bay Area, however, lags in revenue growth, though recuperation is hoped for. In pursuit of portfolio quality, AIR acquired properties across strategic locales and sold non-core assets, focusing on value generation and capital reallocation to AIR Edge assets, expecting to enhance returns through strategic acquisitions and joint ventures.
With an investment-grade, low-leverage balance sheet, AIR maintains substantial liquidity, readying nearly $2 billion to cover maturing debts through 2027. The company has a history of strategic share repurchases, realigning capital to buy back shares when they trade below Net Asset Value (NAV), bolstered by a new $500 million Board authorization to further buybacks if deemed accretive.
Pro forma Funds From Operations (FFO) for 2023 hit the midpoint of guidance at $2.41 per share. Looking at 2024, AIR forecasts an increase in run rate FFO to $2.38 per share, while run rate Adjusted Funds From Operations (AFFO) is projected at $2.12 per share. These predictions account for a 3.8% growth in revenue and expenses; the latter figure considers some higher operating expenses partially offset by consumer price trends. Although real estate taxes are expected to surge by 5-8%, AIR is actively appealing all assessments. Despite an approximate 30% hike in insurance costs in 2023, a lower rate of increase is hoped for in 2024. Through careful financial planning, the company is managing potential increases in interest expenses and inflationary pressures.
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Welcome, and thank you for attending today's AIR Communities Third Quarter 2023 Earnings Conference Call. My name is [ Tridhi ], 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, and good day. 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 our 2024 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 and AFFO. 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. Comments 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 Q&A session, which will follow our prepared remarks.
I will now turn the call to Terry Considine. Terry?
Good morning. And thank you, Lisa, and all of you on this call. I read the first takes this morning and last night and set aside my prepared remarks to address what I understand to be on your minds. There's considerable consensus on AIR's good operations. There's confusion about $0.07 of the increase in 2024 expected interest expense. $0.04 was the result of the third quarter refinancing fully disclosed in our third quarter report.
It reflects the acceleration by a year or so of the difference between legacy interest rates and then current market rates. This will occur in every REIT balance sheet as debts reprice. $0.01 reflects the impact of fourth quarter share repurchases funded by borrowing at a somewhat higher interest rate than in the third quarter and was considered in our underwriting. $0.02 reflects a $50 million increase in expected 2024 borrowings to fund accretive property upgrades.
We have underwritten past and future investments at substantial accretive spreads to our cost of capital. The higher interest expense in 2024 is the price paid for a higher quality portfolio with faster free cash flow growth in '24, but more importantly, in 2025 and later. There is some suggestion that leverage increases variability and lower leverage would reduce same.
Financial leverage does introduce exposure to changing interest rates. This was especially pronounced last year, when for example, the 10-year fluctuated from 3.25% to 5% and back to 4%. With even the highest rates are well below the returns on AIR investment. The bigger point is the use of the borrowed proceeds to upgrade the AIR portfolio and create shareholder value. We are focused on the long-term values of a better portfolio with higher earning power and look past the short-term noise of interest rate changes.
Any discussion of leverage needs to consider risk. AIR leverage at 30% loan to value, to stabilize properties is safe. Comparison to others needs to consider the stability of stabilized properties as owned by AIR with the risk of other business models with development risk, the implicit financial leverage of unfunded completion costs and the risk of second mortgage lending where the much higher leverage from senior debt is off balance sheet, but remains real. There were some concerns about paired trades with minor year 1 FFO and free cash flow impacts.
To state the concern is to answer it. We're comfortable with the relatively minor year 1 noise, if we see considerable long-term value creation. We are confident that 2023's paired trades will outearn their cost of capital. There were some similar concerns about the complexity of joint ventures. The complexity is addressed by transparency, as, for example, shown in Schedule IIb, which provides a clear path from gap to economics.
It fails to consider the benefits to shareholders, which we saw in 2023 and anticipated 2024, including the opportunity to upgrade our portfolio by the sale of partial interest in an otherwise a liquid market and the opportunity to reinvest the proceeds in other properties, often at discounts to their construction costs with higher free cash flow growth rates, all while others are sidelined.
The long-term benefits to portfolio construction are real and predictable. The creation of additional service income lowers AIR's already low G&A. A corollary benefit to stock investors might be the reassurance that the most sophisticated global real estate investors chose and choose to co-invest alongside AIR. There was some discussion of nonrecurring income. It's just that nonrecurring, is cash and needs to be reported. It was exaggerated in 2022 when we accelerated the termination of continuing agreements between AIR and Aimco, declined considerably in 2023. AIR's focus on long-term free cash flow will naturally reduce nonrecurring income. But when it's available, shareholders will be better off if we take it, disclosing as we do, that it's nonrecurring.
Finally, forecast for 2024 are just that forecast. AIR has taken a conservative view to guidance of 2024 market rental rate growth. We also provided a range of guidance that shows a possible and substantial upside. Time will tell where results land. I encourage you to keep score at the end of the year, not at its beginning.
My bottom line. Given the consensus on the performance of AIR operations and the continuing increases in the quality of the AIR portfolio and its growth rate, it seems likely that AIR shareholders at herein will own an enterprise whose value will have increased considerably.
Given that our diversified portfolio is largely insulated from today's surge in new supply, I expect that our results will compare favorably to ours in 2023 and appears in 2024. The expected value creation will be the work of a stable and cohesive team and the advice and oversight of engaged Board of Directors. I thank both for their friendship and help.
With that, I'd like to turn the call to Keith Kimmel. Keith?
Thanks, Terry, I'm pleased to report we wrapped up with good 2023 with a solid fourth quarter. More importantly, AIR is well positioned to begin 2024, and what we see as another good year ahead. Fourth quarter results met our expectations and were reflective of typical seasonality.
AIR continues to benefit from Josh's good work, building a portfolio with broad diversification of markets and limited exposure to new supply. Revenue was up 6.2% with occupancy of 97.3%, up 200 basis points from the third quarter, signed new leases were down 1.1% from the prior lease as we push to build occupancy and pricing power.
Renewals were up 4.7%. Expenses increased 30 basis points and net operating income increased 8.1%. The AIR Edge continues to drive outperformance. With full year controllable operating expenses up only 20 basis points, in part due to AIR's best ever retention of 62.3%.
AIR's operating margin also reached an all-time high, up 76.7% up 130 basis points from the fourth quarter of 2022. The AIR Edge also generates above-market performance in our acquisition portfolio. In the fourth quarter, our classes of 2021 and 2022 and net operating income growth, 300 basis points better than our same-store portfolio. And in particular, benefited from the efficiencies of AIR's operating model and technology stack with expenses down 4.5% from last year.
Our class of 2021 now owned for just over 2 years and has undergone a remarkable transformation. Compared to the fourth quarter of 2021, revenue was up 25%. Controllable expenses have decreased 21%. Net operating income is up 34%. Margins at these communities have expanded over 500 basis points from 68.6% at acquisition to 73.8% today.
Our class of 2022 acquisitions now entering same-store are expected to have net operating income growth this year, approximately twice that of the balance of the portfolio. At Southgate, owned now for 1 year, the rent roll has increased 14% from day 1 and we've had net operating income growth of 23% from the seller's prior year. The combination of above-market revenue growth and predictable expense savings from the AIR platform creates a reliable engine for repeatable growth.
January results have strengthened from the fourth quarter and we are well positioned to start the year. Occupancy continues to be strong at 97.7%. Our high occupancy brings pricing power with new leases up 1.8%, renewals up 5.6% and signed blended lease-to-lease of 3.8%. Asking rents have increased 80 basis points year-to-date and leasing volume has grown sequentially each week as we see the first green shoots of the spring leasing season. We anticipate the balance of 2024 will reflect a typical pre-pandemic year with strong demand, supply pressures, but only in pockets, waning inflation and a premium placed on sales and operational excellence.
Our anticipated 2024 revenue growth of 3.8% is based on 2.4% of earn-in from our 2023 leasing activity and current pricing, 40 basis points of growth in occupancy, 10 basis points improvement from bad debt, 50 basis points contribution from community upgrades and [ asking ] rates they grow another 1% between now and peak season, resulting in a blended lease-to-lease of 3.5% in 2024.
We anticipate positive growth across all markets with the South Florida, Austin, Washington D.C. and San Diego expected to be our strongest markets, while the Bay Area continues to lag in revenue growth, though we remain optimistic for a strong recovery.
My thanks to all our team members for a great year. Your dedication to serving our residents, innovative approach to our business, and consistent drive for results made 2023 one of AIR's best years. I look forward to the year ahead.
I'll now turn the call over to Joshua Minix, our Chief Investment Officer, Josh?
Thank you, Keith. In 2023, we grew our AIR Edge portfolio with 4 acquisitions, 1 located in Miami Beach, Florida, 1 in Bethesda, Maryland and 2 in Raleigh-Durham, North Carolina, where we added a third this year. The acquisitions were funded in a leverage-neutral manner by 2 new joint ventures, the 2023 sale of our last New York City properties, the issuance of both operating partnership units and the assumption of below-market fixed rate debt.
We did not have any transaction closings in the fourth quarter that we remain focused on improving the portfolio and expanding our AIR Edge allocation. In 2023, the acquisition classes of '21 and '22 were 13% of our portfolio and accounted for 22% of our growth. The '23 and '24 acquisitions expand our AIR Edge allocation to 20% of the portfolio, which bodes well for future portfolio NOI growth.
In 2024, we continue our work to improve the portfolio quality and growth through transaction activity that allocates capital to AIR Edge properties. The class of '22 joins the same store for '24. We expect to execute transactions in '24 to replace and expand that AIR Edge allocation. We are off to a great start in close Sunnybrook in Raleigh, North Carolina this quarter.
To fund these acquisitions, we expect to sell property either outright or in JVs to maintain a leverage-neutral position. Our investment philosophy remains the same. We focus on generating a positive spread to our cost of capital and on improving portfolio quality, leveraging our great advantage created by Keith and his team to apply the AIR Edge to generate outsized returns as newly acquired assets benefit from his expertise.
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 strong and flexible balance sheet, full year 2023 results, our expectations for 2024 and conclude with a brief comment on our dividend. The AIR balance sheet is well positioned. It is investment grade, long in duration, fixed rate, 2/3 nonrecourse, and about 30% loan to value, low leverage when you consider our business is focused on stabilized properties and has no exposure to new construction or mezzanine loans or short-term rentals. We have abundant liquidity with just under $2 billion available, sufficient to refinance substantially all maturing debt through 2027. Fourth quarter leveraged EBITDA was 1/10 of a turn above our expectations, a result of opportunistic fourth quarter share repurchases. I was comfortable ending the year about $45 million above our leverage expectation due to the strength of the balance sheet, anticipated 2024 EBITDA growth that absent changes in leverage is anticipated to be sufficient to reduce leverage by 1/2 a turn and the accretive use of proceeds. The share repurchases are part of a balanced capital allocation program. In the past 2 years, we have used approximately 25% of our available capital to repurchase 8% of the company at a discount to NAV. To the extent AIR shares continue to trade at a significant discount in NAV, we anticipate that we will continue to allocate a portion of any proceeds raised to repurchase additional shares in a leverage-neutral manner. To support us in this activity our Board of Directors granted a new $500 million authorization. As we look to grow the company, we have excellent access to dry powder to fund future acquisitions through our Evergreen joint ventures with 2 large global investors. Turning to full year results. Pro forma FFO equaled the midpoint of guidance at $2.41 per share. Run rate FFO, which excludes costs or income that are not anticipated to recur in future periods was $2.36 per share, equal to the midpoint of our expectations and up 7.8% from 2022 and up 20% cumulatively since 2021. Run rate AFFO was $2.09 per share, up 7.7% from 2022 and up 23% cumulatively since 2021. Looking forward, we anticipate that free cash flow and AFFO will grow at a faster rate than NOI and run rate FFO respectively. As we look forward to 2024, we expect 2024 run rate AFFO per share at the midpoint will be $2.12, up 1.4% from 2023. We expect run rate FFO to be $2.38, up 80 basis points from '23. We expect this growth at the midpoint to be the result of $0.11 per share of incremental contribution from the same-store portfolio driven by NOI growth of 3.8%, result of 3.8% revenue growth previously discussed by Keith. Expense growth of 3.8% comprised of controllable operating expense growth of approximately 120 basis points, elevated above AIR's 13-year trend of negative growth but about half of the expected CPI. Real estate taxes are expected to increase between 5% and 8%. 2024 is a particularly difficult year to forecast with 2 contrasting forces at play. Real Estate values declined by approximately 30% during the past 2 years, a result of rising interest rates. While this provides a positive argument when challenging assessments, it is mitigated by continued healthy NOI growth. While the exact growth rate is subject to some uncertainty, I do know for certain that we'll be very active in appealing all assessments. Insurance expenses are also difficult to predict. Despite minimal losses being tendered to our carriers during the past decade, our property and casualty insurance costs for like properties increased by approximately 30% in 2023. In 2024, I anticipate a significantly lower rate of growth, the amount of which I'll be able to address more specifically after our March 1 renewal.
Outside of our same-store portfolio, we anticipate 2023 paired trades to result in a $0.01 of NOI dilution, but be $0.01 accretive to free cash flow. Please don't, this calculation compares to the NOI loss from properties sold in 2023, to the properties acquired with their proceeds, including the January acquisition of Sunnybrook. It also includes the benefit from share repurchases. The paired trades are anticipated to be accretive to NOI later this year.
We also anticipate interest expense to increase by $0.07 or approximately $11 million year-over-year. I understand that the increase in interest expense was little more confusing than I anticipated, so let me spend a moment diving into the details. $0.04 of the increase is due to higher weighted average interest rates. In 2023, our weighted average interest cost increased from approximately 4.1% at the beginning of the year to 4.3% at the end of the year. As a result, and all else held equal, the effective interest rates are expected to be 21 basis points higher than 2024. The increase was a result of our third quarter refinancing activity, which extended duration but marked our debt to current rates of market interest, accelerating interest expense that would have otherwise occurred in future periods. Economically, the acceleration either harmed nor benefited AIR as the swap acceleration income which is excluded from run rate FFO offsets the higher interest cost. In order to appropriately reflect 2023 interest expense, we bifurcated the swap acceleration income including the amounts that were attributable to 2023, which we include as an offset to '23 interest expense and allocated the remainder of the swap income, which was otherwise to be earned in 2024 and 2025 through other income and therefore, excluded from run rate FFO. The result was to lower fourth quarter interest expense by $2.3 million. For those of you that are annualizing our fourth quarter interest expense as a proxy for 2024 interest expense, you would need to increase our reported $33 million by the $2.3 million. This results in an annualized expense of $141.2 million.
There are then 2 other adjustments necessary to fourth quarter interest expense to arrive at $147 million guide for '24. First, our average effective interest rate increased by 5 basis points during the fourth quarter due to the changes in the mix of our debt driven by increased levels of borrowings. Applying this increase to our 12/31 debt balance, increases 2024 interest expense by additional $1.6 million or $0.01. Second, we anticipate $50 million of incremental borrowings to fund property upgrades and other improvements whose ROI is included in our guidance. In impact to interest expense after consideration of any capitalized interest is approximately $3 million or $0.02.
Few other quick notes on guidance. First, run rate FFO at the midpoint of $2.38 per share is $0.02 above the 2023 run rate FFO of $0.03 per share below our 2023 pro forma results, which included $0.05 of net earnings that are anticipated to be nonrecurring.
Second, third-party service income is anticipated to be about $0.11 per share, 6 of which is anticipated to be earned through the execution of our currently in-place property and asset management agreements. The remaining $0.05 will be earned from short duration service income, an amount that is similar to that achieved in 2022 and 2023.
Third, as our guidance indicates, we anticipate being active in the transaction market through paired trades and in partnership with our joint venture partners. However, given our synergies surrounding the cost of capital, volume of transactions, operating plans and timing, we're not providing additional guidance on the impact of these activities to 2024 results.
Fourth, quarterly leveraged EBITDA will likely fluctuate during the year based on the timing of transactions and changes in EBITDA that is anticipated in 2024 at approximately 6:1. Finally, the AIR Board of Directors declared a quarterly cash dividend of $0.45 per share. On an annualized basis, the dividend reflects a yield total of 5.7% based on the current share price. With that, we will now open the call for questions. Please limit your questions to 2 [indiscernible]
Operator, I'll turn it over to you for the first question.
[Operator Instructions] And your first question comes from the line of Eric Wolfe from Citi.
You mentioned that the $0.04 increase was due to your 3Q refinancing activity. I was just wondering if you could give sort of more detail on exactly what that was? What were the amounts? Where did the rates go to and from? And just kind of like how you get to that sort of $6 million extra increase in interest expense. I'm just backing to that from the $0.04.
Yes, Eric, this is Paul. And there'll be 2 ways I'd direct you to, to look at that. As the first, and probably the quickest and easiest way would be to compare the weighted average interest rate as disclosed in Schedule 5 for the first and second quarters to our weighted average interest rate in the fourth quarter. If you do that, you'll see an increase of about 20 basis points. If you apply that 20 basis points to our debt balance at year-end, you get about $6.5 million to $7 million. And that's the $0.04.
Sure. I guess I'm asking, but what drove that increase. Meaning like what drove the 20 basis increase. It sounds like it's something you did in the third quarter. So what was it in the third quarter that drove that 20 basis point increase.
Yes. There were 2 items. We refinance to extend duration of $325 million of term loans that were otherwise coming due in 2024 and 2025 before consideration of extension options and refinanced that $325 million with 5-year and 7-year debt that had an average interest rate of about 5.5%, 5.4%. The effective rate on that debt previously was about 4%, 4.1%.
The second thing we did in one of our joint venture transactions, our joint venture partner, assumed debt and so that reduced -- that was at a lower-than-market rate of interest, which we were paid for in the transaction. But if you just focus solely on the impact to average interest rates, the result of removing that lower cost debt inflated the balance of the portfolio.
Okay. And then just last question. Your 1Q guidance bridge didn't show sort of any impact from the higher interest expense. Now is this something that ends up kicking in later in the year, second quarter through the fourth quarter? Just trying to understand because it seems like there's -- I understand the offsetting adjustment you made in 2023, but I would think that it would just go to a more normal level in the first quarter of 2024.
Eric, that's a good question. The reason you don't see it top in our bridge walking 4Q results to the first quarter results is that you probably noted in the Supplemental Schedule 5, we talked about fixing our interest rates on our revolver and also adjusting our hedges to better match the maturities of our term loans. And the net effect of that was to give us a little bit of a pop of about $0.01, $0.015 or so in the first quarter. So that's why we're consistent on a 4Q versus 1Q basis, and you'll see the increase then in Q2 and beyond.
And your next question comes from the line of John Kim from BMO Capital Markets.
One of the takeaways from last quarter was the recent acquisitions that you've had, once it's on your platform, it would be growing significantly faster than the rest of your same-store pool. So I wanted to focus on your class of 2022 portfolio as well as other real estate. The class of 2022, the growth slowed considerably since the last quarter. I realize that some -- it's only 4 assets. There's probably some volatility in that, but -- can you just comment on that slowdown and what you're expecting for the remainder of the year?
John, I'll start and see if Keith wants to add anything. Specifically on Class of '22, what you're seeing is the impact of a tax revaluation that was -- that occurred in the fourth quarter of 2023. And so that's, that incremental tax expense is what's driving the slowdown in NOI growth. Keith, anything you'd add on the revenue side.
I think the other thing that I would just point to, John, is that -- we basically -- we can see that the NOI growth of the Class of '22 is going to be about double that what we're seeing in our same-store portfolio as we look forward. So it's a combination of things in the early days of that transition, we are repopulating our residents in some degree, repositioning how we staff the communities, and a whole series of different things that we go through. And there could be some volatility in those early parts of the year or for about a year or so, and then we start getting into the stabilization of the AIR Edge taking hold.
And can you remind us what's in the other real estate bucket at those 4 assets? And if you see double-digit growth from this group.
John, the 4 assets that are included on the real estate are the 4 properties that we held a leasehold interest in it, the separation from Aimco and Aimco completed their redevelopment and upon completion of that redevelopment work, we bought out the value of the improvements. And so that occurred in the summer of 2022. And so that those assets will be included in our same-store pool in 2024. As far as the expected growth rate relative to the same-store population as a whole, we'd anticipate growth rate in that portfolio to be fairly similar to the legacy same-store population because Keith and his great team were involved with the lease-up and have been operating those properties from day 1.
Okay. Great. My second question is on -- is for Terry. On your opening remarks, you mentioned that you're confident this year AIR will be performing favorably versus your peers. And I just wanted to clarify how you perform? How you define that.
Well, thank you very much. That is a very good question, John. It's what I would have addressed in my prepared remarks, which is to look at the big picture, that the most important things that are happening at AIR are the increased quality of the portfolio, higher average rents, faster growth rates, higher margins, higher credit customers, greater retention, bigger margins, so forth. And off-balance sheet asset, of course, is a stable and productive workforce. So those are things that, when we look back at the end of 2024, will show up in free cash flow growth and it'll show up in 2025 FFO and AFFO at a greater degree. In 2022, we had considerable nonrecurring income because of the acceleration of the divorce from Aimco. But we called it out, so the market would see it, and focus on the recurring number, which continues to grow comfortably. I think everything we see is that growth continues. I want to emphasize one thing that, again, gets to be lost. In 2023, the real estate markets were largely paralyzed by -- with low volume and transactions because of the standoff in pricing between providers of capital and users of capital. We were very successful in using the kindness of our joint venture partners to participate, to buy properties at considerable discounts that are going to reward us in the future. And we were able to do that also in a way that increased our scale, our assets under management. So our net effective G&A, which is already low, gets lower still. So I just think when we focus on the use of proceeds and not just the cost of proceeds, we're going to be satisfied with the outcome.
I think you mentioned FFO was part of that. Just wanted to clarify.
I think FFO and I, of course, would direct people also to AFFO. I think it's important to consider both and net asset values, which discount growth rates. I think the [indiscernible] will measure the value of the enterprise, which I predict will be significantly higher both than it is today, and we'll have a rate of growth in '24 that will compare very favorably to our peers who are wonderful companies but face different challenges and have different exposures to new supply, have different exposures to foreclosures in their mezzanine loan portfolios, different exposures to development and other such activities. And I think net-net, we're going to do fine.
And your next question comes from the line of Rob Stevenson from Janney.
I guess just piggybacking off of your comments there, Terry, in terms of difference between you and peers. Can you talk about what your systems are telling you in terms of new lease rent growth goes from here. You were negative for a very short period of time and by a much smaller magnitude than almost all of your peers and now it's positive on signed leases in January. Are you going to be able to stay positive on new lease rates in first quarter? And does it turn back negative at any point in '24, given what you're seeing today?
Rob, thanks. Look, we're feeling very optimistic as we go into the year, as you point out here, and it's not just optimism. The facts are our occupancy today at 97.7% is setting us up for a strong acceleration into spring season. The 18, look, implied in our 3.5% blend that would get us to our 3.8 revenue guidance. It puts a 2% new lease and a 5% renewal. So that's essentially what we have in. We have a 1% market growth from today into, call it, July is when we get into peak season and we're already starting to realize that today, so -- but what will happen next, I will say this will be more important being known probably in April but we're already seeing volumes that are increasing coming out of the holidays and the winter months. And what we're seeing is more of a pre-pandemic kind of acceleration. When we look back, let's call it, between 2014 and 2019, prior to the pandemic. This is the type of acceleration we would have seen. And so more work to be done, but we're feeling good about where we're at.
Okay. That's helpful. And then, Paul, has your Southern California portfolio had any material damage from the recent extreme weather and are your California assets specifically insured for flood? Or is that something that if it incurred would be self-insured.
Rob, I'll handle the first part of the question and turn it over to Patti Shwayder, who runs our insurance program to dive into some of the particular details. As far as any material damage, no, nothing material. We have seen what you would expect, leaky roofs in spots, some water intrusion, but the costs of which are less than $0.5 million based upon what we know today.
And yes, we're insured for flood and all other perils in these properties, in around the country.
And your next question comes from the line of Haendel St. Juste from Mizuho.
Terry, I think you mentioned earlier that you don't have plans at the current moment to transact, but that you're certainly in a position to be able to. So I'm curious what your seeing out there today in terms of cap rate IRRs and maybe where they need to be for you to get more active? And where potentially could we see you get more active coastal, Sunbelt, any particular market you'd like to highlight?
Thank you very much. I think that -- I like very much talking about the opportunities we see today and you're pointing to something that is very real. That benefit to people who have access to capital and can make it worth more is what we have at a time when sellers have few alternatives. For specific details, I'd like to turn it over to Josh because he's nodding his head and eager to go and tell you what he's seeing out there. Josh?
Yes. Thank you, Terry. Thank you, Haendel. We're very active in the market in terms of stocking with potential sellers and evaluating opportunities in our markets. We are seeing a pickup in likely transaction activities measured by good chatter among sellers and broker listings as a proxy for what we might see in our typical off-market approaches to transactions. In terms of returns, I think we're still seeing something of a bit of spread. Most sellers are shooting for a low 5 cap rate, and most buyers are shooting for a high 5 to 6. We certainly would want to be at the very top end of the returns, and we'll be focused on establishing our cost of capital and then executing transactions where we have the opportunity to both improve our portfolio quality by buying assets with the opportunity to apply to AIR Edge and generate that outsized growth rate and ultimately generate a spread of 200 basis points or more to our cost of capital.
Got it. Got it. Keith, I guess maybe one for you. I think you outlined, I think, in the guide market rate growth for this year, effectively flat, I think, with renewals kind of in that plus 5%. I'm curious if you're concerned at all about kind of creating a game to lease situation for the portfolio next year and how that might impact your ability to push renewals next year?
So Haendel, just for clarification, we have 1% market growth between now and peak season that's implied in the guidance. So just -- we do see -- we have some optimism that we will start seeing that, and it could be better or worse than that. But at the end of the day, we're seeing it already in our January numbers. . I don't have any particular concern about a gain to lease condition. I know that to be clear about that, I always get a little bit off put around those terminologies because there are points in time. And so if we rent 10 apartments today, that will change up and down loss, deletes our gain to leases. And really, the -- where I'd point your attention to is the 2.4% earn-in and more importantly, the 3.5% blend that we have in our plan that would put us through 2024. All those things become realities, which we anticipate, that will then have earned -- with those -- and into '25 and beyond.
Got it. Got it, okay. And then lastly, I'm not sure if you outlined it. Expectations for turnover this year, how that's reflected in the guide. And I think you mentioned the bad debt improvement, not sure what the number is, but maybe talk about how that plays into your outlook for the expenses as well.
Haendel, this is Paul. I'll start with bad debt. In bad debt, we've actually had a very good track record coming out of the pandemic. If I go back to 2021, I think our bad debt as a percent of revenues was 1.6%. In 2022, it improved to 1%. And then in 2023, it improved to 60 basis points. So we do expect continued improvement in 2024. I don't think we can bank on another 40 bps improvement. But as Keith mentioned in his remarks, we expect about a 10 basis point improvement.
Haendel, I'll just add a couple of pieces. First off, I'll add a couple of things from inside on the bad debt. And then the second piece, I'll circle back to your question about retention. I think one of the things that is being unique characteristic in our bad debt is just sort of our process. And some of the emphasis we put around our resident selection process and those folks that we went to that are not short-term renters, but more importantly, people that stay with us over long periods of time.
This will get a dovetail right into your question about retention. But through that process of the resident selection and then secondarily, is that we collect our rent centrally. And so I don't know if that's something we've talked about before. But here in Denver, we have a centralized rent collection team. And for a person that over multiple decades has done this work, typically, it had -- if you had 100 [ bill of lease ], you might have 100 community managers collecting rent and you're trying to manage all of them and coach them up and figure out who's doing what and what would we have here is about 10 individuals, they're just experts, professionals doing this.
And so when you look at how this bad debt number has improved as Paul just went through the walk up at 1.6% to 1% to 60 bps and where we get to '24, there's a lot of very specific things we do. The one sort of flying the [ abatement ], I would tell you in bad debt is, is that courts have been a little bit slower coming out of the pandemic. So we'll see how that plays out in the future, but we're optimistic about our process. Going to the retention, what we have implied in our guidance of the 38 is essentially more of the same. I just reported that we were at 62.3%, which would be our best number that we've ever marked. We would anticipate something similar, if not better. And when I say, if not better, every single day, we have a very strong emphasis around longer-staying residents, less turnover, avoiding costs and creating total contribution to the bottom line.
Haendel, if I could join in, it's Terry. A part -- I just want to emphasize 2 points. Part of it that Keith touched on is the creditworthiness of our customer. And so we're just less exposed to bad debt because we have people who have a track record of paying their bills. The second is I want to throw a bouquet to Paul. Because we did not make accruals based on optimism during the pandemic. We were very disciplined in our accounting and so we don't have to reverse those accruals. We don't -- we're operating where anything -- any news is basically good news. And so our bad debt for the fourth quarter was all flat, 0. So net-net of those recoveries, then we're not going to say its 0 for the year. I'm not trying to say that. But I just want to point out 2 things that you can use in thinking about the future. One is that the AIR customer is much less likely to have bad debt. And second, the AIR accounting is much more likely to be connected to cash.
And your next question comes from the line of Rich Anderson from Wedbush.
So I can't help, but I'm a cynic, right? 2.4% earn-in is way above your peers, 2% new lease growth is above your peers. These are all really good operators of multifamily real estate. And so I need to be a believer here, but -- is it -- is there an element of luck and I don't mean that in a derogatory way. But supply is on everybody's mind, of course, particularly in the Sun Belt. Are you finding yourselves just not positioned in a place where others are getting a lot of headwinds from new supply.
What -- besides the fact that you're good at your job and all that sort of stuff, what is causing sort of this outsized level of relative growth for you guys relative to everybody else from a same-store perspective?
Rich, as usual, my dear friend, you've got great questions. And I look forward to the headline you'd attach to it. But it's really 2 things. There are really 2 and they're very different, and -- but they're measurable and you can call them out.
The first one is operations. We have a customer that, as I just said, has better credit, so it's more likely to behave the way we expect, more likely to be a good neighbor to the other residents. We have -- as a result, we do more of our business at higher renewal pricing and less of our business at lower new lease pricing. And that's just -- those are structural advantages. We have a record of cost control that is superior, and we give great credit for that to Keith.
But I just have to say that, that's Keith and Matt Holmes, who's here in the room and hundreds of teammates around the country that have done a really good job and are highly productive and highly stable. So one of the most important metrics about operations is the turnover of our teammates and what you see is high tenant -- high teammate engagement and stickiness and stability. They're well compensated. They've good great job satisfaction, and they do a better job than the peers. So that's one. The second one, which goes with it is portfolio composition. That is intentional, but it's also a very difficult exercise because we're subject to political wins and economic changes that go back and forth. And at times when a concentration pays off, you'll see that in the outperformance of investor in California concentrated there did great for 10 or 15 years, [ levered by top 13 ]. That was a terrific moment. You can see concentrated investors in Sun Belt markets did great during the pandemic. When you had this influx of in migration.
We're more of the Steady Eddie. We want to avoid -- we'd love to have those benefits to say that, but we want to be balanced against those risks. And so we've made independent decisions. We made decisions about Florida that were different than peers, made decisions about Philadelphia that were different than peers. They both have pluses or minuses, but that's part of a differentiation which provides -- which results from diversification, which ends up with lower risk. And so that's how we get there.
All right. Second question is entirely unrelated, but on run rate FFO is there -- I need another FFO definition like a hole in the head, and thinking -- speaking to a lot of people. Why didn't you just put this swap gain in core FFO and then there would have been a lot less misunderstanding about how people were growing 2024. Is there a structural reason why you didn't just handle it that way? And two, can we get rid of run rate FFO for now in 2024, since it's the same thing as core FFO. It's a little self-serving, but I'd love to hear your comments about those too.
Rich, I think AIR culture and certainly, my values are to be completely transparent. To the best I can let you know what I know. And what we wanted to communicate, it was run rate FFO, which was originated following the Aimco separation in '22 -- not -- that's the original one in 2020, was that a lot of the income that we -- real income, cash money that we were receiving in '22 was a onetime event.
We need -- we just -- we wanted to ask the market to take the burden of a third definition of profitability, but to see that one part is recurring, one part isn't. We did it again last year with a lesser concern, but we had these -- the swaps that had been accelerated. And we didn't want to either confuse the market or had let the market confused of thinking we were confused, but we knew these were nonrecurring. We're going to call them out. And so we are completely transparent in what we do. And I think sometimes people aren't used to that and just find the volatility of life upsetting. But that's why we do that. I think in 2024, you're right, it's increasingly likely that we won't have that exposure, but we will have nonrecurring income and expenses that are unpredictable every year. Hopefully, they won't be as material.
[Operator Instructions] Your next question comes from the line of John Pawlowski from Green Street Advisors.
Josh, I have 2 questions on recent acquisitions in the last few quarters, just so I understand the underwriting process. One, the Raleigh market, I think is expecting high single-digit per annum supply growth this year and next year. So it feels like rents are going to be more likely down than up. So how do you get comfortable pushing chips in Raleigh?
Second question would be on the Bethesda acquisition. Several months ago, $550,000 per door, $3,600 rents, it's really, really high. And so how do you get comfortable pushing rents over a longer period of time to get to these double-digit IRRs you're sitting?
Thank you, John. Both really good questions. Taking them in order. With Raleigh, this has been a long-term plan for us and part of our intentional portfolio diversification strategy. We're attractive to the market for all the reasons that are probably obvious. The favorable rule of law there. And we love to have a balance of factors across the portfolio, taking a long-term outlook and looking at discounts to replacement cost.
We did underwrite the supply. That's not a secret to anyone, and we're well aware. We think this timing was a particular time where the buyers were all underwriting the supply. And we had the opportunity to purchase on income that took that into account and allow us to get an unusually attractive basis that we think will age quite well as we work in those properties. And we're benefited greatly by Keith, in AIR Edge, which will generate internal growth with those properties, not relying on the market to generate the returns, but really relying on the execution to generate the returns. Following up on Bethesda, the purchases beyond there, we're very excited about. It is an expensive building to buy and an extensive building to live at. It's also the highest quality building that I'm aware of in the greater D.C. Metro. And we bought it under both development and replacement costs and believe that, that will be a long-term asset with a strategic advantage in the space.
And I'll just add, if I might, John, add to Josh's comments. Just as to Raleigh, don't miss the cost basis of buying at a discount to replacement. And as to Bethesda, we've had a show and tell on this SEC filing, which we'll walk through in great detail, show you exactly how we underwrote it.
Okay. Maybe one follow-up on the Raleigh. So what's the exit cap rate [ assumption], long-term NOI growth assumption, however you want to frame it, to get from a mid-5% cap rate in a market where rents are going to be stagnant to over a 10% IRR. It seems like a massive pickup.
Yes. No, really good question. It is a massive pickup, and that's driven by Keith and his team, not by just riding the market wave. So we're really looking at the nuances of the property, taking the in-place cap rate and then we're looking at what happens when Keith operates, it is at its usual level of efficiency. And that provides a significant increase in the yield. And you've seen that in our previous acquisition portfolios where we have roughly double the same-store growth. And we expect that here.
And that isn't market-driven growth. That's AIR and Keith driven growth. So that's the biggest driver. In terms of exit cap rates, we're generally exiting roughly where cap rates are today. So we're not counting -- we're not assuming the cap rates compress over time.
Okay. One more, Terry, on the balance sheet. So I know when you initially did the spin, you had a mid-5x leverage target. And there's been some good resistance around the 6x mark last few years. I'm not worried about balance sheet risk, but there is a missed opportunities, inability to play offense, if opportunities come up. So I guess what I struggle with is, not ripping off the Band-Aid and getting to lower leverage because it has prompted you guys scrambling a little bit to all this derivative activity to fix the debt.
And so why not keep life maybe old fashioned? Well, why not keep life much simpler and just reduce the absolute level of leverage versus having to go out and do all this derivative activity to fix the debt. Any comments there would be really appreciated.
Sure, John. I mean, first, as you know, our debt is -- much of it -- 2/3 or more is nonrecourse. And one of my favorite analysts gives us a 10% discount in the burden of that debt just for that put. . Second, that the question of having an opportunity is a good thing, but it's a good thing when you use it. Having it by itself is sterile. So the time to use it is when there's blood in the streets, when prices are low. And so waiting to do this at another time, when everything is harmonious is to say, to miss the opportunity. So the -- we embrace the opportunity to buy now. And the fact that we've been able to do that and stay within low leverage by certainly by comparison to the asset class and I think compared to our business model is something that can take advantage of what's a structural advantage for apartments generally is something that we're paid to do because it creates value for shareholders.
And there are no further questions at this time. I would like to turn it back to Terry Considine, CEO, for closing remarks.
Well, thank you very much, and thanks to all of you still on the call. I appreciate your interest in AIR. I'm excited about the future. You have questions, please feel free to call any of us. And look forward to seeing you soon at a long number of conferences. Be well. Bye.
Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.