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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good morning, ladies and gentlemen, and welcome to the AvalonBay Communities Third Quarter 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following remarks by the company, we will conduct a question-and-answer session.
Your host for today's conference call is Mr. Jason Reilley, Vice President of Investors Relations. Mr. Reilley, you may begin your conference.
Thank you, Brandon, and welcome to AvalonBay Communities' third quarter 2018 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements and actual results may differ materially. There is a discussion of these risks and uncertainties in yesterday afternoon's press release as well as in the company's Form 10-K and Form 10-Q filed with the SEC.
As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today's discussion. This attachment is also available on our website at www.avalonbay.com/earnings and we encourage you to refer to this information during the review of our operating results and financial performance.
And with that, I'll turn the call over to Tim Naughton, Chairman and CEO of AvalonBay Communities, for his remarks. Tim?
Great. Thanks, Jason, and welcome to the Q3 call. Joining me today are Kevin O'Shea, Sean Breslin and Matt Birenbaum. Matt and I will provide management commentary on the slides that we posted last night and then all of us will be available for Q&A afterwards.
Our comments this morning will focus on providing a summary of the results for the quarter, an overview of economic and apartment fundamentals, and their impact on current portfolio performance, a review of investment and portfolio management activity where we were very active this past quarter. And finally, we'll share some progress on our Columbus Circle mixed-use development.
Starting now on slide 4, our highlights for the quarter include the core FFO growth of 4.1%, which was $0.03 per share above the midpoint of our Q3 outlook. You'll note that we've increased the midpoint of our full-year 2018 outlook by $0.03 to $9 per share.
Same-store revenue growth came in at 2.3% and the same-store NOI growth was 3.1% for the quarter. The midpoint of the range for same-store performance, revenues, expenses and NOI, remain unchanged from our mid-year updated outlook. You'll note, however, we did provide additional ranges for a revised same-store basket that excludes the New York JV assets, assuming that deal closes prior to the end of the year as expected.
We completed $315 million in new development for the quarter at an average initial projected yield of 6.2% and have now completed $740 million at a 6.4% projected yield for the year. We also started two new communities totaling just over $200 million in Q3. And lastly, we raised $170 million of external capital through the sale of one community at an average cap rate of just under 4.5%.
Turning now to slide 5 and an overview of fundamentals, I'll just go through this quickly. As all of you know, the U.S. economy is very healthy currently with the GDP growth running around 3.5%, corporate profits surging by double digits, labor markets one of the tightest we've seen so far this cycle, and the household wealth recently reaching record highs before the recent pullback in the equity markets.
Turning to slide 6, the economy is being driven by both the business sector and the consumer. Strong business and consumer sentiment is translating into increased levels of capital investment and household formation, both of which are good signs for the economy in the housing market over the next few quarters.
While these and most other leading indicators are still pointing up, there are some potential risks that are worth watching, including rising geopolitical tensions, the threat of trade wars, and the normalization of interest rates through continued Fed tightening. But, overall, it appears we'll have a solid macro environment in which to operate over the next few quarters.
Turning to slide 7, this favorable macro environment is in turn supporting apartment fundamentals, which are showing signs of renewed strength with several drivers of rental demand turning up, including young-adult job growth, which is running above 2% again; wage growth reaching a cyclical high; and housing affordability actually hitting a cyclical low; all positive trends for apartment demand. These drivers are all further supported by demographics as the young-adult age cohort, or those under 34, is projected to experience decent growth for the next five years and not peak until 2024.
Turning now to slide 8 in the supply side of the equation. It appears we're beginning to see some early signs of relief in supply, as both permits and starts have been declining in our markets for most of the year. In fact, over the last two quarters, on a seasonally adjusted basis, starts and permits are down by over 20% in the prior two quarters. This is probably mostly due to construction cost inflation that we've been talking about and it's been averaging in the high-single-digit range over the last year, with some regions like the Bay Area even reaching double-digit growth.
With rent growth generally averaging 2% to 3% over the last year, projected yields on prospective deals have deteriorated by 25 basis points to 50 basis points over the last year, so depending upon the market. It stands to reason then that this would begin to have an impact on new development investment, and that seems to be occurring in our markets and to some extent nationally.
We've also seen a pullback in the public markets as the apartment REIT sector's cut back on development underway by roughly 35% since year-end 2016. Of course, this recent pullback and start activity in 2018 won't be felt really in terms of deliveries until 2020 or late 2019 at the earliest, as we expect new deliveries to remain elevated over the next four quarters or so, as you can see in the box in the lower right in this chart.
Turning now to slide 9, as you might expect, improving demand fundamentals are starting to translate into stronger portfolio performance. And indeed, this is happening. This chart depicts the four-quarter moving average in like-term rent change for our same-store portfolio.
As you can see, rent change has started to turn up – again, this is a four-quarter moving average – driven by improvement in Q2 and Q3, which posted stronger rent growth than the same quarters last year with Q3 average rent growth of 3.2% or 70 basis points greater than Q3 of last year. Similarly, growth potential for the same-store portfolio has started to turn up and in Q3 was at 2.3% or 60 basis points higher than Q3 of 2017 for the same-store portfolio.
And turning to slide 10, most of our regions saw solid improvement in the quarter. Northern California saw the biggest bounce with rent growth of 4%, which was 250 basis points higher than Q3 of last year. All three East Coast regions saw good improvement in the 50 basis points to 100 basis points range. Southern California saw modest deceleration and Seattle more significant deceleration from the prior year. Q3 rent growth in both of those regions, however, was still at or above the portfolio average of 3.2%.
These trends have largely continued into Q4 with like-term rents up by about 3% in October. In addition, rent growth is broad-based with every region currently in the 2.5% to 4% range, and the East and West performing roughly in line with one another for the first time since 2011.
I'll now turn it over to Matt, who will discuss investment and portfolio management activities past quarter. Matt?
All right. Thanks, Tim. Turning first to our current development activity. As you can see on slide 11, our completions this year have continued to meet our initial underwriting and deliver very healthy value creation with yields of 6.4% compared to estimated cap rates for those same assets of roughly 4.5%. In addition, our development portfolio is generating lease-up NOI as expected, contributing to earnings in 2018 right in line with our initial guidance.
This quarter we completed Avalon Dogpatch, our largest development completion of the year. This wood frame community which is uniquely positioned in an emerging neighborhood of San Francisco that offers mainly high-rise product was delivered at a very compelling basis, which in turn contributes to its 6.2% yield, a remarkable result for the Bay Area.
Turning to slide 12, we have an excellent long-term track record of delivering new communities in accordance with our initial budgets. This is in large part due to us acting as our own general contractor in most cases and having a majority of our trade costs locked in at the time we start a new project. This is particularly important given the increasing cost base in our industry.
As Tim indicated, construction inflation is running well ahead of rent increases, a particularly acute issue in the tech markets on the West Coast. This quarter, we did recognize cost increases on two wood frame projects currently under construction in the East Bay in Emeryville and Walnut Creek. These budget increases, which collectively total approximately $40 million or 15% of our original estimate for those two projects, were the result of unexpected union pressures and subcontractor performance issues.
These two projects are exceptions to the general trend which continues to reflect excellent construction execution. And across our current overall development portfolio, even including these two communities, our actual costs are tracking within 1.6% of the original budget as shown on the slide.
Turning to slide 13, our sector-leading development platform continues to provide excellent risk-adjusted returns with approximately $3 billion in value creation so far this cycle and another $800 million expected from the development currently underway. While new starts may be less profitable than early cycle deals due to the cost pressures just mentioned, we are confident that long-term returns will still be highly accretive, consistent with our track record as shown in the chart in the upper left. And we continue to manage capital markets risk by match-funding our development activity as shown in the lower right.
Turning to slide 14, our transactions team has had a productive year. As we executed on our strategy to rotate capital into our expansion markets of Denver and Southeast Florida, we are on track to complete the acquisition of four communities before year-end, including two suburban garden properties in the Denver area, the high-rise in downtown West Palm Beach and a garden community in the Baltimore-Washington Corridor just north of BWI Airport and the NSA headquarters at Fort Meade.
We've been opportunistically funding both our acquisition and development activity primarily through the transaction market, as shown in the table on the left-hand side of the slide. We will have sold over $1.2 billion in wholly-owned assets by year-end, which after netting out $335 million in planned acquisitions leaves us as net sellers of roughly $895 million during the course of the year, providing cost-effective capital to fund our external investment activity.
To provide a little bit more detail on the Manhattan JV transaction, as we announced earlier this month and as shown on slide 15, we are selling an 80% interest in five stabilized properties valued at $760 million on a gross basis. As we've indicated for the past several years, our allocation to the Greater New York region is a bit higher than we would like and this imbalance would otherwise be trending even higher due to the development pipeline we have in the region.
We have sold about $1.1 billion in suburban New York assets over the last four years, but have not sold any wholly-owned properties in New York City itself until now. This transaction further reduces our allocation to the Greater New York region, while preserving our brand presence and rebalances our allocation within the region to roughly $130 million (13:06) each in the city, the New Jersey suburbs, and suburban New York including Long Island and Westchester.
It is important to note that while these are among the most highly valued assets in our portfolio, there is a material difference between the short-term earnings yield or initial investment return and the transaction cap rate as that term is defined by various market participants. This is due to the presence of property tax abatements on all five assets and a ground lease structure on two of the assets, which provide a short-term boost to cash flow until their expirations and/or resets.
Consequently, the unlevered earnings yield on the assets is in the low-5% range. But this yield is roughly 150 basis points higher than what might be considered a normalized cap rate after adjusting for these factors.
The impact of the JV transaction on our portfolio can be seen on slide 16. Metro New York share of our total NOI will drop from 24% to 22%, closer to our long-term target of 20%.
Moving to slide 17, I'd like to provide an update on our Columbus Circle development. This asset includes approximately 67,000 square feet of prime retail space on Broadway and 172 residential units, and is on track for completion next year.
Turning first to the retail component of the project, this slide shows our leasing progress to-date. We are pleased to report that we have executed a 35,000-square-foot lease for the two below-grade floors and a main entrance on Broadway to Target. In addition, we are in advanced negotiations to lease just under half of the second floor space as well. These two tenants will bring us to 65% leased by square footage and 45% leased by revenue, and both are at economics at or better than our initial underwriting. We expect to turn over both spaces for TI work to these tenants in early 2019.
As to the residential component, we are currently exploring a shift from rental apartments to for-sale condominiums. From the beginning, one of the most appealing aspects of this project, apart from its absolutely AAA location, has been the flexibility it provides with no tax abatements, zoning restrictions, or affordable component that would impede a condominium strategy if it offer a better return profile.
While the Manhattan condo market has softened somewhat over the last year, as shown in the lower left corner of slide 18, our building offers some compelling advantages as indicated in the upper-right-hand side of the slide. Our average unit size of roughly 1,100 square feet, while large for a Manhattan rental building, would actually be on the smaller side for a condominium offering, which in turn allows for lower whole-dollar pricing than most other new product on the market.
As a result, 85% of our homes would be priced below $5 million at our initial projected target pricing with a wide variety of price points depending on unit size and location in the building, averaging roughly $3.2 million to $3.5 million per home.
And between the 8-foot deep (15:54) facing Broadway and the balconies on the other frontages, more than 40% of the units have private outdoor space, an extreme rarity for such a prime Manhattan address. The outdoor space is not included in the average unit size, providing even greater value to potential buyers.
We're still studying this option in greater detail, but our economic analysis suggests that at current market pricing, there could be more than $150 million in additional pre-tax value through a condo execution. To maximize our optionality, we are proceeding with some modest upgrades to the finishes in the building, which we believe would have value under either scenario and which will increase the expected total capital cost by less than 5%.
If we decide to proceed with the condo execution, we would open for sales in March or April of next year, establish a threshold level of minimum sales contracts which we would require before finalizing the condo regime and proceeding the first settlement. Of course, we will continue to keep you apprised of our progress and our thinking on this as it evolves.
With that, I'll turn it back to Tim.
Thanks, Matt. So, in summary, a healthy U.S. economy is supporting stronger apartment market fundamentals in most of our regions, with same-store rent change improving over the last two quarters and so far in Q4. Development activities generally tracking expectations in terms of lease-up and yield performance, although we are experiencing some cost challenges in certain markets, as Matt mentioned.
We continue to make progress on our portfolio management objectives through activity in the transaction and joint venture market. And lastly, as Matt just mentioned, we're making really solid strides in retail leasing at our Columbus Circle mixed-use development where we're also evaluating a condo execution on the residential component. And we'll certainly continue to share our thinking with that as we explore this opportunity further over the next couple of quarters.
So, with that, Brandon, we'll be happy to open the call for questions.
Thank you. The first question will come from Nick Joseph with Citi. Please go ahead with your question.
Thanks. On Columbus Circle, when do you need to make a final decision on condo execution versus rental?
Yeah. Matt, why don't you walk Nick through kind of the timeline there?
Sure. Yeah. So, Nick, what we're thinking is that we would start some early pre-marketing shortly in the next month or two, just to start building a prospect list. And then, if we're feeling comfortable with it, we would open a sales center onsite probably in March.
One of the things we have to offer that most other new condos don't is that we would have the product to actually show. So we think by March or April, we'll have a floor in the tower with four different unit types complete and kind of white-glove-ready as it were, which would provide – so we're not thinking pre-sales before we actually have product to show.
But if we open on that schedule, we'd open in kind of March, April. And then if we were going to do that, we would just see how it goes. We would establish internally a minimum threshold percentage of units that we would want to have under contract before we locked-in. And that might take anywhere from two to four months, depending on how sales go.
But it wouldn't be until after we reach that threshold, whatever it would be 30%, 40%, 50%, whatever we want, that we would then actually record the condo and start settlement. So we would have optionality all the way up until that point.
Yeah, Nick. And maybe just to add to that, it's probably obvious, but the opportunity costs would be potentially some lost lease-up revenue over the two to three or four months that Matt mentioned, as we're seeing the kind of traction that a condo execution would get, so.
Makes sense. And if settlements do begin in the back half of next year, what do you underwrite in, in terms of timing for a total sell-out?
To some extent, that's going to be a function of pricing and that gets into some of our tactics and strategy. I don't think we're really at a point where we want to throw a target out there yet at this point for that.
Thanks. And just, finally, given the progress made on the retail we've seen, what are the longer-term plans for the retail? And will you look to sell it once it's leased or are you comfortable owning and operating longer-term?
Yeah. Hey, Nick. It's Matt again. I think we would probably expect to complete the lease-up of the retail space in the next year or two, and then we'll look and we'll see. Hopefully, there'll be good NOI stream in place. But we may well turn around and decide to sell that in a couple of years because obviously it is a large retail asset and that's not our core business. But to get maximum execution on that, to go ahead and lease it up, and then we'll kind of see what it feels like at that time.
Thanks.
Thank you for the question. The next question will come from Rich Hightower with Evercore ISI. Please go ahead with your question.
Hey. Good morning, everybody. Maybe just to quickly follow-up on the Columbus Circle retail question there. Can you give us a sense of just how competitive the leasing process was for the space that Target took down and then also what is currently being offered to the market there?
Sure, Rich. It's Matt. I can speak to that a little bit again. There's been a lot of interest from a lot of different categories and for all different kinds of space. We have three very different priced spaces. We have the subgrade space, we have the Broadway frontage ground-level space, and then we have the second floor space. So, at this point, all the subgrade space, a little bit of the ground floor just for the entry for Target and the entry for the second floor tenant and about half of the second floor is spoken for. So, what we're left with, it's still available, would be probably 85% of the ground floor and a little more than half of the second floor.
And we continue to see – it's different categories of users. Obviously, those are different rent levels, so they're different kind of tenants. So we've had pretty good interest from a wide variety of tenants for the space Target took. We've had a reasonable amount of interest on the second floor. The ground floor space is the most expensive space and probably the space that – the thought was we needed to get the anchor tenant set first and that would generate more traction there. We are talking to folks, but we always expected that to probably be the last space to lease. So we're kind of not surprised with where that sits today.
All right. Thanks for the color there. And then my second question, I appreciate the detail in the earnings release surrounding the New York City JV portfolio impact on same-store results for 2018. Can you help us understand, I guess, in rough terms what the impact on 2019 same-store would be from those assets being excluded from the portfolio?
Yeah. Rich, this is Sean. And to the extent that we complete the execution of the JV, whether it's December or January, those assets would be removed from same-store. So there would not be an impact on same-store per se. It would be removed for both periods for both 2018 and 2019 in terms of the calculation of the same-store metrics for the calendar year 2019, if that's your specific question.
The issues that led to the potential change in guidance as a result of the closing of the JV relate to two specific issues. One is the ground lease that we disclosed previously that we acquired; the fee for Morningside Park last December, that's about $2.3 million. And then, there is another roughly $700,000 that relates to the write-off of a retail leased from third quarter of last year. So those are obviously a tailwind as it relates to the 2018 same-store results, particularly on operating expenses, and there was an impact on NOI.
So, that's why it was necessary to basically indicate what the impact on the same-store performance would be by changing the composition of the bucket with and without the New York JV assets.
Yeah. I guess...
But just...
Oh, go ahead. Sorry.
Aside from those two factors, the impact was negligible to the overall same-store.
Yeah. We're pretty much tracking where we thought we'd be in terms of all the same-store metrics, except for the impact of the New York transaction.
Okay. Yeah. And I guess to be clear, I mean, obviously the pool will change in terms of the calculation next year. But I guess my question would be, let's assume they were in the pool for all of 2019 and then we compare that number to what the pool without them in 2019 would be, just to get a sense of growth across the rest of the portfolio, if that helps frame it a little better.
Yeah. I mean, we're not ready to talk about 2019 in detail just yet. But certainly New York is a market that we'd be talking about that there's a fair amount of supply this year. The supply starts to fall off somewhat next year. So you might see some marginal improvement there. But we haven't run through all the metrics in terms of the calculation of what we expect from New York and those assets in 2019 yet to be able to give you enough insight into what the impact would have been if we didn't sell them and they remained in the same-store.
Got it. Okay. Thank you.
Yeah. Thank you.
Thank you for the question. The next question will come from Nick Yulico with Scotiabank. Please go ahead.
Thank you. So, your forecast for supply in 2019 is a little bit higher than this year. Could you break that down, the impact among some of your major markets where you see supply getting tougher or easier?
Yeah, Nick, this is Sean. Happy to address that maybe at a sort of regional level and then insight on a few markets. But as it relates to 2019, in terms of what we expect relative to 2018, we do see supply drifting down a bit in New England, primarily in Boston, up a little bit around 30 basis points in the mid-Atlantic, and then up about 80 basis points in Northern California.
And if you look at the markets where there's some meaningful change to really talk about in terms of increases in supply in 2019 relative to 2018, D.C. is about 3,500 units and then the East Bay and San José are each about 2,400 units in 2019 and beyond what they projected to deliver in 2018.
In terms of meaningful declines, what we can see for sure, Boston about 1,100 units, Baltimore about 2,000, Orange County about 1,200, about 2,000 in San Diego. We do expect to see a decline in New York City, but given the nature of the construction and delivery cycle there, there's some question as to what's going to be delayed moving into next year. So we expect some modest reduction there, probably not what would have been anticipated mid-year when we saw it at that point, which is more meaningful, but we'll be scrubbing that pipeline later in the fourth quarter to provide good solid updates when we get into the January call.
Okay. That's helpful. And then going back to the potential condo sales now in New York, I get that the overall NAV impact may be higher, or the NAV benefit may be higher. But how do you weigh that versus taxes you'd have to pay on sales of units, economic risk for selling units rather than leasing them and, lastly, how this all sort of plays into FFO? And I'd say it feels like investors have kind of discredited condo sales income in FFO historically for REITs. So, how do you kind of weigh all that?
Yeah. Nick, Tim here. First of all, as an investment, when we first got into this, we had a sense that maybe condo may be the highest and best use, just given the fact there's no affordables here, just the outstanding location. We programmed the community to give us some optionality. While the units are smaller than a typical condominium, they're larger than the typical rental. So we'd always sort of programmed this to provide some optionality.
As we got further into construction and we saw what the potential differential was between a rental value, capital highs and condominium, we just thought we owed it to ourselves as a good capital steward to explore further. And, as Matt mentioned, we think the differential may be about $150 million on a pre-tax basis. So, even if you calculate some tax in there, so that's probably still talking about a nine-figure differential. And we think that we owe it to ourselves to explore that.
And just the fact that this building is going to be ready for occupancy sometime next year, it is a unique advantage in that we have existing units that we can sell, whereas a lot of condos that are on the market today are on a pre-sale basis that are well beyond that kind of time period in which they can deliver.
So the cost here, the opportunity cost is a little bit of upgrades that we think we can capture value on the rental side as well. But it's really sort of foregone lease-up NOI for a few months. If we decide that demand just isn't there at the kind of values that we thought, we can always turn the lease-up on this thing in really a couple weeks.
So I think the risk profile, this is maybe a little different than somebody who's thinking about this from ground-up perspective. Renting is our base business, and so if that's the fallback, we don't really see where the extra risk is. And we'll probably ultimately will require a higher pre-sale requirement before making the condominium effective than maybe somebody who is building a condominium purpose-built from the beginning.
So, hopefully, that's responsive to the questions. It's something we've been thinking a lot in terms of how to just risk-manage this opportunity. And as Matt laid out in his schedule, we think we've done that. And as we said, we'll continue to keep both the analysts and investment community very well informed as to how we're seeing the market and how it's playing out.
Okay. Appreciate that. Thanks, Tim.
Thank you for the question. The next question will come from Juan Sanabria with Bank of America. Please go ahead.
Hi. Just a question on the strength or lack thereof of seasonality this year. Have you seen any benefits from an elongated seasonal lease-up period that may act as a headwind as we think about 2019 versus 2018?
Juan, this is Sean. Not really. I mean, things are pretty much falling within a traditional cycle for us in terms of seasonality. So I don't think there's any material impact if you look at it. I mean, there was some discussion around that topic a couple of years ago as it relates to some specific markets and what was happening and a shortened durations to the leasing season, but nothing unusual in terms of what we're seeing this year that would bleed into 2019.
And just going back to Nick's question about developments and kind of the earnings impact from an FFO perspective, I guess is there any development – or should we think about any risk to FFO on developments coming online for 2019 kind of with and without going condo on the Upper West Side project?
Juan, this is Kevin. The only development that really is relevant here would be on the Circle. And as Tim alluded to, there would be as a consequence of pursuing a condo strategy, if we go that route, a couple of impacts as we've discussed. We wouldn't have the lease-up NOI, you'd have capitalized interest ceasing as it would for a rental but it would be stopped once those units were made available, and then probably be some marketing costs associated with the pursuit of a condo strategy that would probably be carved out of core FFO.
So those are probably the two big things, the fact that there might be condo gains that would be carved out of core FFO, marketing costs would be carved out of core FFO. And then I guess the third thing is lease-up NOI that wouldn't be present on the residential piece. There may be one or two other things, but those are the main things.
And when we give our outlook in January 1, we'll be explicit as to what our underlying assumptions are with respect to Columbus Circle and lease-up income as we have this year.
Yeah.
Juan, just one other thing to add to that. I'm not sure if you were referring to this or not, but there was some discussion as we moved into 2018 that our deliveries in 2018 would be down a fair bit relative to 2017. As we move into 2019, we do expect deliveries to come back up to levels that are more consistent with what we saw in 2017. Obviously, you have to set aside the Columbus Circle which would have different use, but you'd start to see more deliveries coming through which would obviously look different to us in terms of earnings impact in 2019 versus 2018.
Okay. Great. And do you guys mind giving the portfolio-wide new and renewals for the third quarter and what you're setting out the fourth quarter numbers at for renewals?
Yeah. In terms of portfolio-wide numbers as opposed to individual markets, I mean, as Tim alluded to in terms of October, we're running around 3% in terms of blended rent change for the entire portfolio. And then if you're looking at offers, offers are sort of in the mid-6% range for November and December.
Okay. Thank you.
Yes.
Thank you for the question. The next question will come from Austin Wurschmidt with KeyBanc Capital Markets. Please go ahead.
Hi. Good morning. Thanks for taking the question. This is really the first quarter we've seen turnover increase in some time, and I'm just curious if this was necessarily by design or just a function on the higher rents on renewals starting to force tenants out? And then, did you see any notable increase, I guess, in the regions for move-out?
Yeah, Austin. This is Sean. What you're seeing is a little bit of an anomaly. We had more expirations in the third quarter of this year relative to the third quarter of last year. So, if you look at it, turnover as a percentage of expirations, it was actually down about 220 basis points, pretty consistent with what we've seen through most of this year in terms of reduced turnover. But there is a change to the expiration profile that moves the numbers a little bit from quarter-to-quarter. So, in general, the trend has been down in terms of reduced turnover, and that remains the case.
So, in terms of reasons for move-out, there's no material changes whatsoever in terms of what we've seen this year relative to last year. It's been pretty consistent.
Great. Thanks for the clarification. And then, as you evaluated the New York City joint venture, I mean, did you consider including any assets in the outer boroughs, I guess, considering that's where it seems like a significant portion of the new supply is being delivered over the next several quarters?
Yeah. Hey, Austin. It's Matt. We didn't. Actually the portfolio that we brought to the market was all Manhattan assets and it was all stabilized assets. And that was by design that for the types of capital we were looking to partner with and selling a partial interest sale, we wanted a portfolio that had a fair amount of consistency to it. And so we were advised by the folks who were working with on it, and I think appropriately, that the more consistent the portfolio could be the better. And for many capital sources, there's still obviously deep, deep institutional demand in the boroughs as well, but that would be kind of the thing that would get the most attention from the capital that we were targeting.
Great. Thanks for taking the question.
Thank you for the question. The next question will come from Drew Babin with Baird. Please go ahead.
Hey. Good morning. A question on New Jersey. It looked like revenue growth year-over-year decelerated a bit in 3Q relative to 2Q. And I was just wondering with a decent amount of supply looking to come to North Jersey next year, is that a market that you expect to maybe be a bit softer going forward? And I guess can you talk about Northern Jersey versus some of the properties you have in Central Jersey and what's going on there?
Yeah. Drew, this is Sean. Happy to chat about that. In terms of Northern New Jersey, we don't have a significant portfolio there. And I'd say what's probably most exposed in this supply, as it normally is, is our Jersey City asset. Yeah, there's a fair amount on the Gold Coast being done, but we don't have a big presence there other than potential impacts on Jersey City. So you will see some impact there.
And the rest of the assets in Bergen County are generally, at this point, in terms of the nature of how they perform, they tend to be not super high data assets is the way I'd describe them. So they're not right along the Gold Coast in terms of sensitivity to new supply. So they tend to just chug along and perform quite well, same thing with the Central Jersey assets for the most part.
So they don't present a lot of volatility, but they tend to be stable environments like this where there's a lot of supply at the high end, whether it's in the city or on the Gold Coast in Northern New Jersey. So we'll provide better insight into it in terms of the supply as we get into next year, but it's a pretty stable book of business overall. It kind of runs like Long Island in terms of performing pretty well without a lot of volatility.
And I guess a related question as you kind of rotate around New York City, the Fairfield-New Haven market, it's not in the New York metro disclosures, doesn't really grow like Boston but also not a lot of new supply. I guess, how should we think about that market long-term? And is there potentially a point where that might make sense for harvesting some capital?
Yeah. I'm happy to comment on that and then Matt can as well. We certainly have been a net seller in the Greater Fairfield market over the last few years. And based on what we're seeing overall in terms of demand drivers in that environment, independent of supply, we probably will likely to be a net seller.
But, again, that market tends to perform just like the other ones that I mentioned, tends to run – I mean, we're talking about 2% year-over-year kind of numbers right now. It tends to hold between, I'd say, 1.5% and 2.5% historically in terms of revenue growth if you look at it over a longer period of time. But to the extent that we find opportunity to sell some of those assets, some of which are uniquely positioned potentially as for-sale assets or others or other uses as rental, we will certainly consider that.
Okay.
Yeah. Drew, this is Matt. I'll just add to that a little bit. We do think of Fairfield and New Haven, they're actually two separate MSAs. So we're pretty much out of New Haven at this point. We sold Milford last year, which I think was our last asset in the New Haven MSA. But of what we have left in Fairfield, a lot of it is much further kind of down county, closer to New York City with better train connectivity. But there are still probably a few assets that are a little more far-flung that we are likely to sell there in the next couple years.
That helps. And then lastly, a question for Kevin on the balance sheet. Seeing property yield on sales obviously down in the mid-4x range, as 30-year debt sort of in the mid-4x range, is there a certain point where if that costs begin to creep up more that you might considered even lower leverage model if the economics between selling properties and secured bonds, if the difference, at least in the short-term, kind of equals out? Is that something that might be explored or should we continue to think about roughly 5x net debt-to-EBITDA sort of the lower bound to the leverage target?
Drew, it's Kevin. Yeah. I think for now probably thinking about our leverage target in the low 5x net debt-to-EBITDA turn level seems to make sense. Certainly, we're tracking where capital costs are today and we have been able to sell some attractively priced assets to help support our investment activity. But I think we're pretty comfortable with where our leverage is right now.
Great. That's really helpful. Thank you.
Thank you for the question. The next question will come from Richard Hill from Morgan Stanley. Please go ahead with your question.
This is Ronald Kamdem on for Richard Hill. Just two quick ones from me. Just looking at the projected long-term goals in terms of New York, and given that that's going to be one where you continue to sell, just curious between New York City, New Jersey, New York suburban, do you guys have a sense of where some of the low-hanging fruits are? Are there going to be more sales in New York City, is it Jersey or is it sort of all around?
Yeah, sure, Ronald. This is Matt. As I've mentioned in the prepared remarks, we had been selling more in the suburbs than the cities, but this is really the first time we've sold wholly-owned asset in the city this cycle. And I think the balance right now, which is roughly a third, a third, a third, feels pretty good. So, we may lighten up a bit more in the New York metro area.
But I would look for kind of those proportions to the extent we do. Central Jersey, we might be a little heavy still because we have a lot of development actually coming in Central Jersey. So it might be a little bit more weighted that direction. But we're trying to keep the same rough proportion.
Got it. And the other one, I was just – it was interesting when you mentioned the two communities in Northern California where those construction costs increased and so forth. One, is there any other markets where you're seeing that sort of pressure? And two, can you just talk about maybe some of the long-term benefits in terms of reducing supplies to those areas?
Yeah, it's interesting. The flip side of the pain, right?
Right.
Certainly, in terms of hard cost pressure, Northern California would be the most extreme right now. Frankly, Denver is also seeing quite a lot of it. We're not building anything in Denver, but that is one thing that's informed our approach to partnering with others and frankly lay off some of that risk to partners, and through potential kind of capital JV-type structures that we've been looking at, similar to what we're doing in Southeast Florida with TCR in Doral.
So, Seattle has seen quite a bit of pressure. I think it has, for whatever reason, a little bit of a deeper labor market and subcontractor base. So, while it's seen also a great ramp-up in supply, it hasn't responded quite as aggressively as Northern Cal, but that would be the other region where we're seeing still very strong hard cost growth.
The impact on supply, we'll see. I think, as Tim mentioned, we're starting to see it in the start numbers in our markets in general, perhaps more so in Northern Cal. I'd tell you, on the development side, we haven't signed up a new third-party development right in Northern Cal in years. What we are focused on is entitlements where we begin to flying (44:06) in our own portfolio and we had a couple of great opportunities there and/or public-private partnerships, like the deal we have with the city at Balboa Reservoir.
So we've certainly seen it in our behavior. And you would think at some point it would start to impact starts there. Again, we're seeing it across our portfolio. I don't know that it's disproportionately to Northern Cal right now though.
Helpful. Thank you. That's all I got.
Thank you for the question. The next question will come from Dennis McGill with Zelman & Associates. Please go ahead.
Hi. Thanks for taking my question. First one, just going back to Columbus Circle, I just want to make sure I understood the catalysts more near-term. When you have the flexibility over time to think about condo versus rental I think since the transaction was initially announced, the for-sale market probably has gotten softer. And then you've got tax reform on top of that kind of creates some additional risk on the ownership side.
So, just wondering, is there something that happened more recently or something as you think about the rental assumptions that would have tilted this towards condo?
Dennis, maybe I'll start and let Matt jump in if you like. I think the one thing that maybe we underestimated was the value of selling a new condominium versus a conversion. So, just from a pure value and execution standpoint, we probably underestimated that as we thought about kind of what our options when we made the investment in the first place. So, that's informed our view a bit in terms of exploring it now rather than saying let's just lease it up and explore it when the market is white hot. So, that's probably been the biggest factor.
From a rental standpoint, the market has been pretty flat to slightly up, I think Sean mentioned. So, that really hasn't changed in terms of our view of the rental economics at least on the revenue side.
Okay. And then, as you think about just the backdrop of the market, you noted a couple of stats there on the slide there about contract activity being down and pricing incentives being up. What would you be assuming over the next 18, 24 months as far as the backdrop of the market? Are you just kind of holding that steady as far as the competitive nature?
Well, I guess the way we're thinking about it is we're going to go into this pre-marketing period and see how strong the market is and let the market tell us. And so, to the extent we get a great response there through the brokerage community, the brokerage network, we think we can start converting some of those prospects to contract within that sort of the second milestone to actually try to start building contracts.
And again, we have sort of a second opportunity to decide whether we want to move forward or not based upon the strength of the market. And again, we don't have to be committed to this route. If the weakness just is stronger than we think, then we always have the ability to lease these units up and essentially cancel any deals that we may have had in the market.
So we think we've got a couple sort of milestones here that we can sort of test the depth of the market. And if it's there, we'll go. If it's not, we'll go back to sort of plan A.
Okay. That's helpful. And then, just one last question on the supply outlook. Today you're looking for relatively stable deliveries in your markets 2018 versus 2017, and then 2019 to be up a little bit. If we go back to earlier in the year, I think 2018 was going to be up more and 2019 would have been a fairly sizable drop.
Can you just maybe explain kind of the shifting between the years? How much of this is a net-net increase if you look at 2018 and 2019 together, versus just maybe delay from some of the competitive supply?
Yeah. I think – Dennis, it's Sean. When we talked about it earlier in the year, I think what we said is that we expected some mild reduction probably in 2019. But given what we've seen historically, to the extent that we see more delays than what has been normal the last two or three years, those numbers could even out. And based on what we see today, that appears to be happening. So the same assets are under construction and what's actually getting delivered in 2019 is increasing as a result of some movement from 2018.
So, as I said earlier in response to one of the questions, we'll be scrubbing the pipeline hard here in Q4 before we finalize our guidance for 2019, and be able to provide a good update at that point. But to be honest, just based on where we are in the cycle for construction and the labor availability, you can say that 2019 number, you expect that probably to come down some as you move through 2019. It's just hard to get visibility on exactly where it's going to be and how much.
But net-net, as you sit here today, is that collective 2018, 2019 in your markets higher today than earlier in the year or just distributed differently?
Distributed differently based on what we know.
Okay. That's helpful. Thank you, guys.
Yes.
Thank you for the question. The next question will come from John Kim with BMO Capital Markets. Please go ahead.
As a nearby resident, thanks for bringing Target to the neighborhood. On your developments, with the pullback in starts among your competitors, is your strategy now to increase your pipeline going forward or elevated costs kind of keeping you at current levels?
Yeah. John, it's Matt. I mean, our pipeline is driven by two things: Bottom-up, where are the opportunities, where are we seeing the opportunities, and are we getting appropriate risk-adjusted returns based on our underwriting. And then a little bit top-down, as we've talked about a couple quarters ago, kind of what can our balance sheet support in a leverage-neutral manner in terms of funding.
So, right now, I would say the bottom-up constraint is probably at least as significant as the top-down constraint. So we don't look at it and say, well, if the other publics are developing less, we should be developing less or more. We really look at it in terms of what deals are there out there that are underwriting that are providing us reasonable returns, and there are few of those. We've only signed up three new development rights all year this year. Interestingly, three in this past quarter, but those were the first three for the year. And one of those is a joint venture on a mall site with GGP/Brookfield, so that's the deal we've been working on for a long time. One of them was a densification of an existing asset that we already owned, kind of like what I mentioned earlier, in Seattle, taking that strategy from Northern Cal to Seattle. We're looking at maybe an opportunity in Southern Cal now to do the same. So it's more of that kind of business.
So I think it's more a reflection of the reality that where hard costs are, it's harder to find deals that work. The ones that do, tend to be more in the suburban and in the Northeast. You look at, for example, we just started a deal this quarter in Old Bridge, New Jersey. That's a deal we've had under contract for four or five years. A market that doesn't see a lot of volatility, has seen less pressure on hard costs and still has a very strong yield.
I think, Tim, you wanted to add?
Yeah. John, just to put some numbers to it. I think we talked about this this last quarter. If you looked at the 2013 to 2016 period, we probably averaged somewhere around $1.3 billion in starts. And it was our expectation in 2017, 2018, and 2019 that was probably going to be down kind of commensurate with what I said, the overall REIT sector is down by about 35%, 40%, more in the $800 million, maybe $900 million range. And that's kind of consistent with kind of the market opportunity that we've seen as well, as Matt was mentioning in his remarks.
So, that's kind of where we see it, at least for the foreseeable future, all subject to kind of what the economics actually look like at the time which we have to actually make the capital allocation decision.
And is the 6.4% yield that you've had on completions year-to-date, is that representative of your overall pipeline at Columbus Circle or when you're underwriting for new projects?
The development rates that haven't yet started, the basket as a whole is probably in the low-6s, so it's probably just a little bit under that. But it varies a lot based on where you are in terms of geography and product type.
Okay. And just one quick one on Columbus Circle. The local press is referring to the building as 1865 Broadway. Is the retail basically being rebranded or branded differently than the residential?
No, I mean, the residential address is actually 15 West 61st Street. Whether rental or condo, that's where the front door to the residential is. It's obviously not on Broadway, which is the prime, most viable retail space. And the retail address is probably a Broadway address. There may be a second floor tenant who technically has a 61st Street address as well, but the retail engages with Broadway, the residential really engages with the side street.
Got it. Thank you.
Thank you for the question. The next question will come from John Guinee with Stifel. Please go ahead.
Great. Thank you. A bit of an oversimplification, but on the condo conversion, looks like, let's say, $110 million profit after tax, 172 units, about $650,000 in additional value created after tax. What happens to the retail we're assuming that you get out of that? Can you make any money on the retail or would the retail offset the value created on a condo?
John, we don't expect to lose money per se on the retail. As Matt mentioned, it's not our core business area, so we're probably a little less confident in our projections here. But based upon our pro forma and the kind of rents that we're currently renting at, we think it probably contributes modestly to the profitability of this project.
Great. And then a second question. What's your crystal ball look like for hard costs over the next two or three years, assuming the economy remains reasonably healthy? Is it the north of 5% annual increases or more inflation-esque at 2% to 3%?
Yeah. No, it's a great question, John. When you're kind of in the middle of seeing these really healthy single digits, you kind of ask yourself what's going to change to sort of change that outcome. We are seeing a drop in starts in our markets. So, that's the first sort of canary in a coal mine where it might actually see some relief on pricing. You are starting to see the builders reporting order volumes being down, so that might help a little bit. But we're at full employment and we're not replacing some of the skilled labor we have in the construction trades. And so, this is maybe both a secular issue and a cyclical issue.
So I don't think we're – we're not betting that it's going to be 2% or 3% or in line with rents, and it's one of the reasons why we're trying to maintain as much optionality on the development of that portfolio as we can. So we also laid it out. Until there's some kind of correction or, ultimately, if we need to write off some of these deals, we will if we just see them as uneconomic.
Last question, any effect on land prices or land prices are sort of remaining sticky?
Yeah. I think it's still too early. John, this is Matt again. We do get that question seems like every quarter. We're waiting. But land prices are sticky. I would say, for the most part, they probably stopped going up. And there are deals that aren't trading. There are land deals that aren't trading. So, in terms of maybe getting a little more favorable, people don't always expect to put it under contract today and close tomorrow. But we haven't seen any material decline in land prices that would make up for the increase in hard costs yet.
Yeah. The thing to remember, John, is land costs are generally 15% to 20% of total capital costs; whereas, construction is probably 65%, maybe as high as 70%, and soft costs maybe another 15%. So, land costs will have to come down a lot to make up for the kind of appreciation and escalation we're seeing on the construction side.
Great. Thank you.
Thank you for your question. The next question will come from Alexander Goldfarb with Sandler O'Neill. Please go ahead with your question.
Hey. Good morning down there. Two questions. First, as far as the condo and the retail at Columbus Circle, are those now both in, like, a TRS? Or as far as the retail goes, is there some sort of holding period that you need to maintain to allow that to be good REIT income versus having it be taxable?
Yeah. Alex, they actually are both in TRSs.
Okay. That's easy. And then the second question is, just as far as New York State goes, with the rent control coming up for renewal next year and the possible change in the Senate and Albany composition, is there any concern that if they change the rent control laws that that would impact your affordable units that are part of your 421-a or those are separate from any legislation changes they may consider?
Yeah. Alex, this is Sean. A good question with a whole lot of speculation around it. And whether the impact would be on affordable homes specifically or more of the market rate homes that are subject to rent stabilization because of the 421-a program, I suspect anything that would be related to the 421-a program, given the fact it's already occurred over that, would probably be very difficult to get through. And that's what would impact potentially our portfolio.
It wouldn't impact it in a meaningful way. There's only about 7% of the units in the portfolio that are basically at legal caps at this point in terms of the rents that are allowed. So the impact wouldn't be material. But I wouldn't suspect that that would happen, given everything we've been through on the 421-a program over the last few years in New York.
Okay. But if they change and do away with vacancy decontrol, you don't think that that would impact you or that could impact you?
It depends on what they're talking about in terms of the population of units that would be impacted by any change, whether it's affordable units or just the stabilized units, because you're into these different programs in New York that you have to work through. So I'd be surprised if it was on the market rate units that are subject to stabilization because of 421-a, as opposed to technically affordable units that are set aside that are different.
Okay.
So there's a lot of speculation around this, but there's nothing substantial that's actually being drafted or negotiated. So I think we'd likely be okay, but even if something came through that affected the piece that we'd be worried about, it wouldn't be a material impact on the assets.
Okay. Thank you, Sean.
Yes.
Thank you for your question. The next question will come from John Pawlowski with Green Street Advisors. Please go ahead with your question.
Thanks. On Columbus Circle, if you had kept it or if you do keep it for rental, what was the unlevered IRR expectation over the long-term for this site?
Hi, John. We typically don't provide disclosure on projected long-term IRRs, but I think we gave a sense that we thought the economics here on a development basis were in the mid-4% range, including the retail. So you'd have to sort of kind of – you can probably input your own assumptions there in terms of growth and reversion at cap rates, as to what that would translate into an unlevered IRR.
Yeah. Understood. Could you share the contracted retail rents per foot and what's under negotiation? How does that compare, how will it compare to initial underwriting?
Yeah. Hey, John. It's Matt. Yeah. We're not going to disclose what the actual rents were in the lease. But as I did mention, the two deals that we have either signed or very close to being signed are both at or better than the economics we had underwritten both in terms of rent and also in terms of TIs and free rent. So, so far, we're tracking a little ahead of our program. Obviously, we still have a lot of space left to lease.
Okay. That helps. Thanks a lot.
Thank you for the question. The final question will come from Wes Golladay with RBC Capital Markets. Please go ahead.
Yeah. Hi, everyone. Just want to go back to those East Bay developments. I think you mentioned you had a $40 million cost overrun. But when I look at Avalon Public Market and Avalon Walnut Creek, it looks like the cost went up $30 million. So, did the subcontractor eat the $10 million? And then if you have costs locked-in ahead of time for the developments, was this driven by increased labor costs or did the whole thing just had to be reworked?
Yeah. Hey, Wes. It's Matt. You're right. What we recognized this quarter across those two projects compared to last quarter was $30 million higher. To be fair, there was an additional $10 million in cost increases we had already recognized on Emeryville, if you go back to the very beginning when we first started the projects. So, relative to what we thought what our initial budgets were, that's where the $40 million came from.
And you're right in that, normally, 90-plus-percent of the time when we start a project we have, most of the trade costs locked-in with subcontractors who perform. And consequently that's why if you look at that slide, over a long, long period of time, we're generally bringing projects in within 1% of budget plus or minus. This is the kind of environment in Northern California, particularly right now, kind of one market once every cycle where you see – while you thought you had your costs locked-in, the subcontractors failed to perform.
You force them to build it. If they're not making money doing it, they thought they could get labor at a certain price, they couldn't. One of those deals in Walnut Creek we had a further complication which was it's a public-private deal with BART as the ground lessor and there were some prevailing wage requirements which in turn created additional union requirements for the execution that we were not expecting there. So, that was a piece of it as well.
But, generally, we are very successful in locking down our costs at the start. But there are extreme situations and this would be one of them where the subcontractors just won't perform and you basically have to switch, find new subs at whatever the prevailing market price at that time is.
Yeah. Wes, maybe just to add a couple of general comments. I think they do apply to what's happened in the East Bay. And as you get late in the cycle like this where we have a lot of production going on, I mentioned earlier just the lack of skilled labor, they are adding skilled labor, but it's oftentimes not as productive, not as good, and just the market is so stretched that the margin for errors is just very low. So, there if one sub fails, it tends to have a cascading effect on all the subs behind them.
So, in a normal market, sometimes if one sub fails, you can oftentimes replace them quickly without an impact to schedule or cost to the other subs. That's not this kind of market right now, particularly in Northern California, just a very low margin of error, and something that we're trying to be mindful of from a risk standpoint at this point in the cycle, so.
Okay. And then last one for me. We obviously just heard Sears filed bankruptcy and we're hearing from a lot of the retail landlords that this can unlock some densification opportunities. So, have you noticed an uptick in inbound calls to Avalon looking at potential multi-family on retail sites?
John, we've actually – I'm sorry, Wes, that's something we've been working on for a while. And, in fact, the deal I mentioned, the new dev right this quarter which is at the Alderwood Mall outside of Seattle, that is actually a former Sears box. So we're working with GGP on it but actually Seritage is in the deal as well.
And we assigned a fairly senior development person to kind of work on those opportunities really about a year or two ago. So we continue to talk to mall owners, to retail owners, and we do view that as a great opportunity for us. I don't think there's anything – we're not seeing any more specifically because of the Sears bankruptcy yet, and frankly, a lot of those locations are not locations that we're going to be all that interested in but, as a general macro trend, absolutely.
Okay. Thanks a lot, guys.
Thank you. This concludes the Q&A portion for today. I'd like to turn the conference back over to Tim Naughton for closing remarks.
Thank you, Brandon. And thanks for all of you being on today and look forward to seeing you in the near future. Take care.
Thank you. Ladies and gentlemen, this concludes today's event. You may now disconnect your lines.