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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Welcome to the Equity Residential Second Quarter 2018 Earnings Conference Call and Webcast. Today’s presentation is being recorded.
And now, I’d like to turn the floor over to Marty McKenna. Please go ahead, sir.
Thank you, Catherine. Good morning, and thank you for joining us to discuss Equity Residential’s second quarter 2018 operating results.
Our featured speakers today are David Neithercut, our President and CEO; Michael Manelis, our Chief Operating Officer; and Mark Parrell, our Chief Financial Officer; David Santee is here with us as well.
Please be advised that certain matters discussed during this conference call may constitute forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are subject to certain economic risks and uncertainties. The Company assumes no obligation to update or supplement these statements that become untrue because of subsequent events.
And now, I’ll turn the call over to David Neithercut.
Thanks, Marty. Good morning, everybody. Thank you for joining us for today’s call.
We’re extremely pleased with the Company’s operating performance to date as we move towards the tail end of our primary leasing season. Because continued strong demand across the board for rental housing and the relentless attention to customer service delivered each and every day by our outstanding property management teams, combined maintained very high levels of occupancy and record setting resident retention that have enabled us to now expect to deliver growth in same-store revenue towards the high end of our original expectations.
With elevated levels of new supply across our markets this year, we had prepared ourselves for modest reductions in occupancy and weaker growth, but it was going to be a -- because it was going to be a very competitive marketplace for new prospective residents and our existing residents, we have a lot of options from which to choose when their lease would come up for renewal. Yet very deep and resilient demand for apartment living in our urban and highly walkable suburban markets continues to be the story.
And here, to take you into greater detail is our recently promoted Chief Operating Officer, Michael Manelis.
Thank you, David.
So, similar to the trend we discussed on the last call, the overall demand for our product remains strong through the leasing, despite the elevated supply. Our team’s ability to execute along with continued job growth has put us in a position to exceed expected revenue results for this quarter and increase our full year revenue growth expectations to 2.1%. New York and San Francisco are driving the majority of the overall guidance increase. For the second quarter, we reported 96.2% occupancy. Our new lease change was up 1.4%, and achieved renewal increases were up 4.7%. All three of these metrics were above our original expectations.
I’d like to take a minute and recognize our on-site teams. Renewing our residents in the pace of elevated supply has been the team’s number one goal. Not only did they deliver a 4.7% achieved increase on renewal, but they also managed to reduce turnover again to 13.4% for the quarter, while increasing our overall resident satisfaction, the highest levels we have seen in the history of our Company.
In addition to being the lowest turnover percent that we have ever reported in the second quarter, when you net out on-site transfers that is residents who are moving to a new unit within the same community, this number drops another 150 basis points to 11.9%. Their ability to deliver remarkable service to our residents is an inspiration to all of us here, and I can’t tell you how proud I’m of all of them.
So, now, onto the markets. Let’s start with Boston. Gains and occupancy, 20 basis-point revenue boost from parking income and a continued ability of the market to absorb the new supply has given us the confidence to increase our full-year revenue guidance midpoint for this market by 50 basis points to 2.1%. Our occupancy for the quarter was 96.3% in Boston, which was 50 basis points higher than our original expectations and 60 basis points better than Q2 of ‘17. As of this morning, our Boston base rents are up 2.7% as compared to the same week last year and renewal performance remains strong with 4.8% achieved increases in the second quarter. July is trending to a 5.1% and August is projected to be 5.2%.
Moving over to New York. Consistency in operations and disciplined market pricing are the highlights for this quarter. 96.8% occupancy for the quarter was 70 basis points better than both expectations and that of the second quarter of 2017. Achieved increases on renewals were 30 basis points better than expected at 2.8%. Our use of concessions in New York remains very limited and strategic. Our second quarter concessions were 37% lower than that of the second quarter of 2017. And for the past several months, we have only had approximately 5% to 10% of our weekly applications receive some form of moving concessions. We remain focused on competitive net effective pricing and the use of confessions at our stabilized assets will remain targeted, but it is expected to increase in the softer demand period, later in the year.
Full-year revenue guidance for New York is being increased by almost 100 basis points from negative 75 basis points to a positive 20 basis points. Today, our occupancy in New York is 96.7%, which is 70 basis points higher than the same week last year. Base rents are up 2.9% year-over-year, and this week is the 14th consecutive week of base rents being positive on a year-over-year basis and the 5th consecutive week being above 2%. Achieved increases on renewals remain strong with 3.2% expected in July and 3.4% for August.
So, strong demand and disciplined market pricing in New York positioned us well for the peak leasing season. This provided us the opportunity to both, raise rate and grow occupancy. That being said, we are not out of the woods yet as the third quarter is the peak delivery quarter for New York . Now, these deliveries are concentrated in Long Island City and Brooklyn were to date, we have not seen a significant impact to our operations. Our New York team has performed extremely well through the leasing season, and we like our position here heading into a softer period of activity.
Main headline for Washington DC continues to be positive economic conditions have aided in the absorption of new supply, but the overall DC continues to be a market with minimal pricing power. That being said, this is a market that’s going to continue to deliver almost 3,000 units per quarter through the end of 2019. Pricing power will remain pressured until we either see a decrease in supply or an increase in jobs above the 40,000 per year level.
Our second quarter revenue growth in DC was slightly better than our original expectations, primarily driven by 96.3% occupancy, which was 60 basis points better than expectations and 80 basis points better than Q2 of ‘17. Renewals were 30 basis points below expectations with an achieved increase of 4.1% for the quarter. Today, our occupancy in DC is at 96.3%, which is 10 basis points higher than the same week last year, and our base rents are 3.4% up year-over-year. We expect to achieve a 4.5% increase on renewals in July and 4.7% increase for August. We have revised our full-year revenue projection for Washington DC for 1.2%, which is a 20 basis-point increase from our original expectation at the beginning of the year.
Moving over to the West Coast. Our overall second quarter revenue results in Seattle were slightly below our original expectations. On our last call, we told you that we were experiencing continued moderation and that our ability to grow rate was less than expected. That trend has continued through the second quarter, and we are not seeing signs of pricing power improvement, typically observed during the peak leasing season. Occupancy for the second quarter was 95.8%, which mirrored Q2 of ‘17 and was 10 basis points less than our expectations. Achieved renewal increases for Seattle averaged 5.9% for the quarter, which was also 10 basis points less than what we expected. The Seattle job market remains strong, which has helped in the absorption of the new units, but we expect continued rate pressure from the new supply through the remainder of the year. The good news on the supply front is that the 2019 supply is less concentrated in any one submarket, which should allow modest pricing power to return to our portfolio.
Today, our occupancy in Seattle is 95.6%, which is 30 basis points lower than the same week last year and our base rents are down 1.7% year-over-year. We expect our achieved renewal increase to be 6.3% for July and August is trending towards 5.5%. We have adjusted our Seattle’s full-year revenue growth projection down 25 basis point to 3% to reflect lower-than-expected base rent growth.
Moving down to San Francisco. Pricing power and occupancy gains fueled by strong demand has resulted in another quarter of outperformance versus our original expectations. We have said in the past that market had the indicators that it could outperform the high-end of our guidance range. We now expect our full-year same-store revenue growth for San Francisco to be 2.9%. San Francisco’s occupancy average 96.2% for the quarter, which was 40 basis points better than expected and 50 basis points better than Q2 of ‘17. Achieved increases on renewals were up 5.2%, which was 100 basis points better than we expected. Job growth remains strong in the Bay Area, 2.1%, and is really fueling the demand and aiding in the absorption of the new supply. Our own newly developed community 855 Brannan in downtown San Francisco is a great example of the strength of this market. This community is expected to destabilize approximately six months earlier than we initially thought. Today, 855 Brannan is at 95% occupancy, and we just renewed 54% of all of our June and July expirations with an achieved increase of 4.2%.
Overall, the new deliveries in downtown San Francisco will be limited in the third and fourth quarters. The bulk of our competing products is already delivered and is currently in lease up. Another example of the strength of this market is the fact that our own performance in the Peninsula with 28% of our Bay Area NOI, remained strong in the pace of steady year-to-date supply delivery. We estimate that the Peninsula deliveries will decline by 70% in 2019, which should provide a favorable tailwind to already strong performance.
Today, we are 95.9% occupied in San Francisco, identical to where we were the same week last year. Our base rents are up 6.1% year-over-year. Our achieved renewal increases for July are at 5.5% and we project 5.4% increase for August.
Moving further down the West Coast, I am pleased to report that Los Angeles, which accounts for almost 30% of our portfolio-wide revenue growth, produced second quarter results, slightly ahead of our expectations. We mentioned on previous calls that we had a strategy to increase occupancy early in the year to not only position us to raise rates but as a defensive move against the elevated supply in this market. For the quarter, we had 96.0% occupancy, which was 20 basis points higher than our original expectations and 30 basis points higher than the second quarter of ‘17. Achieved renewal increases for the quarter in LA were up 6.2%.
In the past, we’ve been asked a lot of questions about delays in deliveries impacting our results. We have explained our process and outlined how from an operation standpoint we also focus on when first units begin leasing. Our response has been consistent and that we were not seeing delays beyond the typical 10% to 15% moves between quarters.
Specific to LA, this quarter marks the first time we are seeing above-average shift in the timing of deliveries. It is hard to quantify the exact benefits of this shift as we still had over 4,000 units begin leasing activity in the first half of ‘18 but we do recognize that our performance during the first half of the year was impacted in a positive manner since the delivery pressure was not as an intense as expected. Our occupancy in LA today 96.6%, which is 10 basis points lower than the same week last year. Our base rents are up 5.6% year-over-year, and we expect 6.5% increase on renewals for both July and August.
Based on modest gains in occupancy, stronger pricing power above our original expectations, along with increased potential pressure in the second half of the year due to the supply shift, we have revised our full-year revenue projection to 3.4%. This would have been a 3.5% increase, but as we’ve disclosed in the release, during the second quarter, we had a onetime write-off from the retail tenant vacancy that will impact the full-year results in this market by 10 basis points.
Moving to Orange County. Second quarter results were below expectations, primarily due to lower occupancy and lack of pricing power from lease-up pressure in the quarter. Occupancy for the quarter was 95.9%, which was 40 basis points lower than both expectations and that of the second quarter of ‘17. Achieved renewal increases for the quarter were 5.4%, which was 80 basis points lower than what we expected. Today, we continue to see moderate pressure on pricing in Orange County but our occupancy has recovered to 96.6%, which is 40 basis points higher than the same week last year. Our base rents are up 1.9% year-over-year, and achieved increases on renewals are up 5.9% for July and trending to 5.6% for August.
Given the lack of pricing power experienced year-to-date along with revised expectations going forward, we have adjusted our Orange County full-year revenue growth projection down 50 basis points to 3.5%. While this was not as robust of a leasing season in Orange County as we have hoped, this market will still produce our second strongest results in the portfolio for 2018.
And last but not least, San Diego. Our results for the quarter were in line with expectations. Occupancy was 96.4%, which is exactly what we anticipated. And achieved renewal increases for the quarter were 6.3%, which was slightly better than our expectations. Today, our San Diego occupancy is 96.7%, which is 60 basis points lower than the same week last year. However, it’s still in line with our guidance expectations.
Our base rents are up 1.6% as compared to the same week last year. And we expect achieved renewable increases for July and August at 6.3%. There is no change to our full-year revenue growth expectation of 4% for San Diego.
In closing, we are more than halfway through our peak leasing season, and we continue to see strong demand for our products. New supply is being absorbed at a rate greater than we expected and pricing of those units remains rational.
New York and San Francisco drove the majority of our 50 basis-point positive guidance provision. Seattle and Orange County, two of our smaller markets, continue to be a bit behind our original midpoint expectations. And Boston is ahead of our expectations. And the rest of our market DC, LA, San Diego are basically on track and performing slightly better within 10 basis points to 20 basis points of our original expectations.
A sincere thank you to the entire Equity team. Peak leasing season is exhilarating and exhausting at the same time. Your efforts and results year-to-date are beyond appreciated. Your relentless focus on delivering remarkable experiences to our residents is clearly paying off. Keep it up. Thank you.
Thank you, Michael, and good morning.
Michael has just discussed our markets and the upward revision to our same-store revenue guidance, and I want to take a couple of minutes here to talk about our revisions to our same-store expense guidance and to our full-year normalized FFO guidance.
First, for same-store expenses, we have lowered the midpoint of our full-year same-store expense guidance to 3.75% from 4%. This is primarily driven by our expectation of modestly lower property tax expense growth and for lower on-site payroll expense growth. As a reminder, these two expense line items together constitute approximately 65% of our same-store operating expenses. Year-to-date, we have produced expense growth of 3.5%. We don’t expect a big change in the growth rate of our expenses in the second half of the year.
Now, I’ll give you a bit more color. You saw us produce 4.5% growth in property taxes through the first six months of 2018. We now expect our full-year property tax expenses to grow in the range of 4% to 4.5%, and that’s down from the 4.75% to 5.75% prior range. This is due to both significantly better than expected appeal activity, as well as our expectation of a reduction in the growth rate of our taxes upon the sale of a same-store asset that David Neithercut will discuss in a moment. Also, we have lowered our expectation for on-site payroll expense growth to a range of 3% to 4%, and that’s down from 5% before.
At the beginning of the year, our budget assumed continued pressure on on-site payroll, especially compensation for our maintenance personnel. While we are still feeling wage pressure, especially on the maintenance side, our on-site payroll expense growth has been positively impacted year-to-date by a reduction in our estimate of medical reserve expenses. Year-to-date growth of 2% in on-site payroll means that payroll expense growth will be higher in the back half of the year than it has been year-to-date but that is mostly due to a harder 2017 comparable period in the second half of the year than any real change in trend.
Now, moving over to normalized FFO. In our earnings release, we raised the midpoint of our full-year same-store revenue guidance to 2.1% from 1.6%, driven by the strong renewals, low turnover and high occupancy in our portfolio that Michael just discussed. I just went over our expectation of a decrease in same-store expenses which collectively allow us to raise the midpoint of our same-store NOI guidance to 1.4% from 0.75%. On the normalized FFO side, we are picking up about $0.03 per share from higher same-store NOI and another penny or so from our 2018 transaction activity due to our narrowing of our reinvestment spread and the timing of our acquisition and disposition activity. These positives are partially offset by a one penny per share increase in interest expense, primarily due to the increase and timing of the same transaction activity and its impact on our intra-period borrowing. The result is a modest increase to our normalized FFO guidance from $3.22 per share to $3.25 per share. All-in-all, revenues improved, expense is slightly lower, normalized FFO slightly improved.
And with that, I’ll turn the call over to David.
Thanks, Mark.
On the transaction front, second quarter was pretty quiet with only one acquisition occurring and no dispositions. That acquisition being a 240-unit mid-rise property built in 1999 located in Hoboken, New Jersey.
Now, as noted in last night’s press release, through the first half of the year, we have acquired two assets for $200 million and sold four assets for $290 million at an accretive spread of 10 basis points. Also noted in the press release is a revised assumption for the year of $700 million of acquisitions and an equal amount of dispositions, which obviously will require a fair amount of activity in the second half of the year. Included in that activity are several acquisitions under contract and in the due diligence process totaling nearly $500 million, which includes a couple of recently built properties in close-in, highly walkable neighborhoods of Denver. As we said repeatedly, our exit there was not market-related but rather portfolio-related. We’ve continued to carefully watch Denver, because it possess many of the characteristics we look for in one of our markets that being a highly educated workforce, strong growth and high paying jobs and relatively high cost to single family housing as a multiple of income. And we think that with the new supply that has recently been and will soon be brought on line in Denver, there will be additional attractive opportunities to acquire assets that meet our investment criteria, as we rebuild a critical mass in the market.
Our second half transaction activity will also include the disposition of an asset on Manhattan’s West Side that is currently under contract at a price in excess of $400 million, and at a very attractive disposition unit. This sale is expected to close late this quarter with all contingencies currently waived and subject at this time to only normal closing conditions. This disposition will be discussed in more detail following closing, but it does represent an opportunity for us to reduce our exposure to the West Side where we have a significant portfolio of assets, as well as an opportunity to address the negative impact on our New York City growth rates by reducing our exposure to properties with expiring 421-a real estate tax benefits.
In fact, going back to Mark’s comments just a moment ago, on the expected improvement in our 2018 same-store operating expenses, this sale will reduce our portfolio-wide growth and same-store real estate taxes by 30 basis points.
Turning to development. During the quarter, we started work on our tower in Boston to West End neighborhood that we discussed on our most recent call. This is a 469-unit project that will be delivered in 2021 at a cost of $410 million. We were also very pleased to note in last night’s release that we now expect to stabilize three development deals on the West Coast two to three quarters sooner than expected. More clear example is the continued strong demand for high-quality, multifamily properties across our markets.
So, I’d like to close with just a few comments on Proposition 10 that’s being the California ballot initiative to overturn Costa-Hawkins. For those of you unaware of the situation, municipalities in California have for many years been able to implement rent control. However, it would be subject to certain limitations, as a result of the Costa-Hawkins Law. One, it can only be imposed on properties built before 1995; and two, properties are subject to rent control must be allowed to move their rents to market upon vacancy, which is known as vacancy decontrol. Preposition 10, which will be on the ballot in California this November, seeks to repeal Costa-Hawkins, which would remove these limitations on rent control for those jurisdictions opting to implement rent control, which of course not all actually do.
Now, our EQR has joined the California Apartment Association, public and private landlords across the state, numerous trade organizations, affordable housing groups, state and local chambers of commerce, veterans and minority groups, nationally recognized independent research organizations, among many others to create a coalition to defeat this proposal. This will not be an easy fight because on the surface who isn’t supportive of affordable housing. However, when made aware of the negative impact the rent control has on the existing housing stock and of the disincentive it creates to build more housing, which is truly the only way to address the shortage of housing, many people come to understand how bad rent control can be for the neighbors, neighborhoods and communities.
So, we will fight Proposition 10 at a cost to EQR of $1.6 million to-date. And regardless of the outcome, we will continue to fight attempts at the local level to enact rent control. Because this is bad housing policy, plain and simple. There is a reason that it has made no headway in the legislature and why the current Governor and both gubernatorial candidates have come out against it. And that is because it is widely understood that rent control creates a disincentive to invest in the existing rental housing stock and a disincentive to build more rental housing and is therefore the worst possible action that could be taken to address the shortage of affordable housing, because rather than address the problems, it exacerbates it.
The answer is to build more housing. And there is not one solution that will work everywhere there is a housing shortage. But, the basket of solutions includes inclusionary zoning, looking hard at some of the regulatory requirements can add significant costs to new development projects, increasing federal low income housing tax credit program, and addressing the nimbyism that exists in many of the areas where the current housing shortage is the most acute.
Now, there is no question that we have a serious housing issue across our nation which needs to be addressed. And while the answer may not be easy, solutions do exist. And it has been proven time and time again that rent control is not one of them.
So, Kathy, we will be happy to open the call now to Q&A.
[Operator Instructions] Our first question will come from Juan Sanabria with Bank of America.
Hi. Good morning. I was just hoping for the latest portfolio-wide color on 2019 supply and the expected delta versus ‘18. And if you could maybe just highlight which markets are seeing the biggest deceleration, if any and are you seeing an unexpected increase?
Yes, sure. This is Michael. So, I guess, I would say, at the highest level, we have rolled up about 71,000 units for 2018, going down to 57,000 units in 2019. And when you go across the markets, the market that probably has the most pronounced reduction is New York, dropping from 19,400 units down to 8,500 units. The rest of them are moving, I mean slightly, but it’s not as material of a decline as what we see in New York.
And with the latest cut of the numbers, has there been any material move from ‘18 into ‘19 outside of the LA market which you highlighted in your prepared remarks?
No, no material change moving between here outside of what we saw on our LA.
And thank you for the color on the renewals by market. Would you mind providing the new lease spreads by market, as well as the portfolio-wide spot occupancy?
Yes. So, I want to just say on the new lease and I kind of -- I think I said this on the last call, so I think it’s important that I reiterate. We don’t believe that looking at these results for any single one quarter is the best way to think about this metric at a market level. I’m just going to tell you that we just went through the process of updating all of our full-year expectations when we went through the guidance revision process. And on our full-year basis, our assumption changes were as follows. So, New York was in increased by a 100 basis points in our expectations for new lease change, San Francisco was increased by 50 basis points, and Seattle and Orange County were both reduced by a 100 basis points. The rest of our markets were either on track or had marginal moves in either directions.
Okay. But, can you provide the second quarter figures for the new leases?
Yes, sure. So, Boston was positive 30 basis points; New York was negative 1.2% or 120 basis points; Washington DC was negative 0.9%; San Francisco was up 5.1%; Seattle was up 0.7%; LA was up 2.6%; Orange County up 0.4%; San Diego up 3.7%, putting the entire portfolio up 1.4% as we disclosed in the release.
We’ll now hear from Nick Joseph with Citi.
On reentering to Denver, how many assets or what percentage of NOI do you need to own to reach an acceptable scale?
That’s a good question, Nick. As we look at, we think that we can get an appropriate sort of critical mass with, call it 14, 15, 16 assets. That’s probably around a 1.5 billion or about 5% of our sort of NAV allocation, if you will. And these two assets we’re underwriting, get us 20% of the way there.
Okay. So, do you expect to reach that level over the next two to three years or is it more of a next cycle target?
I think, it’s hard to say. A lot of it will just be -- we can find opportunities to trade out of other markets, sort of what we are doing here and trading out in New York, and reallocating that capital in Denver. If there are opportunities that might be faster, but I think it would be hard pressed to sort of put a specific timeline on it, but one that we will be -- really have our eye on and try and get there as soon as appropriately possible and what we think about allocating capital.
And then, you’ve done a great job with renewals and drive internal but lower. Is there an opportunity to drive it further, or do you think you are close to frictional turnover level?
I guess, I would just say tell you, I think our expectation is that we’re going to continue to see the results that we’ve seen play out for the first half for the balance of the year. I mean, the teams are focused on this. How much more improvement are we going to see than these 100 basis points declines that were post in each quarter, I don’t know. I mean, I think we’re probably getting down towards where we will post kind of the lowest turnover, but we will see kind of where we go from there.
Thank you. Our next question will come from Steve Sakwa with Evercore ISI.
David, I just wanted to make sure I head you correctly. I think, in your opening comments, you said you were maybe trending towards the high end of the expectations. I just wanted to make sure, given that you’ve done 2.2 revenue growth in the first half, the 1.9 at the low end would kind of imply a 1.6 second half. So, I’m assuming you’re not assuming there’s a big deceleration. I mean, is it fair to assume you’re kind of in that 2.1 to 2.3 range right now?
So, Steve, this is Michael. I guess, I would say, yes. So, we have a lot of confidence in the 2.1% midpoint that we just put out there. I do want to say that it doesn’t take much to move our revenue by 10 basis points in the portfolio, winds up coming down to $2.4 million. And the 40 basis points range that we just communicated in the release is really just the result of a sensitivity analysis that we complete for each market that kind of looks at best likely and worst. And I said, right now, we’ve got a lot of confidence in the 2.1. We have a pretty difficult comp period coming up in front of us from an occupancy standpoint and several of our markets have peak deliveries occurring in the third quarter.
So, as far as the bottom end of that range, the 1.9, there is a couple of different ways to get there, but it basically is going to come down to our ability to hold occupancy at 96.1% for the second half of the year. And a 30 basis-point decline in occupancy in the second half, which we do not see happening at this point, but that would result in revenue towards the bottom end of our range. But on the opposite end of the spectrum, continued improvement in retention and demand, which we are seeing, will accelerate rate growth and push occupancy higher, and that in turn would result in the higher end of our revenue range.
And then, I guess, I want to just how you guys address maybe construction costs. I know, you don’t have that many new projects starting other than the new one in Boston. But maybe David or somebody else could just sort of address what you’re seeing in import costs and things like steel and wood, and how that’s impacting maybe underwriting today for new deals?
Well, it’s hard and hard, Steve, particularly as these construction costs go up more quickly than rental levels. We thought -- in 2017, across our markets we saw 4% to 8% increase in hard costs and we’re expecting an underwriting same sort of expected growth this year, even though that we are not bidding anything ourselves. But as our guys track those costs, that’s what they are seeing, again this year. And that is before any inclusion of any kind of impact of tariffs. I have had just -- my construction guys tell me, I think steel, because of the results of the tariffs are up at least 25%. And I know Mark has had some conversations with others that might -- has some color for you as well.
Yes. I mean, Steve, attending some industry events and hearing a large general contractor speak to a room full of developers, so, I’ll tell you, had rapt attention on this point. What they are seeing with -- and this was before the steel tariffs, but just the general threat of it, plus the lumber tariffs that already exist with Canada that all of that was pushing our cost up 4% to 8%. And indeed, it was also adding a cost to a lot of construction contracts that created real uncertainty where the general contractor and the subs weren’t willing to take risk on some of these items, which really puts a lot of pressure on the developer and on their contingency.
So, I guess, it’s fair to assume -- or I mean, can you point to or do you expect then that to just really lead to kind of a drop off in new supply here over the next kind of say 6 to 12 months?
Well, we’ve certainly -- we’ve said that for some time. Certainly, there is product in the pipeline that would be unaffected by this. Our deal when we started in Boston is unaffected by any of this, but that contractor sort of locked down. But certainly, we hear anecdotally all the time, Alan George, our investment guys share all the time about projects that are being pushed aside, equity capital that unwilling go forward, in deals that are looking for new capital sources specifically as a result of this. So, I see no reason why this won’t have a significant impact on the number of starts going forward.
Our next question comes from John Pawlowski with Green Street Advisors.
There has been some news articles out there about pop-up hotel at your 100K Apartments in DC. I was wondering if you could provide the economics, average rents, margin, CapEx reserve on that building now that will be a more of a short-term lodging type focus versus if there was a 100% traditional apartments.
I don’t have that compared to what it would be, John. But we have cut a deal with this entity called WhyHotel where they are chasing down 95 units for nine months in our property that will soon be delivered. We get a base rent from them as well as a participation over some thresholds. These are apartment experienced guys. So, they’ve been very easy to work with, very compatible to work with. We think it’s a great opportunity to deliver some income in vacant units that would otherwise remain vacant over that nine-month period.
And John, they provide all of the goods. They are providing -- they are furnishing the units. There is no additional capital on our part. And they are providing the staffing to address any concerns that their hotel residents, so to speak, have. So, there isn’t like a cost impact effectively on us.
Okay. Can you share a stabilized yield projection?
I beg your pardon?
Could you share a stabilized NOI yield projection on the development?
On that particular property, 100K? We think that deal will stabilize in the mid-5s.
And then, turning back to Denver -- sorry, if I cut off you there.
No. Just to be clear, the hotel part will go away. When lease is up, David’s projection is strictly a residential apartment execution…
That’s the 12 months forward return on a fully stabilized apartment product. The existence of the WhyHotel will just provide some income in advance of that calculation.
Okay. Turning back to Denver, when you are underwriting that market, again, obviously, I know, it wasn’t end market exit, but when you are underwriting Denver and long-term NOI growth in Denver versus your existing portfolio, how is that market ranked against your existing markets?
Well, we think that Denver will be not particularly strong performer in the current and in next year because of the new supply that’s being delivered. We do believe supply will reduce considerably in 2019 and that it should probably -- perform most likely in the upper half of the market in which we currently operate.
And one last one if I may. To get the $500 million, will -- what other markets will be source of funds to grow or $1.5 billion, I’m sorry -- to get to the $1.5 billion, current environment, what other markets will be source of funds to fund Denver?
Well, I guess, it’s possible all of them could. Again, this is just a relative trade process. I think it’s possible we will continue to look at other New York assets that are subject to the 421-a tax burn off, but that’s not a requirement. So, as we look at across all of our properties on a regular basis, and we have sold out of all of our markets from time to time, and it will just be depend on what we think the best opportunity is at the time.
We will continue on to Rich Hill with Morgan Stanley.
One, I guess, macro question and then a little bit more micro. Talking about the New York -- the New York market for a moment. Obviously, it seems like, for lack of a better term, the worst case scenario has been taken off the table. And you are a lot more optimistic about New York City than you were previously. But, I’m sort of thinking about the future, and is this less than 1% of revenue growth, sort of a new steady state, just given the supply versus demand technicals? And while it’s not going to be nearly as bad as maybe some fear? Is it fair to say that we are not getting back up to the 2% plus revenue growth that we have seen in the past the like other markets? So, I guess, what I’m trying to get your view on is supply versus demand technicals. And if supply ebbs over the next couple of years, are we expecting to see a reacceleration in same-store revenue or is it just more muddling along in this zero to 50 basis-point range?
So, this is Michael. I guess, I’m not going to speak too specifically about ‘19 or into ‘20, but I guess I’d tell you, just given where we are in the trajectory that we have and the ability for this market to absorb the units that they seem to date in a rational way, I’d suggest that we will start to see modest pricing power start to return. And it may be neighborhood by neighborhood, submarket by submarket, but I think we will be in a position to get back to what you just described as more normal growth, 2% and 2.5%, something like that. I’m not sure if that’s going to happen immediately in ‘19 but I think clearly you are going to see some of that momentum start to emerge.
And then, back to the micro question. It looks like a retail move out in LA might have been just a little bit of a topline headwind. I’m sorry, if you mentioned this, but it looks like just back of the envelop that was maybe 10 basis points off the topline, or am I thinking about that correctly?
Right. So, for Los Angeles, we had one -- we had two retail centers vacated, single asset was about $500,000 in straight line rent that we reversed. So, by the end of the year, it will have no effect on the entire portfolio. And I would say to you right now, it had a very minimal rounding effect on the 2.2 we reported for the entire portfolio. For LA, you saw the footnote, there was an impact and that’s why we footnoted it. By the end of the year, as Michael mentioned in his script for Los Angeles, it might be a 10 basis-point negative, but not much.
Our next question comes from John Kim with BMO Capital Markets.
Just to follow up on that retail vacancy. Was this an unexpected vacancy? And do you see this occurring in other markets, just given the tough retail environment?
Sure. Just to give context, about 2% of our total rental income is from retail. We have a very small retail portfolio. We run it mostly as an amenity for our residents in our buildings, so coffee shops and like are very common tenants. So, no, this is uncommon, it’s lumpy, it’s -- I wouldn’t -- we don’t see this as a repeating event.
Couple of questions on Denver. One, do you expect to develop in this market, or just growth of acquisitions? And two, one of the arguments about being in this market was new supply, and what makes you comfortable about overcoming this characteristic?
We currently will reenter that market through acquisitions. We will certainly consider some joint venture development, the opportunities that they present themselves, and that is the way we got into the development business back in 1990s. And if appropriate, we believe there is capacity to develop ourselves there, we will certainly consider that.
Just with respect to the market, I’ve said and we’ve said for quite some time that this was not a market related exit, but it was a portfolio related exit when we sold the last time. And as -- when we did so, we saw this new supply coming and knew that it would have an impact on the marketplace. But we also thought that new supply would likely represent opportunities for us down the road, if and when we decided to reenter the market. And that’s exactly what’s happening right now. So, as I said previously, we’re not expecting to get terribly robust revenue growth, maybe in the first or second year in Denver. But, we think we’re buying it at a great assets, at a very good basis that will perform very well, as we get into 2019 and we begin -- we see that new supply begin to abate.
We’ll continue on to Michael Lewis with SunTrust.
You guys talked a bit about the low turnover and rightly it sounds like a lot of that is due to what you guys have been able to achieve. I was just wondering, if there is anything more macro out of your control that you think is causing the wind to be at your back on the turnover. Maybe it’s -- in your markets maybe SALT deduction is causing people to move out from ownership or maybe it’s some other factor that’s either continue to help you or turn against you on that front?
I think, there is a lot of reasons why this reduction is occurring. I think, the efforts of our onsite folks is just kind of the icing on cake that’s brining us down. But, you’ve got momentum in people deferring life decisions, marrying later, having children later, not rushing out to buy homes. I mean, buying home is the move up has declined in every single one of our market this last quarter outside of Orange County. So, I think, there is clearly other factors that are contributing to this decline, but I think our relentless focus on renewing our residents is clearly helping this as well.
Maybe a part B to that next question and the demographics are interesting. The oldest millennials are 38 this year. Have you seen anything on the margin there with movement, maybe an increased move toward homeownership?
No.
I mean, as noted, we’ve seen percentage of our move-outs to buy single family homes reduce. And we operate in the markets that have got very expensive costs of single family homeownerships such that we would expect our residents to remain renters for significantly longer, and that’s exactly what’s happening.
Thanks. You had that 2.2% year-over-year same-store revenue growth actually in each of the past four quarters, and the quarter before that was 2.1%, and the midpoint of the guidance this year was 2.1%. So, it’s really kind of steady now in this range. And I’m sure your cost, talking about 2019, but given this kind of steadiness and it looks like maybe supply is going to ease a little bit. I mean, do you think 2019, since the revenue growth is going to be higher or lower than ‘18 or do you think -- this is kind of where we are at right now as far as kind of a balanced market.
We can’t go into 2019 revenue growth at this time. We’ve sort of given you all the facts we see them. And at least for this juncture, you’ll have to come up with your own conclusion to that.
Our next question comes from Rich Anderson with Mizuho Securities.
So, the way you are approaching Denver, which is to buy now, even though the market isn’t great is interesting. And I’m wondering if that can be extrapolated to the New York City metro area, despite the fact that you got a $400 million asset for sale. Do you think there’s any opportunity to buy at this point where it isn’t great, but maybe will get great eventually again?
Well, I think that you are generally on to the thought process there, Rich, and that is, this is a trade. Right? We are trading capital from one market into another market. And as we look at what’s happening in New York and the low growth we’ve had there and the expectation for lower growth as -- in some of these assets as a result of the 421-a tax burn-off, it may make sense to rotate some capital into some other markets.
Now, I do want to note that the asset we acquired this past quarter, it happened to be in the New York metropolitan area. So, it’s not as though that we are selling or exiting New York. We were just rotating some capital out of some New York assets into another New York based asset as well as into Denver at this time.
And then, if I could just ask the other recent question little bit differently. I’m not going to look for 2019 guidance, I know you are not going to give me that. But maybe you can give 2021 guidance. And the way I’m thinking about it is, do you feel like this is a tight turning kind of situation with regard to your new guidance? I can appreciate, it’s going better for you in this current year. But having experienced cycles in multifamily for many, many years, not to dig you, I’m curious where do you think we stand right now in terms of how it’s playing out versus history? In other words, revenue of 2.2 last year, maybe you are getting close to that this year. Are we at the bottom or at least nearing the bottom from your perspective, particularly when you consider the decline in deliveries that you’re seeing in your markets?
Well, there is all sorts of things that will influence performance in 2020 and 2021. But, I think that you did touch on some important issues there. Michael just talked about what improved pricing power expected in New York soon as a result of this reduction in the new supply. There is a significant fall off of new supply coming in, in 2019. And as discussed earlier, to one of the questions, we are expecting supply to remain sort of in check, if you will, among other reasons, for the increase of construction costs and now the tariffs, and to Mark’s comments, the uncertainty of costs as a result of the tariffs. So, we look at supply being reasonably in check, beginning 2019. In general, there are some markets where like DC we are expecting it about the same on a year-over-year basis but just across the portfolio. So, absent any other sort of external sort of geopolitical sort of shocks or economic sort of shocks, we certainly expect with the current demand we are seeing and the retention that we are seeing and the expectation that our residents will be unable to afford single family housing or will opt to remain in rental housing for whatever reason, we think that the supply-demand fundamentals and the dynamics will improve from here.
We’ll go to Drew Babin with Baird.
A question, kind of taking supply out of the picture, lots of questions on supply. I guess, which markets would you see that on a seasonally adjusted basis you are seeing the strongest pick-ups in demand, both from an employment growth standpoint and a wage growth standpoint, which market do you feel are the most exciting and I guess which markets are kind of the most sluggish at this stage of the year?
Well, I mean, San Francisco clearly kind of tops the list right now, with the most momentum -- I don’t know how you can look at this stuff without thinking about the supply and the ability of the market to absorb the supply that’s coming to the market. But that market I think we’ve said now for a while, has been having these indicators of showing strength. And I gave you kind of great two great examples, not only for our own portfolio, the Peninsula from our own lease-up of that market just to kind of put that into context.
From a sluggish standpoint, it has to be the two markets that aren’t kind of meeting the expectations that we laid out originally, which would be the Seattle and Orange County. And I think both of those to me are short-term because of the impact to supply, they still have diverse job occurring. And I think we just need to see. We just haven’t found equilibrium in those markets, which is the ability to consecutively raise rate and keep velocity at a place we need, which tells me that we’ve got to work our way through the supply for those two markets.
I guess, said differently, are there any markets where you are seeing employment growth or wage growth reaccelerate or accelerate in a way that’s been surprising? It sounds like that has occurred in the Bay Area but in other markets.
No, I don’t think so. I mean, I think they are kind of all within check of what the original expectations were from job growth and where the job growth is coming from.
And then, on kind of segmenting the New York performance from a Manhattan but the New Jersey, Hudson waterfront properties. Can you talk a little bit about that area? I know there has been a little bit of supply there, and just talk about whether you are seeing concessions and any glimpse of pricing power in the near term there?
So, no concession. I mean, if there is concessions because they are nominal, they are targeted, they are strategic from a marketing standpoint. I mean just to put into perspective the kind of that Hudson waterfront area, it’s doing the best out of all of the submarkets that we have in New York on a year-to-date basis, posting kind of 1.3% revenue growth. So, I guess, at this point, I would say the trajectory looks good. I mean, I think, come Q4, like I said, in the slower periods, we will see what we need to do from a concessionary environment. But, the absorption of the supply there and our ability to kind of raise rates and maintain occupancy has been strong.
And one more for me. I was hoping if you could talk about the stabilized yield expectations on West End tower in Boston. And I guess kind of classify that as a spread through some of the acquisitions that you’ve made and are going to make in the duration of this year. I guess, most specifically kind of newer properties, obviously Denver is a much different market than Boston, but some of the recent developments you’ve been acquiring. I guess, what is that spread, and do you feel that that’s enough spread to compensate your further development risk in the Boston case?
Well, we think that our yield on that Boston deal at current rents will be in the low to mid-5s and will likely stabilize somewhere with the six-handle. We think that’s a terrific yield in a marketplace where that asset would probably trade today, maybe with a high-3 cap rate. So, we think we’re getting appropriately compensated for the 10 years worth of blood, sweat and tears that’s gone into to try and get that deal. Plus, it’s Mark, we think Boston is a great long-term market. There is a lot of exciting things going on in Boston and in Cambridge. And this will be a perfect asset for us own and operate for a long time.
John Guinee with Stifel has our next question.
Focusing on page 20 and building off the last question. It looks like you’re all-in development is about 874,000 a unit for West End tower, but you have only spent about 63,000 a unit so far. Does that imply that the land cost was less than 63,00 a unit? And if so, what your hard cost and soft cost per unit get up to a total development of 874,000 per unit?
I don’t have that level of specificity here. We had a land base -- essentially we’ve own that -- the property on which that tower is being built for 20 years or so. We had a land basis of about $20 million in that property. So, that represents a lot of what we’ve done. We’re incurring some demolition cost today of the existing garage, and that’s all that’s really been in there today, that land basis and some demolition costs as well as the capitalized costs that we’ve incurred in terms of architectural and engineering and all those sort of things. So, there is not a great deal of hard cost in there yet and I don’t have the breakdown at finger tips of that transaction.
Okay. Looking at your completed but not stabilized 724 million, it looks like your second quarter ‘18 number is about an annualized 3.5 yield on cost. What do you think these three completed, not stabilized assets will stabilize at 855 Brannan and the two Seattle deals? You are about 3.5 now at 90% occupied on average.
855 Brannan, we expect to stabilize at a high 4, the Helios deal at a about 5, and the Cascade deal at about 6.3, those are the three deals. And the Cascade deal went about 6.3.
That’s a long way…
But when you use the numbers in the release, that’s wherever these properties were at that particular moment. So, this is going back in time and looking at these numbers. So, having $6 million as this thing is ramping up, that’s not the right way to do, that’s not the correct math. That’s not going to get to a number that’s going to make any sense.
But the 3.5 second quarter number can ramp up into the mid-5s on stabilized?
Well, I guess by definition. Right? But whatever yields we are receiving today, will grow to the yields that I just told you on those transactions, as we lease and occupy those properties and get them stabilized.
And then, the last question on the -- I guess using maybe your Manhattan west asset as an example. What’s the yield impact on the 421-a tax burn-off? For example, let’s say your trailing cap rate is X and the buyers stabilized cap rate post 421 burn-off is Y, how much yield erosion is there as those tax abatements burn off.
Well, it also depends on what one is underwriting on the top line as well. But bottom line growth will be negatively impacted as those roll off. And depending on what property is that roll off and between two and three to five or six years from now.
The cap rate on -- the valuation on those buildings will not change as that occurs because the cap rate will reduce as the income is negatively impacted by that, and those deals will ultimately trade on a fully tax basis in the -- somewhere in the 3s most likely.
So, if you hold to your tax -- if you hold your top line constant, what’s the yield erosion over the burn off period, or is that impossible number to give us?
It’s an asset by asset determination. We have assets that are subject to 421-a that haven’t yet begun the burn-off period. We have assets that are done and we have assets that are in the middle and some assets are in different schedules than others. So, really, it’s kind of a custom calculation, asset by asset.
Alexander Goldfarb with Sandler O’Neill, please go ahead.
Just three really quick ones, so I’ll just go quick. First on Denver, David. Are you guys sort of just thinking like Cherry Creek area or how broadly are you defining your target, Denver MSA portfolio?
Well, the two assets we have under contract now are both in the sort of uptown, downtown area, if you will, not in Cherry Creek. So, we will continue to look for downtown, highly walkable sort of locations. We would certainly consider Cherry Creek but the two assets that we’ve have in our contract today are not in Cherry Creek.
Okay. But, are you looking broader in the greater MSA, or you really want to be more Denver proper?
Well, again, we’re looking for higher density, walkable sort of properties. So, I guess, I’d -- by that it seems that we would not be in distant suburbs but we will look at properties that have got a transportation components, or certainly walkability to -- probably that have got high walk scores.
Okay. And then, on the acquisition disposition guidance, both have increased the spread between acquisitions, and disposition has decreased, has narrowed. How has that impacted your IRRs that you are looking for both on what you are selling and what you are buying?
Well, those spreads don’t impact IRRs. So, I’m not sure I understand the question. That’s just the first year yield comparison between what we’re buying and what we’re selling. So, the IRRs on what we’re selling have been very good, plus 10% generally. And what we think we are buying in today’s marketplace, we think we’re buying probably in the 7s by and large.
So, I guess if I could rephrase it. As far as the impact to EQR’s earnings, if that spread is narrowing, do you view that that is decreasing the growth benefit of what you are buying versus what you are selling, or you are viewing that there is no difference to the growth profile of the assets that you are trading to EQR, based on that spread narrow?
Again, I’m sorry, I’m not picking up the question. I mean, certainly, it is in our benefit to have that spread be as narrow as possible or positive, right, to be selling lower yields and buying higher yields, provided you believe you’re -- we are strategically investing capital long-term strategically appropriately. So, it’s not as we are going to be selling New York and reinvesting in light spread assets. But if we can invest in our core markets and kind of assets we want to own long-term, the benefit of the Company and the business for that spread to be as narrow as possible if not positive, which will be highly unlikely that it would be positive.
And then, just finally, appreciate your comments on the Costa-Hawkins. From your people on the ground and everyone that you speak with, is there a sense that the local communities understand how vacancy decontrol impacts the market or is there a view that people just aren’t really aware of that, and what damage that could cause if that is removed?
Look, I think people’s feelings about this, Alex, are all over the board. There are some groups who will not listen to that side of the story. You just believe that it’s incredibly important to make rents affordable to the populace today and are unwilling or unable to sort of understand what the long-term impact in the housing market of that will be. Our belief is that while -- when people are initially asked about rent control and affordable housing, they are generally in favor of such. But when one describes what the long-term impact is on the existing housing stock and the negative impact on valuations of the housing stock and of single-family housing, at all, they will generally realize that perhaps it’s not the right thing to do. But, people have opinions all over the board on the matter.
Our next question comes from Tayo Okusanya with Jefferies.
When we first had the change, the tax reform issue, there was all this concern about big disadvantage for states that have high bid on local taxes. I was just kind of curious, now that it’s kind of been around for a couple of months, are you seeing that impacting demand for your assets or is that kind of just nothing -- you just have the zero impact or zero effect on demand in many of your key markets?
I think, in the short-term, any impact we’ve seen has been very positive, based upon the business communities, very positive reaction to the tax law change. And with capital expenditures, we now see them taking place in the hiring and the increase in wages as a result. So, very short-term impact has generally been very positive.
Any concern about any longer term negative impact though, or no?
Well, I think there are a lot of questions about the impact on some of these communities as a result of the limitations on SALT, on the state and local tax expenses and therefore the increased tax burden on people in some of these higher tax states. But as we have discussed I think on the last call, these continue to be extremely important economic centers of our country, and all continue to be -- seem to prospering extremely well as a result of lots of different things, including the new tax bill. And we will sort of see what happens. But right now I mean New York and California are two very high state -- tax burdened states, things seem to be going pretty well.
We’ll go to Wes Golladay with RBC Capital Markets.
I just want to go back to the Prop 10. Do you think that this will have any impact on development starts over the near-term? And then, conversely, a bigger picture outlook on supply. Could we get a contraction a few years out, as maybe some owners go to a condo, convert their apartments to a condo, and have Equity Residential contemplated doing such action.
Well, we’ve kind of not contemplated any specific reaction to this just yet. So, we’re -- I think there is -- one of the concerns that many have about rent control is the fact that it could take existing housing stock and turn it into for sale stock and remove it from the rental stock, which would obviously be a negative. With respect to new construction, I think that’s mostly impacted today by costs. It seems to me that whatever happens with rent control, there will be some limitation as to on what year product is built. So, the product likely built today, would not be negatively impacted by any changes in rent control as a result of the repeal of Costa-Hawkins. But all that remains to be seen.
Okay. And then, going with the costs, can you remind us what the allocation of steel is to the overall construction cost of call it maybe a high-rise in a major city?
Yes. On our property in Boston where my development guys are suggesting that the cost of steel would be about 25% greater today than what was priced when we did our deal, represents about 1% of the total cost of the project.
And with no additional questions, I will turn the...
I’m sorry. That’s a 4% cost, which is an effect of 1% on total cost. So, it’s 44 -- steel is about -- is 4% of the total cost.
Okay. So, with that, thank you, Catherine. This Equity Residential, we’re really -- we’re pleased to celebrate our 25th anniversary as a public company on August the 12th. Who knew back in the summer of 1993 what our 22,000-unit apartment company with an enterprise value of $800 million would become. We are extremely grateful for this support of so many in investment community over that time for the dedication of our Board of Trustees, both past and present, and for the many thousands of hardworking professionals that have built this company its very special and enduring culture. So, many thanks to you all, best wishes to you all for an enjoyable summer, and we’ll see you in September.
Thank you. Ladies and gentlemen, again, that does conclude today’s conference. Thank you all again for your participation. You may now disconnect.