Welcome, ladies and gentlemen, and welcome to AvalonBay Communities Third Quarter 2023 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 Investor Relations. Mr. Reilley, you may begin your conference.

Thank you, Rob, and welcome to AvalonBay Communities' third quarter 2023 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. The 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 will turn the call over to Ben Schall, CEO and President of AvalonBay Communities, for his remarks. Ben?

Thank you, Jason, and thank you, everyone, for joining us. In keeping with our custom, we posted a presentation last night to accompany our earnings release. In addition to my opening comments, you will hear from Sean on our operating performance and revenue building blocks for 2024; from Matt on the significant earnings being generated by our development projects and lease-up; and from Kevin on the strength of our balance sheet. I want to start with my thanks to the AvalonBay team and our 3,000-plus associates for delivering another strong quarter of financial performance and operating results. Particularly in the current environment of higher interest rates and uncertain cap rates, we are laser-focused on driving cash flow growth from our portfolio. The bottom line results from our operating model transformation led by our on-site and centralized teams and powered by our technology, revenue management, data science teams, and proprietary systems continue to outpace expectations. Our strong operating performance also speaks to our portfolio positioning, which is 70% suburban and primarily in suburban coastal markets, which continue to benefit from a combination of steady demand and limited new supply. Turning to Slide 4 in the presentation, we grew core FFO by 6.4% in Q3, which was $0.06 ahead of our expectations. This outperformance was primarily driven by better-than-expected revenue growth, which positions us well, as we enter the traditional slower leasing season. As shown on the bottom of Slide 4, we have raised $855 million of capital this year at a 4.3% initial cost, which includes the drawdown of our $500 million equity forward, which we priced at $250 per share and with the remainder coming from asset sales that we've sold at an average cap rate of 4.7%. We completed three development projects in Q3, two in suburban submarkets in the Northeast and one in Miami at a 7.2% stabilized yield. As Matt will emphasize later, our lease-up communities continue to outperform our original expectations by a wide margin. These projects are funded with yesterday's capital, at yesterday's capital cost, and are slated to generate outsized value creation and earnings for investors. We also started two projects this quarter, one in Princeton, New Jersey and one in South Miami, with projected yields in the mid-6% range. I will come back to our positioning on new development and capital allocation at the end of our prepared remarks. In Q3, we made $50 million of commitments under our structured investment program or SIP and feel fortunate to be building this book of business in today's environment with these new commitments generating an attractive 13% return. Slide five provides the breakdown of our Q3 revenue outperformance relative to guidance from the end of July with a 30 basis point uplift from higher-than-expected occupancy, 20 basis points from higher rates, and 10 basis points from improving bad debt. Turning to slide six, we've exceeded and raised guidance three times this year. We now expect core FFO to grow 8.6% in 2023, which is 330 basis points above our initial expectations for the year. Same-store revenue growth expectations are up 130 basis points. Expenses are down slightly, leading to NOI growth of 6.3%. And with that, I'll turn it to Sean to comment on the favorable demand and supply drivers in our markets and provide a fuller operating update.

Thanks, Ben. As we start to look forward to 2024, I thought I'd provide some initial thoughts on two topics. First, I'd like to highlight a few macro factors that will support the performance of our portfolio in the coming year. And then second, share a few building blocks as it relates to the outlook for 2024 revenue growth specifically. Starting on slide seven, we believe our portfolio is well positioned as it relates to rental affordability, particularly as compared to other regions of the country and single-family for sale product. In Chart 1, you can see that rental affordability in our established regions is actually better than pre-pandemic levels, given the strong wage growth that's been experienced over the last few years. And in Chart 2, the difference between the cost of owning the median-price home and median rent in our established regions has increased by roughly 10x if you look at the first three quarters of 2023 relative to the average during 2020, which certainly makes apartment living a more attractive option in these regions. We've already seen the impact of this trend in multiple data points. For example, the volume of existing home sales in our established regions has declined by roughly 25% over the past year. And in our own portfolio, the percentage of move-outs to purchase a home has dipped below 10% this year well below the mid-teens long-term average. Moving to slide eight, our portfolio is also relatively insulated from new supply, particularly as compared to the Sunbelt. In our established regions, we expect new multifamily deliveries of approximately 1.5% of existing stock. And in the specific submarkets where we own assets, new supply is projected to be roughly 1% of stock. This bodes well for revenue growth in all market cycles, but is a particularly valuable attribute of our portfolio if we experience a weaker economic environment during 2024. Transitioning to slide nine, I'd like to highlight four specific building blocks for 2024 revenue growth. First, the embedded growth in the rent roll from leases we've executed during 2023 stands at approximately 1.5%, which is above our long-term average at this point of the year. Second, our current loss to lease is roughly 2%, led by the East Coast at about 2.5%, while the West Coast and expansion regions trailed behind at approximately 1.5% and 70 basis points respectively. Third, we continue to drive incremental revenue from our operating model initiatives. For example, the September revenue from our Avalon Connect offering was about 40% greater than the average monthly revenue for the first nine months of the year, and that monthly revenue run rate will continue to grow during the last two months of 2023 and throughout 2024. Lastly, we are expecting a continued tailwind from the normalization of bad debt. During the first half of the year, underlying bad debt averaged approximately 2.7% as compared to the Q3 average of roughly 2%, and we expect continued improvement as we move through 2024. The benefit from an improvement in underlying bad debt will be partially offset by the loss of rent relief we've recognized in 2023, but still be a net meaningful benefit for 2024. Taken together, these building blocks should support healthy revenue growth during the upcoming year. So with that, I'll turn it over to Matt to address our lease-up activity and structured investment platform.

All right. Thanks, Sean. Turning to slide 10. Our lease-ups continue to deliver outstanding results, laying the foundation for strong future growth in both earnings and NAV. We have five development communities that had active leasing in Q3, and those five deals are leasing up at rents that are $485 per month or 17% above our initial underwriting. This, in turn, is driving a 90 basis point increase in the yield on these investments to 7.4%, far above any estimate of current cap rates and even further above the cost of capital we sourced to fund these deals back when they broke ground several years ago. After a relatively light year of deliveries in 2023, we do expect to see a significant increase in our apartment completions in 2024, which will provide incremental NOI and FFO as these communities reach stabilization. Slide 11 provides an update on our structured investment program where we initiated two new investments last quarter and $52 million at an all-in average interest rate of 13%. As we've discussed on prior calls, these are three to five-year investments where we provide capital to merchant builders that sits above the construction loan but below common equity in the capital structure. We're still early in the buildup of this new line of business and expect it to continue to grow to roughly $400 million over the next few years, providing a nice tailwind to earnings growth as these dollars get invested and start earning a return. We're also fortunate that we're able to underwrite most of this business in today's more restrictive environment, providing a strong risk-adjusted return, particularly for the latest additions to the program. And with that, I'll turn it over to Kevin.

Thanks, Matt. Turning to the next few slides. We continue to enjoy tremendous financial strength and flexibility both from a balance sheet and a liquidity perspective. Specifically from a balance sheet perspective, as you can see on slide 12, we enjoy low leverage with net debt to EBITDA of 4.1 times, which is below our target range of five times to six times. Our interest coverage ratio and our unencumbered NOI percentage are at near-record levels of 7.5 times and 95% respectively. Our debt maturities are well-laddered with a weighted average years to maturity of 7.5 years. And our development underway is nearly 100% match-funded essentially with yesterday's lower cost of capital, which in turn helps ensure that these projects provide earnings and NAV growth when they are completed and stabilized. In addition, from a liquidity perspective, as shown on slide 13, we continue to maintain a high level of excess liquidity relative to our open commitments for development and structured investment products as of quarter-end. Specifically, we enjoy $1.5 billion of excess liquidity. And so, as a result, we continue to enjoy tremendous financial strength and stability and the flexibility to pursue attractive growth opportunities that may emerge across our investment platforms in the coming months. And with that, I'll turn it back to Ben.

All right. Thanks, Kevin. We have consistently maintained a strong balance sheet throughout cycles, and as a result, we are well prepared for the current environment. As we have shown over the past couple of years, we proactively adjusted our capital sourcing and capital allocation activities based on changes in the environment, as emphasized on slide 14. We locked in our equity forward in early 2022 to pre-fund future development activity. We shifted in the second half of 2022 and in 2023 to be a net seller of assets with a portion of the proceeds being utilized to fund acquisitions as we reshape the portfolio and the balance to fund accretive development. We have continued to be responsive in adjusting our development start activity, reducing starts last year and this year as our cost of capital changed. As we've emphasized, we are 95% match-funded on our development underway, which means all of that capital has already been raised at an attractive initial cost and allows us to deliver projects in 2024 and 2025 that will generate significant earnings and value. On a go-forward basis, we have raised our return requirements on new development. For a standard development deal, our target return was in the low to mid-6s in the middle of the year, and is in the mid- to high-6s today. These target returns are up over 100 basis points since last year with the goal of underwriting 100 to 150 basis points of spread between development yields and market cap rates. We expect to be in a lower development start environment in the coming quarters and with spreads at the tighter end of this range after a number of years of outsized development profit margins. While in the current environment we're focused on maintaining our balance sheet strength, we believe that we are well-positioned given our low leverage, ample liquidity, and unique strategic capabilities to capitalize on opportunities that might result from market dislocations. In the near term, while volumes are modest, we're able to deploy capital at double-digit returns through our SIP program. Slide 15 concludes our prepared remarks with our key takeaways. We continue to deliver strong operating results with tailwinds specific to our suburban coastal markets and incremental NOI to come from our developments and lease-up, all supported by a fantastic balance sheet. And with that, operator, please open the line for questions.

Thank you. At this time, we will be conducting a question-and-answer session. Our first question comes from Eric Wolfe with Citi. Please proceed with your question.

Hi. Thanks for taking my questions. I think you said that you raised your development yields, that's underwritten to be mid to high 6s. Just curious why you think that's the appropriate level? And what percentage of your future development pipeline will that criteria? So if you just take your rights pipeline and everything else, what percentage would be started under that criteria?

Hi, Eric. It's Matt. I guess I can speak to that one a little bit. As Ben mentioned, we're really trying to preserve that spread of 100 to 150 basis points between cap rates and development yields. So mid to high six is a reflection of where we think they are. It's very hard to know where spot cap rates would be today. I think we had a pretty good sense of where they were over the summer when transaction activity started to pick up with the most current rise in rates. It's a little bit of a guess, but if you think cap rates are maybe in the mid-5s, then that would translate into development yields in the mid to high 6s to preserve that spread. It does vary by product type and by region, of course. But that's really kind of the thinking behind that. And as it relates to what percentage of the current book meets that threshold, it's actually hard to say because things are moving around so much. What we've found is that until we have CDs permits in hand, hard drawings to bid on the street, we don't really know where hard costs are today. They are starting to come down, but you don't realize that on an estimate that you want to realize when you're ready to go. So, what I would say is we have plenty of deals that do clear that hurdle. We just started two deals this quarter. We're in the mid-6s. We have at least a couple more that could start over the next couple of quarters that we think are in that position. We do have some that on the most current underwriting from six to 12 months ago will probably fall a little bit short of that. In many of those cases, we're hoping that with some value engineering, maybe some changes to the land economics with the landowner, and changes in hard costs that by the time those deals are ready to go they will meet that.

Understood. That's helpful. And then you gave some good detail on the building blocks for same-store revenue growth for next year. Obviously, the one piece that's missing is just your expectation around what market rents will do. Then I know it's too early to provide that, but I was just hoping you could give us a sense for the process that you go through in terms of figuring that out whether you're building up or down? And then sort of if you were to do it today if you just have a sense for what market rate growth would look like?

Yes, Eric, it's Sean. That's a good question. We approach this in two ways: a macro perspective and a grassroots bottom-up analysis. From a macro standpoint, based on our current insights, we expect demand to slow down as we enter 2024 due to anticipated slower job and wage growth, along with other potential challenges like oil prices, interest costs, and student loans. There are several macro factors that seem to be acting as headwinds. We continuously review the consensus forecasts for various macroeconomic indicators throughout the year. When January arrives, the latest forecasts will guide our outlook for 2024, similar to how we operate every year. We also assess what we observe on the ground as we refine our supply pipeline to estimate the impact on market rent growth using our algorithms. Thus, we utilize both macro top-down and bottom-up approaches depending on the variables considered. Currently, it's challenging to provide a precise estimate, but we do expect a softer demand environment in 2024 compared to 2023 based on the current consensus outlook for macro variables.

Got it. That’s helpful. Thank you.

Our next question comes from Austin Wurschmidt with KeyBanc Capital Markets. Please proceed with your question.

Thank you. So, more near-term I guess has the moderation in lease rate growth been partly strategic as you sought to backfill some of the occupancy you lost around midyear? And then you've just kind of continued to build occupancy into the softer part of the leasing season? Or is this more related to the pockets of softness across the portfolio like in Northern California, it looks like and also in some of your expansion markets?

Yeah. Austin good question, I'd say it's a mix of those answers frankly. At the early part of the third quarter, I would say it was more a reflection of our efforts to build occupancy which was successful in a number of markets. Combined with I'd say one or two places that continue to remain soft even a little bit softer as we got to the end of the third quarter. That was certainly important to Northern California as the primary region where we experienced that. So really a combination of two things as it relates to what you saw in rent change through the quarter as well as into October.

On the topic of external growth and investment, how do you feel about the size of the development pipeline? Considering what you know today, do you think that as deliveries and completions increase next year, you will be able to maintain the size of the pipeline in 2024? Or do you believe it would be wiser to invest more in new acquisitions given the risk-reward profile and your strategic goals of entering expansion markets?

Austin, I'll start with that. It's Ben. So on the developments we have underway we do have strong conviction that those are going to continue to create meaningful earnings and value. We obviously got good visibility there on when they're going to be delivering. As we head into 2024 and 2025, we do expect a fairly significant ramp-up of that activity. It may not be quite at the same outperformance levels that we've seen over the last year but still expecting strong performance out of that pool. As we think about new capital and the decision-making process there on the development side, I think we've been very clear. We want to make sure if we're going to undertake new development that there's a sufficient profit margin relative to underlying market cap rates. Another way of saying we want to make sure there's sufficient profit margin to where we could buy an asset. In today's environment, there have been opportunities in both. There are certain markets and certain projects that we've been able to structure for new development where we're able to obtain sufficient spreads and there are other markets and you saw this in some of our acquisition activity over the last quarter too, as an example in Dallas where we're able to buy assets below replacement cost and start to build the portfolio in those markets. So it's a multifaceted approach. We're fortunate in that we have multiple levels to grow over time. As we've emphasized, it's on us as a team to make sure that we continue to stay flexible in that approach and change our approaches depending on what's happening in the market environment as well as what's happening with our cost of capital.

Thank you.

Our next question comes from John Kim with BMO Capital Markets. Please proceed with your question.

Thank you. I wanted to ask on leasing trends in some of your markets, specifically Northern California which looks like the lease growth rates kind of nosedived in September and October. And that diverged from Seattle which is a similar market in terms of tech job growth where you saw an improvement. But can you just discuss the demand picture? And why there was such a difference in performance in those two markets?

Yeah. John, it's Sean. Good question. There are a couple of different answers to that. First, as it relates to what you saw in Seattle, which also occurred by the way in the Mid-Atlantic and Denver is that we're starting to get into a period particularly as we get further into the fourth quarter where the comps are easier on a year-over-year basis. That’s a reflection of the step-up that you saw in rent change in those three regions in a more meaningful way particularly in Seattle as you may have noticed. Whereas in Northern California most concentrated in San Francisco, I would say, which is only 30% of our current portfolio. Things did soften more so particularly as we got to sort of mid-September into October and that's what's reflected in the rent change, you saw continued to tick down through the quarter and then more meaningfully into October. I think there's a couple of things there. One is San Francisco just to pick on it since everyone seems to like to lately. There's a number of different headwinds there, as I think we're all well aware of probably not the best time of the year to be seeing some elevated demand there. It's just not the case. There’s not really a great reason for people to be coming back to the office at this point still. So fundamentals have remained weak, and they did get weaker as we moved through the quarter into October. So trying to know exactly what's underneath that other than weaker demand overall. It's hard to be precise, but I'd say we did not see the same level of weakness in Seattle. You combine that with the year-over-year comp in Seattle, and that's why you saw the uptick there. So Seattle is still not strong. But on a relative basis compared to last year, for example, there was a lot of short-term leasing activity throughout the year and then burned off in the third quarter putting more pressure on rates at the end of Q3 and Q4. We didn't have a lot of that short-term demand in 2023, and therefore, the year-over-year compensation is easier. Not to get too far into the weeds, but that's some insight into what you saw in a place like Seattle as compared to Northern California.

That's very helpful. My second question is on bad debt, which you discussed has improved this year and is likely to be a tailwind in 2024 earnings. My question is how much of an improvement can you see from the 2.1% pre-resident relief funds that you got this quarter? And in particular, Southeast Florida was surprisingly your worst-performing market in bad debt. I was wondering if you could provide some commentary on that.

Sure. So on the first question as it relates to bad debt, so 2023 if you look at the beginning of the year to sort of where we're trending today just sort of rough justice there's about 100 basis point improvement in underlying bad debt roughly from 3% down to sort of trending around 2% today. We've seen improvement across almost all regions Florida kind of being the outlier as you noted. But I think what we've seen in 2023, there was meaningful improvement in a market like Southern California, which started the year at roughly 6% and now we're below 3%. As compared to some other regions has certainly improved, but it improved at a more modest rate. As we look forward to 2024, I think the expectation for continued improvement is there, but it may be at a slightly lower rate than what we experienced in 2023 given the meaningful improvement that we experienced in Southern California. Now we're down to some regions like New York as an example where things are moving a little more slowly. The pace of improvement throughout 2024 may be slightly lower than what we experienced throughout 2023 if that makes sense. But the other thing to keep in mind is that we will have some meaningful improvement, but it will be partially offset by the loss of rent relief that's going to be roughly $7 million that we're not expecting to recognize in 2024 that we did recognize in 2023. So these are some of the building blocks as it relates to bad debt that hopefully are helpful. As it relates to Florida specifically, what I would tell you is where we've seen elevated bad debt, and frankly, it's been beyond our expectations. It has really been in Miami and Fort Lauderdale, the West Palm Beach market has held up kind of where we would have expected it would have been, but it has been elevated in the other two markets beyond what our expectation was.

Great. Thank you.

Yeah.

Our next question comes from Adam Kramer with Morgan Stanley. Please proceed with your question.

Hey, everyone. Thank you for your time. I was curious about the timing for sending out lease renewals for after November and December.

Yeah, Adam, we sent them out at 6% for November, December, which is relatively consistent with what we quoted for where we were for the 2 months of Q3 on the last call. We have seen in some markets a little more degradation in terms of the committed offer to realization, but it's still within sort of the 150 to 200 basis point range what we're seeing renewals coming in at 4% to 4.5%, depending on the more recent time period you're looking at.

Got it. That's helpful. Can you remind us what percentage of move-outs to buy a home was in the most recent quarter?

Yeah. As I mentioned in my prepared remarks, it has been trending below 10% all year. It's about 9.5% in Q3. I think we're roughly 9% for Q2. So it has been trending down. As I mentioned, the long-term average is kind of in the mid-teens and it's been as high as the sort of high teens kind of pre-GFC.

Great. And maybe just one last quick question from me, if that's alright. I'm interested in the progression of bad debt, not necessarily asking for a specific time frame or number. Considering the recovery path back to pre-COVID levels, is that the goal, and do you think it's achievable to return to those levels? Also, what do you estimate the rough time frame for that recovery might be?

Yeah. Good question. In terms of pre-COVID levels, which are typically call it, 50, 60 basis points, the question is whether it's going to be a new normal or not. I think probably the industry expectation is given various regulatory changes that have occurred in most markets across the country that it might be ideal to get back to 50, 60 basis points, maybe 70, 80 is more realistic. I don't think we really know yet. In terms of the time to get there, certainly, what I would say is I don't believe we'll get back to full stabilization by the end of 2024. I would expect it to carry into 2025. What we really need to see is a little more movement as it relates to cases moving through the courts, particularly in markets like Maryland, D.C., and the Greater New York region. As I mentioned earlier, we've seen significant progress in Southern California. 6% bad debt down to sub-3% now. We haven't seen anything like that in terms of percentage improvement in some of the other regions I just mentioned.

Thank you.

Our next question comes from John Pawlowski with Green Street. Please proceed with your question.

Thanks for taking the question. Just a follow-up on the delinquent tenant conversation. As you work through the backlog, evictions, and long-term delinquent units, do you expect a meaningful acceleration in repair and maintenance costs next year?

Yeah. Good question, John. We can. We have seen some of that this year as reflected in what we've posted in terms of cost because there's greater damage in the units. You might do billing damage receipts back to the resident, but then you're pretty much immediately writing it off because you're not collecting it. So I would say that has been elevated this year, and I would expect that along with legal and eviction costs to also remain elevated in 2024. It may not be a significant growth rate from 2023 to 2024 but it should remain elevated in both categories.

Okay. Sean, one market level question. Can you just give us some color on the large sequential revenue decline in D.C. proper this past quarter?

Yes, D.C. proper there's a number of issues there. As it relates to primarily, what you've got is sort of a seasonal issue. We have probably three assets there that have exposure to the student population near AU or other universities. You typically see that occur sequentially during that quarter, and then it bounces back in Q4. That's the most meaningful component. There are other miscellaneous things as it relates to supply and the number of submarket and other things that you could overlay on top of that, but by far the sequential change for the student population is the most meaningful one.

Okay. Thanks for taking the questions.

Our next question is from James Feldman with Wells Fargo. Please proceed with your question.

Great. Thank you. I guess for my first question, can you just talk more about the acquisitions both in the quarter and the October acquisition? I guess, what I'd love to hear about is how distressed were the sellers – how much did pricing move before you decided to buy the assets? Just any color on what the market looks like in pricing?

Sure. It's Matt. I'll speak to that one. So again, just taking a step back here, we sold $445 million worth of assets this year, including one – our last disposition, which will close at the end – close next week. Those were at a blended average cap rate in the high 4s. Those were kind of sold and priced throughout the year better pricing earlier in the year, and softer pricing later in the year. We bought three assets for about $275 million, all in the last 60 days. Those cap rates were more like mid-4s. I would say in no cases were the sellers distressed. In one of those cases, we did assume some debt, which probably gave a little boost to the price. All of those assets, if we were to price in today's market would certainly price at a higher cap rate than that. I don't know how much higher. Same with the dispose. Again, we pivoted to being a net seller of assets so we sell first. In many cases, we're holding some of those proceeds for a 10/31 exchange, and that's informing kind of our appetite on the buy side. We were net sellers of $200 million or really more like $230 million after you factor in the assumed debt in terms of the cash proceeds we realized from it. The other thing I'd say is when you think about what we bought versus what we sold, it is a good illustration of what we're doing with our portfolio allocation. We sold four assets out of our established regions; they were on average 25 years old. We sold them at an average price of $450,000 a unit, and the average rents on those assets were $3,300 a month. The three assets we bought were in Dallas and in the Greater Charlotte area. In all three cases, there are assets where we are able to add value through our operating platform in many cases. It's part of getting to operating scale in those regions. We think that while the cap rate is in the mid-4s, the yield is more like a 5. Between some value add, we're doing a little bit of light value-add with washer dryers and some hard surface flooring, but a lot of it is just bringing it onto our operating platform as we get economies of scale in those regions. Those three assets on average are seven years old. We paid on average $245,000 a door, which is below today's replacement cost, as Ben mentioned, and an average rent of $1,700. So a much more affordable price point which we think has a much better growth profile.

Okay. Thank you for that. I mean M&A commented this morning that they're seeing developers cut rents, so that they can get occupancy up and get assets ready for sale if they're having debt maturities. So I guess, sticking with kind of the distressed line of questioning, I mean do you think that's coming your way in your expansion markets? And then similarly, as you think about the SIP book over the next few years, I know you mentioned $400 million, but do you think this environment helps you accelerate that? And do you have a view on maybe what you could do over the next 12 months? And what kind of yields?

Jamie, it's Ben. We'll put it this way, we're not seeing distress at this point. We do expect there to be some dislocation that comes through the system. On the buying side, there are a couple of different areas in which we're hunting. One is what Matt talked about, places where we can be adding to the density of our portfolio, assets nearby other assets, places where we can add incremental value by bringing the operating initiative activity over to our acquisitions, so that's very much top of mind. Another potential pool and we've been staying close to potential opportunities here are deals in lease-up that maybe are coming up against nearer-term loan maturities. What we've been seeing there to date is situations where equity capital is putting more equity into those deals, effectively recapitalizing them and/or lenders who are agreeing to extend out those loans. And what you're finding is the borrowers and lenders are agreeing to say extend it out; you get the step-up in the interest rate not going to be a lot of cash flow generated off of the asset, but better to extend there and get the asset fully leased than monetize it, at least for the types of assets in the markets that we're looking to acquire in. Now, that won't be the case right for all types of equity. There's going to be equity that doesn't have the ability to put in more capital, and it won't be the case for all types of lenders; there's only certain profiles of lenders that can extend out. So, it's an area that we are staying close to. Quickly on kind of two other areas of opportunity, one on the land side. Our developers as Matt talked about today are actively reworking our existing pipeline, recutting deals, restriking deals. We're also out looking for new land opportunities. The current capital environment and our expectations for what that capital environment will be over the next year, we expect to see opportunities there. Apparently, there's going to be less competition from merchant builders in those markets. So, it'll be selective, but that could be a fruitful area. The third area of opportunity is providing capital to the third-party developers. We have two programs there, DFP and SIP. We'll be selective. But for sure, in terms of the quality of sponsor approaching us, the quality of the real estate that they have under control, and the return profile of those deals, all of that is enhanced in this environment. So that's another place that we can deploy capital accretively.

So, on the SIP, do you have a sense of how much you can deploy over the next year or so?

In the SIP, we have a target of building that book of business up to $300 million to $500 million over a couple of year period. Given the financing markets, it is tough for deals to pencil, but there are some that do. We are very selective. These are deals we're underwriting not to own them but to be comfortable owning them if we need to. And in places where we can get a 13% return; we think that's a pretty attractive source of capital. So, it's an area of focus. I wouldn't necessarily say it's an area we're looking to accelerate activity. We want to build that book up in a measured way over the next couple of years.

Our next question comes from Michael Goldsmith with UBS. Please proceed with your question.

Good afternoon. Thank you for taking my question. My first question is about customer behavior. Can you share insights on traffic and the percentage of people looking to buy homes? Are you noticing any trends with residents doubling up? Additionally, November and December of 2022 were particularly weak, but there was a rebound early in 2023. How are you assessing the last three months? Do you anticipate the same trajectory as last year, or do you expect better growth in the fourth quarter due to easier comparisons? Thank you.

Yeah Michael, it's Sean. I'll take those. In terms of customer behavior, I'd say the trends we've seen this year have remained relatively consistent. As I mentioned earlier in response to a question in my prepared remarks, move-outs to purchase a home is well, well below long-term averages sub-10% and has been below there for some time now. So not surprising given everything you're experiencing in the single-family for sale market in terms of a run-up in values and REITs and now the slowing market, etc. people not terribly inclined to purchase a home and renting is not only more affordable but if you're a risk-off mode you may not want to consider it anyways. Nothing else notable I would say in terms of customer behavior at this point in time. As you noted, the year-over-year comp does get easier as we proceed further into Q4. A little bit of that as I mentioned in October as it relates to the uptick in rent change in the Mid-Atlantic, Denver, and Seattle regions. We do expect rent change to somewhat stabilize as we look at November and December. And while it won't be anything super terrific in terms of a significant rebound as an example, it should be more stable than what we experienced last year based on what we know today.

Thanks for that. And my follow-up question is related to taxes. The New York City tax burn-off was a significant factor in the real estate tax. What's the expected impact going forward? And how should we think about real estate tax for the expansion markets versus the coastal markets?

Yeah. Good question. As it relates to property taxes, which are about 35% of our expense structure, we do expect another elevated year of tax pressure in 2024, most of it related to the expiration of those tax abatement programs that we experienced this year. The level of impact next year will be relatively similar to 2023. As it relates to tax rate, or just tax growth in the Sunbelt or our expansion regions versus the established regions independent of the expiration of the tax abatement programs, certainly, I would expect more pressure in the expansion regions and the Sunbelt in general given the significant run-up in values that they have experienced over the last three years relative to the established regions. I think that's pretty clear. There's always a lag effect. So the question is just which market, which submarket tax jurisdiction, etc., but certainly expect more pressure in those regions as compared to our established regions, which is still the majority of our portfolio.

Thanks for that, and good luck in the fourth quarter.

Thank you.

Our next question comes from Joshua Dennerlein with Bank of America. Please proceed with your question.

Yes. Hey, guys. I appreciate the disclosure on the two new product starts and then also how you're kind of doing that with the projects in lease-up right now to 90 basis point higher spread. Just trying to...

Hey, Josh, we're getting a lot of feedback on the call.

I apologize.

Why don’t you dial and we will get you back in the line.

The next question comes from Steve Sakwa with Evercore. Please proceed with your question.

Thanks. I just want to circle back on the development. So are you guys planning development starts in the fourth quarter, or is it up in the air? It sounded like Matt you had some things that would pencil on that high six maybe seven range. But I'm just not sure if you actually were starting anything in the fourth quarter. And if we think about 2024 starts would those most likely be back half weighted to give yourself some time to kind of see how the economy plays out here?

Yes Steve, we may well start a deal in the fourth quarter that would be on similar economics to the Q3 starts. We're 95% match funded on development underway today, so if we have deals that we think make sense we think we do have some room there. I wouldn't be surprised if we have a similar level of start activity in Q4 to Q3, maybe whether it's one or two deals I don't know. When we think about 2024, I think you're probably right. It probably is more back half weighted based on kind of how the capital markets evolve and kind of our access to and pricing of new capital that would fund that business. We've been in a again for us if we track to roughly $800 million in starts this year or maybe a little bit under that, that would be a pretty light year for us and certainly lighter than what we expected going into the year which was the same last year. We're at a pretty modest level of starts volume relative to our kind of long-run capacity and averages and that's a response to what we're seeing in the markets, but I don't think we would view that as a significant level.

Got it. And then just secondly on expenses they've come in a little bit better than what you originally guided, but still kind of elevated in the six-plus range. Just as you think about the puts and takes into next year how do you maybe see expenses trending? What might be a little bit better and what overall might be still headwinds into next year?

Yes, Steve, it's Sean. I can take that one. I mean we do expect 2024 to be another somewhat elevated year primarily due to a few factors I can touch on. One I mentioned earlier property taxes which is about 35% of our expense structure. We do expect it to grow at an elevated rate due to the expiration of those tax abatement programs that I mentioned previously. Utilities, which is about 12% of the expense structure, the continued implementation of our AvalonConnect offering which is a profitable endeavor. We're expecting kind of $25 million of incremental NOI from that program, but it is a burden on OpEx growth as it's being implemented, and we do expect that to be continuing through 2024 as well. And then two other sort of pressure points really are going to be insurance even though it's only 5% of OpEx. It's still a difficult market. We'll be trying to mitigate that pressure through the use of our captive and other strategies to help offset it relative to market growth rate, but it's still may be elevated relative to sort of normal trends. The last one is the repairs and maintenance and legal costs, which I mentioned earlier is a result of continuing to move out sort of the nonpaying residents and puts pressure on turn costs legal and eviction costs, etc. Some of that will be offset by continued benefits from the initiatives particularly on the payroll side of things. But certainly, we won't be able to offset all those other macro trends that we'd see occurring in 2024 similar to 2023.

So not to maybe put words in your mouth, Sean, but it sounds like the 6.3, I don't want to call it a run rate but it doesn't sound like there's a lot of nonrecurring that would really burn down. It sounds like expenses could be kind of in that ballpark for next year or maybe a little bit better but elevated I guess relative to history?

Yes. I think the elevated relative to history is the operative statement there. I think that's appropriate. There may be a little bit of relief in some areas like in utilities we should have some better contracts in 2024 relative to 2023, but we still do have the AvalonConnect offering. Again, it's profitable but moving through the year. So I think your phrase is generally in the ballpark.

Our next question comes from Connor Mitchell with Piper Sandler. Please proceed with your question.

Hey, good afternoon. Thanks for the time. So my first question, you guys talked about distressed deals in the environment a little bit. So, I guess, I was just wondering when you guys approach distressed deals, taking over private deals how does it compare for the underwriting of those deals versus your internal underwriting? Are the assumptions similar, or do you guys have to make a lot of adjustments? And maybe also that can relate to the SIP program you were discussing earlier about how you underwrite those in the case you have to take over projects?

I guess, I can try and take that one. We underwrite everything more or less the same which is we develop our own view of what we think the NOI is going to be and where we think the asset value would be. In the SIP frequently, almost always the sponsor will provide a projection of NOI that we think is overly optimistic. Again, we have a lot of data that we can leverage to do good underwriting in these programs, and the fact that we own and operate assets and have real rent rolls and everything else in all of these markets is one reason why we think that this is an appropriate place for us to invest and a prudent way to leverage our capabilities and our proprietary data. We get their underwriting. We won't say we throw it in the trash, but we do our own underwriting. Based on that, we come up with our own view of where we think the NOI would be for that asset, very similar to if it was an asset we were developing. Then we build in a margin of safety on that when we think about how high we're willing to lend in the capital stack under the expectation that again we're going to be paid back out of an asset sale in the back end. We are prepared to step in at our lender basis, and have the view that if we have to step in at our lender basis, because they can't pay us back that would not be a bad outcome for us from an investment point of view the basis we would be in that asset. There are some assets we just wouldn't lend on, because we wouldn't be prepared. We wouldn't want to own them really under almost at any price. So that's one of our screens in the SIP. As it relates to acquisitions or development, it's kind of the same. We'll just look at where we think the deal should underwrite. Based on that, we'll formulate a view of what we think is worth and make an offer and see if we can tie it up.

One maybe just to add one thing, I'm not sure this is exactly where you were going but we do try to apply what we think is sort of a market-based underwriting given our standards. Matt was mentioning earlier, we may be buying a deal at what we think is we'll pick a number of 4.5 cap, 5 cap, or 5.5 cap, above when we bring it on our operating platform we may take up 50, 60, 70 basis points from our own sort of operating platform. We wouldn't underwrite the benefit of it being on our platform and have that reflected in the value of the asset. It would be based on sort of a standalone asset with sort of market-based underwriting with our scrutiny of it if that's where you're going.

Yeah. I appreciate that. That's great color. And then my second question and apologies, if you guys have already mentioned this, but how much of the improved earnings outlook is driven by developments versus operations?

In terms of the third quarter update relative to the midyear reforecast, do you have a page in our earnings release that covers this? It is on Page 5. As you may recall, our midyear reforecast for core FFO for the year was $10.56, and it has now increased to $10.63, which is a $0.07 rise. If you look further down, you can see that $0.04 of this comes from improved same-store residential revenue, $0.01 from improved same-store residential operating expenses, and there are some adjustments in overhead and other factors that account for the additional $0.02.

Appreciate it. That's all for me. Thank you.

Our next question comes from Brad Heffern with RBC Capital Markets. Please proceed with your question.

Yeah. Thanks. So you guys reported a negative 80-basis-point newly spread in October. I'm curious how that compares to normal for this time of year and just generally how things are progressing versus the normal pre-COVID seasonality?

Yeah, Brad, good question. I don't know if there's a normal per se for October. But I mean generally what I would describe for rent growth throughout the year is that a typical seasonal bell curve. We typically see rents went up from January to July or August a 7% range or an average year and then they decelerate down by 4% or 5%. For this year, if you look at it sort of on average point-to-point from January through year-end, you might see effective market rent growth in the 2.5% range somewhere in that ballpark. What I would say in general about what we've seen in the back half of this year is slightly less seasonality across most markets with one exception being Northern California that has been more seasonal than normal relative to its history.

Okay. Got it. And then I think in the prepared remarks you talked about hard costs and said that you're not really seeing cost savings in bids but you expect to see them when they actually start going? Can you give us some color of where you think real hard costs in real life have actually gone?

Sure, Brad, it's Matt. I can elaborate on that. It's very regional. We've noticed some decreases in hard costs compared to last year, particularly around 5% in the Mid-Atlantic, and maybe more significantly, about 5% to 10% in Boston. Northern California is starting to show some improvement after a prolonged period of softness. However, we haven't seen similar reductions in Seattle. There’s been a slight uptick in Austin, but the initial increases were so substantial that the current changes aren’t particularly significant. We also haven't observed much in the Sunbelt markets like Denver or Southeast Florida, but we anticipate that improvements will occur there. However, I should note that the most reliable data comes from deals that are ready for hard bidding. At this moment, we don’t have such opportunities across every region, which makes it difficult to draw firm conclusions. We do collect specific data points that are valuable, as they provide insight into real-time conditions. However, the situation really depends on the unique dynamics within each region.

Okay. Thank you.

Our next question comes from Rich Anderson with Wedbush. Please proceed with your question.

Thank you. Good afternoon. I have a question about your expansion into new markets and the process involved. You mentioned staying flexible earlier, and I'm curious if the methodical approach you are using for growth helps keep you informed and allows you to adjust your strategy as needed. If you had the opportunity to execute everything perfectly in one go, with everyone applauding your transaction, would you prefer that approach? How committed are you to this process? Additionally, how is the Sunbelt performing? I'm not asking how it compares to urban coastal areas that everyone is aware of, but rather how it aligns with your expectations. Is it becoming more appealing to you even if it is currently underperforming compared to other regions in the country?

Hey Rich, it's Ben. I want to share a few thoughts. First, we remain committed to our long-term strategy of shifting 25% of our portfolio to expansion markets. This decision is driven by the understanding that our main customers, knowledge-based workers, are now located in a wider variety of markets. Additionally, we can leverage our strengths to deliver more value to our shareholders in those areas. In terms of timing, we're noticing some softness and dislocation in our expansion regions, which we view as a potential opportunity. It's a chance to acquire assets below replacement cost, which we've begun to explore, particularly in development markets that may have fewer competitors or those with less access to capital than we have. While we aren’t looking to speed up our expansion at this moment due to our current cost of capital, there could be a time in the next few years where more substantial opportunities arise that would result in favorable, risk-adjusted returns.

A follow-up question is to Kevin perhaps. The 4.1 times leverage the target of 5% to 6%. I mean, how do you ever get to that target anytime soon given the rate environment? And maybe one way is debt assumption, which was a part of a transaction you mentioned earlier. Is there any realistic lift to 4.1 in this environment, or could there be transactions here or there where you add debt at reasonable costs through your transaction activities? Thanks.

Sure. Rich again, it's Kevin. It’s an interesting question. We discuss and debate internally here. As you point out we are at 4.1 times net debt-to-EBITDA levered relative to a five times to six times target range which has been a long-term target range that we've had for more than a decade, which speaks to a normalized environment. If you look at 4.1 times, it's benefited from cash. If the cash weren't there we'd be kind of in mid-4s just as a further contextual comment. More broadly, if you look back at the last four years or so, I don't think anyone would agree we've been in a normalized environment from the pandemic and its effects as it's moved through. As you think about how things have played out this year, we are at that low four times leverage level in part because of our capital decisions over the last few years. This year’s capital plan where we've essentially will have paid off about $750 million of debt this year and brought in about $750 million of new and recycled equity from the equity forward and the net disposition activity that's deleveraging and not necessarily reflective of a normal year but this has proven to be the right capital plan for this year. What that does is give us financial flexibility to deal with an uncertain and volatile capital markets environment liquidity and strength to deal with an environment where we may wish to be patient regarding additional capital formation as the recent rise in debt rates. To the point that you're getting at, it gives us leverage capacity. To the extent we wish to seize upon certain investment opportunities whether they are in our established markets or in our expansion markets that we view as attractive where we can bring the strength of our balance sheet to bear and potentially rely on a greater than normal level of debt that may be attractive relative to those opportunities and lean into the balance sheet and generate some growth in that regard. We are certainly willing and able to get to that five times to six times leverage in the right circumstances. I will note that there are sometimes we got there in less than desirable circumstances such as three years ago in the pandemic when we actually were 5.4 times net debt to leverage EBITDA in Q3 of 2020, but that's sort of preparing the balance sheet for a downturn. Given where we are, it's a low leverage level, but we think it's appropriately so because it gives us strength to deal with potential challenges that could happen ahead as well as strength to deal with potential opportunities that we hope will be in front of us.

Okay. Great color. Thanks very much.

Our next question comes from Haendel St. Juste with Mizuho. Please proceed with your question.

Hey, good afternoon. Thanks for taking my question. I appreciate the color earlier on the renewals for October, November color on October new lease rates. But I didn't catch if you did provide them your expectations for new lease rates into the year-end. So maybe some color there on then what would that imply for a full year 2024 earning? Thank you.

Yes, it's Sean. I didn't provide specific expectations for new move-in lease rates in Q4. However, we did mention that renewal offers were in the 6% range. Based on recent trends, I would anticipate a dilution of around 150 to 200 basis points from that, landing us in the 4% to possibly 4.25% range. It's worth noting that the comparisons become easier in November and December, which explains the increase in rent changes we observed in markets like the Mid-Atlantic, Denver, and Seattle in October. Therefore, we expect a relatively stable trajectory for lease rates through the end of the year. Regarding the earn-in, we shared a snapshot in our slides presented last night, showing it at about 1.5. My expectation is that it may soften slightly between now and the end of the year, although I haven't specified a number yet.

Thanks for that. Can you give us an update on the loss to lease in the portfolio and perhaps where it has in Lewis?

Yes, that was posted on the slide as well. We recorded loss to lease roughly 2%, led by the East Coast markets north of 2 and then the West Coast and expansion regions trailing roughly 1.5 points and around 70 basis points in the expansion regions.

Okay. Thank you. And then last one and then apologies if you want to touch on this, but are there any markets that you commented that you're seeing an acceleration in concessions or perhaps more aggressive lease-up for merchant developers?

Yes. The one market I mentioned a couple of times earlier that has been softening more recently is Northern California, most notably San Francisco but to a lesser extent San Jose as well.

Thank you. Have reached the end of the question-and-answer session. I would now like to turn the call back over to Ben Schall for closing comments.

Thank you and thank you, everyone for joining us today. We look forward to connecting further with you in November. Talk soon.

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.