Earnings Call Transcript - EQR Q2 2020

Operator, Operator

Good day and welcome to the Equity Residential Second Quarter 2020 Earnings Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Marty McKenna. Please, go ahead.

Marty McKenna, Investor Relations / Moderator

Good morning and thank you for joining us to discuss Equity Residential's second quarter 2020 results. Our featured speakers today are Mark Parrell, our President and CEO; Michael Manelis, our Chief Operating Officer; and Bob Garechana, our Chief Financial Officer. 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. Now, I'll turn it over to Mark Parrell.

Mark Parrell, President & CEO

Good morning and thank you all for joining us today. During one of the most challenging periods in our country's and industry's history, we feel that our business showed considerable resiliency. We continue to be pleased with the financial strength of our customer base, with our average annual household incomes of $164,000. Data suggests that only 4% of workers making more than $150,000 a year have recently lost their jobs compared to the low teens for lower income categories. We have collected about 97% of our residential rents during the second quarter and attribute this to a customer base that remains well-employed and capable of meeting their obligations. July is trending similarly. We also demonstrated strong expense results. While the pandemic both added and subtracted costs from our operations, the innovations around leasing and service that we described in prior calls have really taken hold and we expect a durable reduction in our expense growth rate even after COVID is in the rearview mirror. And while our 90 basis point decline in same-store residential revenue was our first quarterly revenue decline in 10 years, our residential business held up reasonably well under very trying circumstances. We also believe that we have stabilized our physical occupancy at 95%. In a moment, Michael will give you some color on what is going on in each of our markets and Bob will address our expenses, non-residential operations and balance sheet. And then, we will welcome your questions. But before I turn it over, I want to highlight a couple of things. First, in the quarter, we stabilized two development properties, one in Cambridge, Massachusetts and another in Seattle, Washington. The Cambridge asset is a 64-unit property adjacent to an existing asset of ours and was built for $47 million and stabilized at approximately a 5% yield on cost. This property complements our large existing Cambridge portfolio of six properties with about 1,100 units and is ideally suited to house the biotech employees working in that area. The other property consists of 137 units and is located in the Capitol Hill neighborhood of Seattle and cost $65 million to build. It stabilized at about a 5% yield on cost. In terms of transactions, we're pleased to close on two dispositions during the quarter and have sold more than $750 million in assets during 2020. We feel that we received strong pricing on these quarter sales, as both sold assets were over 50 years old and our combined disposition yield was 4.4%. But we note that these sales were priced prior to the pandemic and so shouldn't be seen as a look-through on current pricing. We have not acquired anything this year, but we like to think of ourselves as professional opportunists and have a balance sheet that is as strong as it has ever been, which will allow us to take advantage of opportunities when they present themselves. And now a bit about our capital allocation strategy. We have spoken on prior calls about the company broadening its portfolio by expanding into Denver and into the dense suburbs of our markets. For the last few years, we've been actively pruning our exposure in some urban locations, including Manhattan, and buying more dense suburban assets. Our current portfolio mix stands at about 55% urban and 45% suburban. We will continue to build and buy apartments in locations, both urban and dense suburban, where affluent renters wish to live and in markets where we feel long-term returns will be maximized. We believe that our strategy is sufficiently flexible to retain high-quality urban properties while adding some breadth to the portfolio over time so we can continue to produce a reliable and growing stream of income for our shareholders. And now, I will turn the call over to Michael Manelis.

Michael Manelis, Chief Operating Officer

Thanks, Mark. Let me start by acknowledging the dedication and hard work of our employees during the second quarter. Despite very challenging operating conditions, the team was able to focus on the health and safety of their fellow employees and our residents by implementing our new operating standards to address COVID concerns. These heightened cleanliness standards have been well received by residents and prospects. The team elevated their voices in various listening sessions held throughout our organization to share how they were navigating and managing stress due to the unrest in our country. Their voices will help us continue to cultivate a culture of inclusion at Equity Residential. They stayed on top of delinquency by executing a consistent and transparent process that emphasizes frequent communication with residents who are financially impacted by the virus. Our collection rate remained strong and fairly stable throughout the quarter, with a little over 97% being collected. They focused on retaining existing residents, as evidenced by turnover at 11.8% for the quarter, which is 130 basis points lower than the second quarter of 2019. This was driven by a 10% reduction in move-outs during the quarter, as more residents opted to stay in place. Achieved renewal rate increases were positive 70 basis points for the quarter, but we expect this number to trend lower as negotiations become more challenging. Right now about 20% of our renewal offers for July and August include a slight market rate increase. The team also adopted new technologies for both sales and service that allowed us to meet the needs of our customers while creating operating efficiencies, which contributed to the low growth in our operating expenses. As to occupancy, we stated on the last call that we expected the occupancy impact to be the most pronounced in the second quarter, setting a new base from which we'd hoped we would improve as shelter-in-place orders were lifted. That so far appears to be the case. The portfolio was 95% occupied today and we averaged 94.9% through the quarter after recovering from a 94.2% low point in mid-May. On the rate side, since last week in May, base rents have been relatively stable, but this is a bit of a bifurcated story. Pricing remains challenged in the urban cores of New York, the city of Boston and Downtown San Francisco, which represents about one quarter of our portfolio. The rest of the portfolio is showing more price stability. The rents are still lower than last year. New lease change was down 7% this quarter for our same-store portfolio, before concessions. New lease concessions during the quarter were heavily concentrated in the urban cores of New York, San Francisco and Boston. Factoring in concessions, the net effective new lease change for the portfolio during the quarter was down 9%. Overall traffic and application activity improved throughout the quarter as net effective prices were being lowered. As we mentioned on last quarter's call, application activity was recovering at the end of April and continued to do so through the remainder of the quarter. By late May and into June, we are seeing somewhat higher new applications week-over-week relative to the same periods in 2019. This improvement, however, was not sufficient to make up for the nearly 40% year-over-year reduction experienced in April. As a result, the total number of move-ins for the second quarter were 20% below the second quarter of 2019. At present, we think it is helpful to split our portfolio into three pieces as we think about our forward operating performance. First, our suburban assets, which represent approximately 45% of the company's portfolio, have been more resilient during the pandemic with occupancy declining to a low point of 95.2% before recovering fully to levels at or above prior year and ending the quarter at to 96.6%. Suburban renewal percentage was very strong at 65% and continues to trend well above prior year. Rates have been slowly recovering since early May, and there have been very limited concessions used in this portfolio. Second, our urban assets that are located in the city of Boston and Cambridge, Manhattan and Brooklyn and Downtown San Francisco, which represent about 25% of the company's portfolio, are currently 91% occupied. As stated earlier, this portfolio has the highest use of concessions and the most rate pressure. For the quarter, this urban portfolio renewed 58% of residents, which is 500 basis points lower than Q2 of 2019 and was trending down throughout the quarter ending at 53% in June. The urban cores in Boston, New York and San Francisco have the highest risk of volatility in operations for the balance of the year. Our third grouping consists of urban assets in other markets like Washington D.C., Seattle and Southern California and comprises about 30% of our portfolio. These assets reached the low point in occupancy of 94% in mid-May, but quickly bounced back and remained at 95.2%. Pricing has been stable since the middle of May, with rates being down year-over-year and concessions being used on about 15% of our applications. During the quarter, 57% of residents renewed from these assets, which is 300 basis points better than the second quarter of 2019. Overall, this group of urban assets has had consistent operations for the past two months with a slight uptick in occupancy in the past couple of weeks. Let me provide some quick color on the markets. Starting with Boston, the urban center of Boston and Cambridge represent about three quarters of our total Boston portfolio and were more impacted by early terminations and non-renewals from international students and third-party corporate providers. While neither one of these represent a significant amount of total units, the impact was concentrated. The Boston urban center is now 91.5% occupied and continues to be pressured on rates and occupancy, especially given the uncertainty around international students and the competitive supply being delivered. The other submarkets in Boston have been operating at 95%, with consistent rates and very little concession use. Overall, applications have been running at or above prior year for the entire market as we see good demand for our product. We continue to like this market long-term due to its combination of bio, education and technology jobs and the high quality of lifestyle. Washington D.C. continues to demonstrate some resilience, although the market has not escaped pricing pressure. Absorption of new supply continues and the use of concessions remains extremely limited in our portfolio. Applications have been running at prior year levels and the portfolio is 95.8% occupied. Moving on to New York, which continues to be one of our most challenging markets. Leasing traffic and application volume returned to 2019 levels by mid-May, but at reduced rental rates and higher levels of concessions. The leasing traffic in the city is heavily centered around local bargain hunters who are moving within the market and searching for a deal. Concession use is widespread with about 50% of our applications receiving concessions, which now average greater than one month. While the application count has recovered to prior year levels this was not enough to make up for the deficit created by the lack of volume in April. Retention started strong in the quarter but has since moderated. During June we renewed 57% of our renewal offers, which is strong by all accounts but lower than June of 2019. Our assets on the Hudson Waterfront, New Jersey, which is about a quarter of our New York exposure have performed better than Manhattan and Brooklyn. We have held 95% occupancy on the Waterfront for the past month and while concessions are being used, it's at a lower level than in Manhattan. Our New York same-store portfolio including New Jersey is about 92% occupied today. Recovery in Manhattan and Brooklyn will take some time but if office re-openings begin in early 2021 as currently expected and the city continues to show good progress on controlling the virus, we may see higher than usual demand later this year and early next year during a period when demand is typically seasonally soft. Heading over to the West Coast, Seattle delivered the strongest revenue results in the quarter both in terms of absolute revenue growth and the combined impact of new lease change and renewals. The portfolio is 95.3% occupied today and overall revenue performance has been very consistent since early April, although pricing decelerated slightly through what normally is the growth period of peak leasing season. We have not seen big layoffs in tech jobs in the market, but we are keeping an eye on employers like Amazon, who last week announced that they were extending their corporate office employees working from home until early January and have delayed new hire start dates from August into September, October. Overall, this trend may cause some short-term pressure on demand and occupancy, but could also provide a boost to the fourth quarter, which typically slows down. San Francisco's revenue performance is very different depending on the submarket, most notably between urban and suburban. Our portfolio in this market is approximately 30% urban and 70% suburban. In the city of San Francisco, we are seeing declining rents that are presently well into the double digits year-over-year and represents the largest year-over-year decline in our entire portfolio. The city also has widespread concession use at or above four weeks and has experienced the biggest impact from startup layoffs and the lack of foreign immigration. Our suburban portfolio located in the Peninsula, South Bay and East Bay, as well as the few urban assets that we have in those submarkets stabilized in early May. While rates are down on a year-over-year basis here, they have been holding in place for over a month with very limited use of concessions. The South Bay is still at risk as new supply enters that submarket at a time when the large tech companies have slowed growth and are trying to figure out longer-term work-from-home policies. That said, the San Francisco Bay Area remains a great place to live, tech companies remain a strong high-wage job growth engine and the long-term outlook remains positive. Heading to Southern California, overall pricing is down in L.A. but very stable through June with very little concession used in our portfolio. L.A. is 96.1% occupied today. West L.A. remains the most challenged submarket, but even here occupancy recovered to 94.1% and the Downtown submarket, which currently has supply pressure has been stable at 95%, although rent declines are the most pronounced in this submarket. Overall, we are seeing strength in the suburban submarkets of L.A., which is about 45% of our L.A. portfolio. This strength is mitigating the rate and occupancy declines in Downtown, Hollywood and Mid-Wilshire in West L.A. While the high levels of competitive supply being delivered in the second half of the year, recent spike in COVID cases and the reversal of phased opening plans for the market are certainly potential short-term negatives, the content creation and technology job story in this large diverse market remains positive. We think jobs in L.A. have the potential to grow even more strongly coming out of the pandemic in order to meet the increasing demand for new online content. Finally, Orange County and San Diego are both performing well with occupancy above prior year and very limited downward pressure on rates. These are challenging times, but our business is demonstrating resilience and our teams have shown that they can deliver. At this point, I will turn the call over to Bob.

Bob Garechana, Chief Financial Officer

Thanks, Michael, and good morning, everyone. Today I will make a couple of brief remarks on same-store expenses, delinquency and bad debt, and conclude with the balance sheet. Same-store expenses declined for the quarter relative to prior year, driven by the advancements in our technology initiatives that Michael mentioned and delay or deferral of certain expenses largely stemming from the pandemic. Page 16 of the release provides detailed color on specific line items. I do want to highlight that expenses in the quarter included approximately $1 million related to one-time bonuses for our frontline workers and another $500,000 from elevated cleaning and other health and safety costs. As evidenced by our strong 97% collection rate for the quarter, our high-quality resident continues to pay their rent. That said, the combination of the small percentage of our residents that have been financially impacted by the pandemic and our conservative accounting policy has led to elevated residential bad debt in the quarter. Residential bad debt reduced revenue growth by approximately $9 million or 150 basis points in the same-store portfolio. That is about 100 basis points higher than the comparable period in 2019, which would have been a more typical level. For the next quarter or so, economic and regulatory uncertainties may lead to continued elevated bad debt. Turning to our non-residential business. I would remind you that the non-residential business is a small part of our overall operations at approximately 4% of revenues historically. But it is likely to have a disproportionate impact on total same-store performance for the next few quarters. Retail tenant collections were about 60% for the quarter with collections trending slightly higher in June. Uncollected amounts that were deferred were almost entirely reserved against during the quarter from the financial statement standpoint. About two-thirds of the decline in non-residential revenues quarter-over-quarter stemmed from these reserves and other bad debt related items. Much like in residential, we have applied a relatively conservative accounting policy. This business is likely to continue to face challenges and we expect that the third quarter could be even tougher given likely delays in reopening activity and the potential lack of additional government small business stimulus. If retail performance continues to be stressed, we expect that a significant portion of the straight-line non-residential receivable disclosed on page 11 could be at risk and therefore could be written off. Finally a quick highlight on our fortress-like balance sheet. We entered the pandemic from a position of strength and have further enhanced our position through thoughtful refinancing activity and incremental debt reduction from disposition proceeds. By taking these steps, we have ensured sufficient liquidity and incremental debt capacity for any opportunities that may present themselves. We have limited near-term maturities, modest development spend and incredible access to capital. With that, I'll turn it back over to Mark.

Mark Parrell, President & CEO

Thanks, Bob. And a final note while we fully acknowledge that the next few quarters will be difficult, the cities in which we operate have shown great resilience over time and while some of them are certainly challenged today, we believe that they will bounce back when we reach the other side of this pandemic. We expect that these cities will remain at the center of the knowledge-based economy and will continue to attract high income renters. We think that the obituaries for the great urban centers have been written much too prematurely. The world's great cities have continued to adapt and thrive over time and they will do so again. We appreciate the continued support we have received from the investment community as we navigate the current storms and look forward to coming out of this pandemic well-positioned for long-term growth. Now I'll turn the call over to the operator for the Q&A session.

Operator, Operator

Thank you. Operator instructions. And we will take our first question today and that is from Rich Hightower with Evercore. Please go ahead with your question.

Rich Hightower, Analyst (Evercore)

Hey, good morning, guys. Hope everybody is doing well.

Michael Manelis, Chief Operating Officer

Morning.

Mark Parrell, President & CEO

Morning.

Rich Hightower, Analyst (Evercore)

So a lot of ground we could cover on this, but I'll try to limit to a couple of questions here. So thanks for taking the questions. Just to go back to the topic of renewal rents for a second. I wanted to back up to one of Michael's comments; I guess 20% of renewals for July and August you said included a slight increase. Does that imply that 80% roughly are flat to negative? And then, are you seeing increasingly bold asks among your tenants on the renewal side specifically given that it's probably a pretty well informed tenant base?

Michael Manelis, Chief Operating Officer

Yeah. Hey, Rich. So I would start and say really for the past couple of months the performance in renewals has been relatively consistent. So the comment about 20% having an increase—that's the quotes going out the door. And you need to remember we're still subject to a lot of various rent freezes in place. So you are correct: 80% of our offers that went out for July and August include no increase. The negotiation process has been very consistent. We're quoting about a 1% increase and we're achieving about negative 1%. So about a 200 basis point spread on that performance.

Rich Hightower, Analyst (Evercore)

And that negative one that's inclusive of any concessions just to clarify that?

Michael Manelis, Chief Operating Officer

Yeah. So we're not doing a lot of renewal concessions or we haven't been in the portfolio. I think we've seen a handful in the quarter in New York but it's very insignificant dollar amounts.

Rich Hightower, Analyst (Evercore)

Okay. That is helpful. And then just a quick one on capital allocation. Mark I know that you said in your prepared comments that the pricing that was achieved on the dispositions in 2Q is not really reflective of private market reality today. But where do you see that spread between private market today and EQR's implied trading cap rate and then where the share repurchases potentially fit into the capital allocation strategy?

Mark Parrell, President & CEO

Wow Rich that's a compound question. So we'll start by talking about values and we'll start with the private market. In the quarter, there just hasn't been that much activity. We think activity in our markets for our kinds of assets—meaning assets with over 50 units that are of our type of quality—are probably down 70% in the second quarter. So what I'm about to tell you is based on pretty limited volume. But it seems to us that private market values have held in there. We've seen a few deals trade in Downtown Seattle, stuff in the north side of suburban Denver, a complex in Washington D.C. and the Virginia side and then a couple of these New York deals that we've been watching, but they haven't closed. Those are all trading at values that indicate to us that the pandemic has not taken private market values down, or not taken them down very much at all. But again, very small sample sizes. And then you asked about share repurchases. Well certainly the company rarely trades at this significant a discount to NAV. I mean this is very unusual for us. I'm not at all dismissive of share buybacks; I would just tell you that you start as a REIT with the inability to retain earnings. And you also start with the ability to return capital through a pretty large dividend. Our annual dividend is $900 million of capital returned to shareholders every year. So I'd say to you that we're open to it, we have a $13 million share allocation on the share buyback side, that's a conversation we'll continue between the Board and myself and we'll think more on that. But I will say this is pretty unprecedented for us to trade at this discount. And I think, again, as far as I can tell private market value changes don't justify it.

Rich Hightower, Analyst (Evercore)

Okay. Thanks very much.

Mark Parrell, President & CEO

Thank you.

Operator, Operator

Thank you. And we will take our next question and that is from Nick Joseph with Citi. Please go ahead with your question.

Michael Bilerman, Analyst (Citi)

Hey, it's Michael Bilerman here with Nick. Mark, you had quoted an opportunistic mindset in the press release. I wanted if you could sort of drill down a little bit about what you are implying about having an opportunistic mindset: is it acquisition, is it sale of more assets, is it strategic portfolio reallocations—you just talked about stock buybacks—what does it encompass?

Mark Parrell, President & CEO

Yeah. Thanks for that question, Michael. It's sort of all of the above. Again, not much going on in the transaction market; there is not much of an opportunity for us to demonstrate that opportunistic mindset at the moment. But historically, this company as an equity company has always been looking for opportunities to purchase assets at prices that we think will create long-term value. About a year or year and a half after the Great Financial Crisis you saw us buy a lot of assets. We are only four months into the pandemic—it feels like a lot longer, but it has only been four months. I'd expect that at some point there would be opportunities: maybe there are development deals that need to be completed or at least stopped— we're quite good at that. Maybe there are opportunities in retail where you've got lots of existing retailer big boxes that have closed that we can knock down and reposition as apartments or whatnot. So we're open to all of that. I mean I just answered the question on the share buyback; that's certainly something we'll keep in mind as well.

Michael Bilerman, Analyst (Citi)

If it sounds like being opportunistic is much more on the deployment of capital rather than trying to narrow the gap if you believe your stock trading at a big discount—selling off a substantial or maybe insubstantial amount of assets and sort of narrowing the gap that way? It sounds like you want to be more externally focused than internally focused.

Mark Parrell, President & CEO

I'll take your question. Whether we could sell enough assets for example and buy enough stock back to close the gap on NAV—I don't see that as possible. The company is just too large and when you start selling assets and start implicating large tax gains, you start to create other issues; you also need to scale the business differently. So I don't see it as likely that we would do a massive stock buyback in an attempt to close that NAV gap. I think what you're likely to see if we do a share buyback is that we just think it's a good investment and a good trade and it doesn't preclude other opportunities, because that's the big thing on REITs: when you are using capital you are either borrowing or you are selling assets, you are changing your opportunity set. And you might make it harder a year from now to take advantage of some of those opportunities we just spoke about.

Michael Bilerman, Analyst (Citi)

Right. The second question I wanted to ask was just in terms of your commentary around cities and urban versus suburban environments and I think you made the comment that we shouldn't write off cities at this point. I want to drill down in terms of what's your forecast on when cities start to recover because clearly there has been a substantial amount of home buying in suburban and generally employers follow talent and if that talent is leaving the urban environments as evidenced by your trend that you talking about in New York City and Brooklyn and in San Francisco—why wouldn't the corporations ultimately then move to that over time? And the whole changing nature too of where people are living if they're exiting even at the wealthier aspects and moving where those decision makers may move to. What gives you the confidence that it may rebound quicker than what the market is expecting?

Mark Parrell, President & CEO

So we think about that as both the short-term and the long-term question. In the short run in some of these dense urban centers, the ones that Michael just mentioned that are pressured, you are certainly seeing people say, these aren't the urban centers I want to live in right now, because they're not energized, they're not as activated. Over time the pandemic will go away—when is a really good question—but if it isn't permanent, there will be a point where this pandemic will be lessened and then these cities will open up, and there will be an opportunity for people to move back. Our resident, who again is someone who has an average household income of $164,000, with a median age of 33, is likely working long days in biotech, law, finance or research and values the energy and amenities these markets provide. I think the actions that we're seeing that are hurting us right now in our urban centers are all about the here and now. As this pandemic wanes, and again I can't tell you when that is, but it isn't forever, then there will be a turn and there will be interest in these markets again, because I don't think anything has changed in the long run. There are huge network benefits. If you're in content creation, there's a lot of benefit being in Los Angeles. If you're in technology, there's a lot of benefit to being in Seattle or San Francisco, and the same in finance in New York. Those network benefits, combined with our demographic tendency to value excitement and energy in urban centers, suggest they will endure. Work-from-home is a fair question, but I don't think work-from-home and urban living are inconsistent. When you're done working from home, you're happy to go out and do those exciting cultural things in our markets. So I'm very confident in the long run; what I can't tell you is when the pandemic wanes.

Michael Bilerman, Analyst (Citi)

Okay. Well, I was always cheerful about those people sitting in their shorts and T-shirts, while we were walking around suits. So now I have a better appreciation for what they have. Thanks for that.

Mark Parrell, President & CEO

There you go. And I — go ahead, I'm sorry. Next question please. Thanks Michael.

Operator, Operator

We'll take our next question and that is from John Pawlowski with Green Street Advisors. Please go ahead.

John Pawlowski, Analyst (Green Street Advisors)

Hey, thanks for taking the question. Michael, I appreciate your detailed thoughts on the markets. I wanted to talk a little bit more about New York and San Francisco, those markets which are being disproportionately impacted by employers not coming back to the office. Based on what you see in terms of your scheduled move-outs today in New York and San Francisco and just leading demand indicators, what does the trajectory of occupancy look like in these markets the next few months and what's the trajectory of rental rates as well?

Michael Manelis, Chief Operating Officer

I would say right now they've been very consistent. The urban cores of New York and San Francisco have both been running at about 91% to 91.5% occupancy and the rates, as I alluded to earlier, have been bouncing around as we try to find a stability point. I think our forward outlook for the near term is consistency on that front. We did see some shifts in migration patterns, so we're looking at forwarding addresses for those people that are leaving us. Both New York and San Francisco stood out as seeing a change in behavior from Q2 2020 compared to Q2 2019. In New York, typically about 35% of those residents leaving provide a forwarding address out of state. In Q2 2020 that increased to 50% and the number one state they were going to was New Jersey. San Francisco was a little different in that we didn't really see a strong uptick in residents leaving the State of California; rather we saw a pronounced uptick in leaving the MSA and the number one place they were going to was Santa Clara County. So they were moving down. We're seeing some changes in the patterns, but from a consistency and operations standpoint, we've been optimizing revenue at this 91.5% and that's probably where we would expect to see it stay for a little bit.

Mark Parrell, President & CEO

And John, it's Mark. Just to add, there was something we put on page 3 of the release that we want to draw your attention to. We mentioned that the July 2020 results were about equal to the June results. What we're trying to talk about is the rate of change. We talked first about stabilizing occupancy in April and we did that. Then we talked about what's going on with new lease and renewals. For the most part, at least for two months, we've stabilized. Now we're not suggesting it is a permanent plateau, but it feels pretty good. That's what Michael means by stability. Now we're fighting the concession battle, and we're working through that and we're happy to talk about that. But it's sort of a step-by-step process and I think the sense that things are in some sort of precipitous decline is not how we feel here at the company. It feels like one thing after another and we've got plenty of demand, so occupancy feels okay. We feel okay on what our new lease rate and renewals are going to be given June and July being about the same number. And then now we're going to address these concession issues and again the markets reopening are key to that.

John Pawlowski, Analyst (Green Street Advisors)

Sure, I understand. Nobody knows when the market's going to reopen. But I guess I struggle with the consistency tone because concessions are part of the game and somebody could argue a lot of private and public operators are buying that floor in occupancy right now. So I guess the concern is New York in the fall or San Francisco in the fall you start pushing up against occupancies with a net headwind. So New York occupancy going to 94.1% in the quarter, sounds like it's 92% in July with new leases declining and then concession is getting worse. I just, I'm struggling with the kind of floor consistency tone—it's not just this call, it's other public and private operators out there as well.

Michael Manelis, Chief Operating Officer

Maybe let me just address one thing on concession use, because I think the markets we've been talking about need some more color. For the portfolio as a whole, we have been relatively consistent: about 25% of all of our applications every single week have been getting some form of concession and it's about equivalent to one month. When you look at New York specifically, we've been running about 50% of our applications receiving a concession and for us we're typically at about a six-week concession in that marketplace and strategically going up to a two-month concession. In San Francisco, about 40% of the applications are receiving a concession; we're predominantly at four weeks and every now and then strategically we go up to six. That's been fairly consistent in our platform for the last month or so in use of concessions. As to fall, I don't know where we'll be. I'm thinking about the next 30 to 60 days and how the portfolio will play out because we have transparency into traffic, application volume and renewals. At some point you may sit on the sidelines; concessions could continue to go up and you may just see us park ourselves right at the levels I'm talking about and occupancy may decline in the fourth quarter. But I don't know yet how to think about that—I'm focused on the next quarter and how we want to run the portfolio.

John Pawlowski, Analyst (Green Street Advisors)

Okay, great. Last one from me: could you share what economic occupancy is currently in L.A. versus the physical given the concerns around eviction moratoriums getting extended?

Bob Garechana, Chief Financial Officer

Hey, John, it's Bob. For economic occupancy in Los Angeles specifically and I'm going to give you the quarter numbers so Q2 of 2020, we're at 93.7% compared to 94.7% physical occupancy. So about a 100 basis point delta. You're correct that Los Angeles is where we've seen the higher delinquency pattern and that corresponded to the higher bad debt write-off. While we're at it, I thought I might also talk a little bit about comparability related to concessions and bad debt because I know there are questions on that. Our policy on residential bad debt is as follows: we write off all former resident account balances once they move out. If you vacated the unit we write it off 100% of anything that you owed us and those accounts convert to a cash basis. For residents that continue to occupy the units but still owe us money, we write off 100% of their account balance once they reach three times their monthly rent. From that point forward we convert to a cash basis. For residential, our net receivable balance before security deposits was about $11.7 million and after security deposits it's about $9 million or 150 basis points of quarterly revenues. In the second quarter, same-store reported revenue growth was reduced by about one percentage point overall consistent with this policy. Going into the third quarter, we expect that bad debt will remain elevated. If collection rates remain the same and consistent, the impact shouldn't be hugely different than the second quarter impact. We continue to be diligent on writing off those delinquent accounts. For non-residential it's a bit different and is more tenant-by-tenant. We continued to account for that on an accrual basis but this quarter we reserved against pretty much all of the unpaid rent, effectively converting it to a cash basis and we also wrote off a portion of the straight-line receivable. We continue to monitor that straight-line receivable and that's more a function of the future prospects of those tenants. We have a number of those on a watch list and depending on future conditions there could be future write-offs. Finally, on concessions: in our same-store reported numbers we report in line with GAAP. So we run the straight-line concession through the reported revenue numbers, and we've done that for a number of years. I'm happy to give you the cash basis numbers by market or in aggregate. The difference was about 120 basis points: for residential only, we reported in the second quarter a 90 basis point decline; on a cash basis it would have been 120 basis points. By market that relationship is pretty consistent. Boston would have been negative 1.7%, New York negative 1.9%, D.C. flat, Seattle 1.5% negative, San Francisco negative 1.4%, L.A. negative 2%, Orange County positive 90 basis points, and San Diego flat. Hopefully that gives you a little bit of color on comparability items.

John Pawlowski, Analyst (Green Street Advisors)

That's great. Thanks very much for all the details, it's very much appreciated.

Bob Garechana, Chief Financial Officer

Great.

Operator, Operator

We'll move on to our next question and that is from Richard Hill with Morgan Stanley. Please go ahead with your question.

Richard Hill, Analyst (Morgan Stanley)

Hey, good morning guys. Thank you for the details on the bad debt. That was one of my primary questions and I think that was a very helpful and efficient explanation. I did want to come back to allocation of capital and maybe some of the questions at the beginning. I think there is a case to be made in a lower interest rate regime—and against the backdrop where apartment fundamentals probably still remain quite strong over the medium to long-term—that cap rates can compress. I know there hasn't been a tremendous amount of transaction volume. But I'm curious if you can talk about that and maybe go back to previous comments about external growth and maybe you being opportunistic about buying some properties. Does that sort of fit into your thesis in how you're thinking about things?

Mark Parrell, President & CEO

Thank you for that question. We had a conversation on the last earnings call about cap rates potentially going down. With 10-year treasuries at very low levels, the spread to prevailing cap rates is high on a relative basis, so a case can be made for cap rate compression. There's a significant amount of capital interested in the apartment business. As for external growth, to get more aggressive you need to be comfortable with growth rates of NOI and your view of exit cap rates. Right now we're not in a situation where a lot of external growth is possible; we are certainly not issuing stock at this stock price. For us it would be mostly recycling. We'll have opportunities to recycle because some assets will trade well and some buyers will see renovation or repositioning potential. If cap rates compressed, sitting on $40 billion of real estate would be beneficial to us.

Richard Hill, Analyst (Morgan Stanley)

Okay, helpful. Maybe I can ask the question slightly differently. There's obviously a tremendous amount of money on the sidelines with private equity funds. Would you ever consider partnering with a private equity fund that wants to take a longer-term perspective to maybe demonstrate that your net asset value—where your stock is trading relative to net asset value is too cheap?

Mark Parrell, President & CEO

I'm going to have to ask you to be more specific. The company doesn't lack capital. If we had opportunities to allocate capital we have debt capacity; we could issue debt to buy $0.5 billion of things above what we could sell. We are comfortable doing that. We like joint ventures; we do a couple and would consider more if they made sense. But I don't know that a private equity partner would validate the value of the company. People know what the company is worth; they just think the next couple of quarters will be tough and that's what the stock price is reacting to.

Richard Hill, Analyst (Morgan Stanley)

Understood. I was politely trying to ask about take-private because there's interest from some investors about the lag in REITs relative to private market valuations. I assume that's not a question you'd be willing to address on a public earnings call, so I appreciate the feedback.

Mark Parrell, President & CEO

Thank you.

Operator, Operator

We will take our next question and that is from Nick Yulico with Scotiabank. Please go ahead with your question.

Nick Yulico, Analyst (Scotiabank)

Thanks. I don't know if you have these stats, but I'm wondering if you have an idea of how much of your renter base has a job that is actually an office-using job versus working in a hospital or some other type of industry where they can't work from home?

Michael Manelis, Chief Operating Officer

We don't really have insight into that in a comprehensive way. We capture the employer at the time of application, but we won't have a sense right now. I think it's pretty clear when you look through the properties that a large percentage of our resident base are working from home, but I don't have a precise statistic.

Nick Yulico, Analyst (Scotiabank)

Okay. And is there any way to frame out how much of the typical summer leasing period benefit you would get this time around? For example, students returning to school, internships, jobs that start in September—how much of that benefit is not happening this time?

Michael Manelis, Chief Operating Officer

I don't think there's a way to precisely frame it out. In normal seasonal patterns, right now is about the time of year where rents are the highest and then we start a seasonal decline. On the occupancy front you have two peaks in the peak leasing season: this period right now and another around the end of August into September. Given current demand patterns, we could be shifting some demand later and extend leasing into September or even October, which might show gains year-over-year in applications. That doesn't mean we won't face pricing pressure or concessions, but it's possible the leasing season will have a longer runway this year.

Nick Yulico, Analyst (Scotiabank)

Okay, that's helpful. One last question: you mentioned move-outs in New York and San Francisco and where people are moving. Do you have stats on how many of those moving are moving into a house (renting or buying)? Also, within your own portfolio, are you offering incentives to make it easier to move to a suburban location? Any stats on those issues?

Michael Manelis, Chief Operating Officer

We do capture reasons for move-out. Historically about 12% of those leaving say they are leaving to buy a home. In Q2 that percentage actually went down a little, partly because in April there were fewer people moving at all. Home prices in our markets remain high, so we haven't seen a big surge of people running out to buy homes. We did see a small uptick in D.C. and Southern California markets, but it's a small increase. We don't typically offer incentives to make internal moves between our own suburban and urban portfolios in a way that would be broad-based; we handle those on a case-by-case basis.

Nick Yulico, Analyst (Scotiabank)

Okay, thank you, Michael.

Operator, Operator

We will take our next question and that is from Alua Askarbek with Bank of America. Please go ahead with your question.

Alua Askarbek, Analyst (Bank of America)

Just a quick one in terms of early terminations: I know you mentioned Boston that was an issue early on in the quarter. Have other markets experienced early terminations recently as more companies announce working from home?

Michael Manelis, Chief Operating Officer

Yes. During the quarter we did see an increase in early terminations or lease breaks, predominantly in New York and Boston and very much weighted toward April. If I look at performance for May, June and even through July, we're not in a period where we're seeing more people break leases. As for recent employer announcements—like Google extending return to office until next summer—it's too soon to see a pattern. We're clearly watching it and it could put a little pressure on renewal conversations, but it's early.

Mark Parrell, President & CEO

I'll add an anecdote: many people are eager to return to a normal routine and many younger people in particular want to get back to city life. While some are leaving temporarily, a number of our residents are likely to reassess and return to cities once the public health situation allows. But of course if the pandemic worsens that could slow the trend.

Alua Askarbek, Analyst (Bank of America)

Got it. Thank you.

Operator, Operator

And we will take our next question and that is from Rich Anderson with SMBC. Please go ahead.

Rich Anderson, Analyst (SMBC)

Thanks, good morning everyone. Bob I just want to simplify the talk about bad debt. There's three buckets every month or every quarter: there is the 97% collection rate, then of the remaining 3% there is a deferral that is recorded as deferred and then the bad debt reserve—those are the three buckets correct?

Bob Garechana, Chief Financial Officer

Yeah, that's correct. And I would add that the bad debt reserve isn't just the allowance for doubtful accounts; it's also the write-off of any resident who moved out during that period as well.

Rich Anderson, Analyst (SMBC)

Understood. Okay I just want to make sure that was clean. Talk a little bit Michael when you were going through the offers at +1% and getting -1% on renewals. Is it greedy to ask for 1% when if you don't keep them you lose the residents you have, incur downtime, cost of releasing the space and then you take an 8% hit to that because of new leasing? So I'm wondering if Equity Residential might be more willing to negotiate downward to avoid those dynamics and renew at a lower number than you're doing today?

Bob Garechana, Chief Financial Officer

I'll point out that the 20% that are receiving some form of increase are residents that are below market today, which is why those increases are going out. And we will always be cognizant of replacement rents and the cost to replace a resident. We know the largest thing people want is to avoid moving and they often want to work with us.

Michael Manelis, Chief Operating Officer

We're being sensitive to the situation, especially for residents that have been financially harmed. Looking into August and September, I think our increases will stay around 1% in pockets, particularly in the suburban portfolio where we can push rents up a little. But there are pressures balancing this out. The process is fluid and we're following that mindset.

Rich Anderson, Analyst (SMBC)

Okay fair enough. And then last question for Mark: EQR sort of doubled down on urban in 2016 when you sold to Barry Sternlicht the suburban portfolio; now we're in this mess and you're 55% urban 45% suburban. Could EQR, being opportunistic, move to an even higher urban percentage because you believe urban will come back—say 65% urban rather than 55%?

Mark Parrell, President & CEO

We're open to buying urban or suburban. We recently sold some suburban properties and bought some suburban assets in New Jersey, so it has to make sense both on an asset and allocation basis. If an urban asset underwrote well, we wouldn't hesitate to purchase it. It just has to make sense relative to our allocation in that submarket. I wouldn't necessarily predict an increase or decrease; we'll be opportunistic and make sure it fits our long-term strategy.

Rich Anderson, Analyst (SMBC)

Did you say 55% is more likely to go down or up in the next couple of years?

Mark Parrell, President & CEO

I was hoping we'd grow and urban wouldn't shrink as much as suburban would grow, but I would think we'll sell a few urban assets here and replace with newer assets. This quarter both assets we sold were suburban properties that were older and required renovation that we didn't want to undertake.

Rich Anderson, Analyst (SMBC)

Okay. Excellent. Thanks very much, everyone.

Mark Parrell, President & CEO

Thank you.

Operator, Operator

And we’ll take our next question and this is from Haendel St. Juste with Mizuho. Please go ahead with your question.

Haendel St. Juste, Analyst (Mizuho)

Hey there. I wanted to ask about cost controls. You mentioned some things you're doing in the quarter to help same-store expenses and expect that to continue beyond the COVID period. Can you add more color around that and comment on tech investments and quantify the opportunity—how we should think about potential savings either on a dollar or same-store expense basis over the next couple of years?

Bob Garechana, Chief Financial Officer

I'll start on the dollar piece and take you back a few months before COVID to give a frame of reference. We had excellent expense control in Q2 and that came from the initiatives Michael talked about: converting more leasing and administrative tasks to digital platforms, virtual tours, increased efficiency, employee utilization changes, and reduced on-site payroll via attrition. We also saw benefits in R&M from deploying mobility for service personnel and using them more efficiently, which impacts payroll and R&M because it allows better staffing decisions and reduces contractor usage. There were COVID-driven deferrals and some incremental costs, but overall from a sustainability standpoint we're running 50 to 75 basis points lower in expense growth than what we would have thought at the beginning of the year before COVID. That's the real positive.

Michael Manelis, Chief Operating Officer

On tech investments, we are involved in two different proptech-focused funds—one with Camber Creek and one with Navitas Capital—which helps us stay on top of new technologies emerging in our industry and others to assess applicability. This is an area we're excited about: opportunities to improve efficiencies through technology. Later this year we'll be deploying our sales technology piece to move 100% of our sales process to a mobile app and we're beginning pilot deployments. Similar to what we did on the service side, you'll see further moves into smart building access and smart home access. There's still a lot of opportunity for the industry to advance technology and increase efficiencies.

Haendel St. Juste, Analyst (Mizuho)

That's helpful. Thank you. Mark, you mentioned a few transactions on the market that closed that were pre-COVID. Are you seeing anything in the shadow market about what buyers are underwriting now and what IRRs they're targeting? And when do you think New York City same-store NOI returns positive—2022 or could it be 2023?

Mark Parrell, President & CEO

On the shadow market, there's very little activity currently; brokers are not reporting a lot of shadow deals. Private equity and other investors remain interested in the space, despite current turbulence. As for New York, it's complicated: property taxes and potential appeals will play a role, and quarters could get worse before they get better because the rent roll is deteriorating. That makes timing hard. I can't give a precise year for NOI turning positive. We hope taxes and appeals moderate future impacts, but public health uncertainty makes it difficult to forecast precisely.

Haendel St. Juste, Analyst (Mizuho)

Thank you.

Operator, Operator

We'll take our next question and that is from Alex Kalmus with Zelman & Associates. Please go ahead with your question.

Alex Kalmus, Analyst (Zelman & Associates)

Thank you for taking my question. I'm looking at your concession results: are concessions consistent across studio, one-bed and two-bed products or are they over-exposed to the one-bedroom products?

Michael Manelis, Chief Operating Officer

In the urban cores concessions are being applied pretty much across most unit types. We are seeing the lowest occupancy in our studios specifically in downtown areas like Manhattan and City of Boston, so those unit types are pressured. Concessions are flowing through more toward one- and two-bedrooms because application counts on studios are not as high.

Alex Kalmus, Analyst (Zelman & Associates)

Makes sense. Taking a three-to-five year view, considering shifting demographics with millennials moving to suburbs to buy homes and a softer Gen Z coming up, would you rather be overweight any particular product?

Mark Parrell, President & CEO

I like having a variety. Studios have the advantage of being the lowest price ticket and can be attractive to newcomers to a market. We try to have a thoughtful mix—studios, one-beds and two-beds. Large unit types are harder to rent in our buildings; three- and four-bedroom units compete with condos. So studios, one- and two-beds are the sweet spot for us. Gen Z is large and preferences remain to be fully known, but we're happy with a diversified unit mix.

Alex Kalmus, Analyst (Zelman & Associates)

Makes sense. Thank you very much.

Operator, Operator

We will take our next question and that is from John Kim with BMO Capital Markets. Please go ahead with your question.

John Kim, Analyst (BMO Capital Markets)

Thank you. You changed your definition on renewal rent growth to no longer being an effective growth number? I'm wondering why you changed that definition?

Bob Garechana, Chief Financial Officer

We haven't changed the definition. We've always given renewal rate growth excluding concessions and we also gave new lease excluding concessions as well. What we added this quarter is the effective blended lease rate, which includes the impact of concessions so you can see the blended impact with and without concessions.

John Kim, Analyst (BMO Capital Markets)

Is that something you could break out going forward by market? In other words, effective rental growth rate by market?

Mark Parrell, President & CEO

Your request is to see blended effective rates by market—yes, we'll take that and provide it.

John Kim, Analyst (BMO Capital Markets)

Have you discussed plans for your retail or non-residential portfolio? Do you plan to retain it as retail or potentially convert it to other uses?

Mark Parrell, President & CEO

We're working through things with retail tenants and hope to save a few as the city reopens. We've also discussed repurposing retail that is not working—could some retail be repurposed as amenity space or office-like lounge for residents, with good Internet and amenity use rather than full public office. That could require rezoning and significant TI and is not easy, but it's intriguing. Vacant retail is not appealing and taking on more retail risk is not exciting, so repurposing to serve residents is an idea we're kicking around.

John Kim, Analyst (BMO Capital Markets)

Okay great. Thank you.

Operator, Operator

We’ll take our next question and that is from Alexander Goldfarb with Piper Sandler. Please go ahead with your question.

Alexander Goldfarb, Analyst (Piper Sandler)

Hello. Good morning and thank you. Mark, you mentioned your average age is 33 with average income around $160,000. If there is a generational shift where older demographics move out and cities are populated by younger singles who may earn less—say upper $90,000 to $100,000—do you feel your portfolio is priced appropriately for that potential shift?

Mark Parrell, President & CEO

For example in New York City, only about 10% of our residents have children. We have people in their 20s who are earning good incomes and couples in one-bedrooms. While it's a theory, we haven't seen evidence of a permanent shift. These markets continue to have large numbers of people making over $100k or $150k. I worry that many of those who want homes will buy them, but our demographic hasn't shown a large shift toward home buying yet. The pandemic has put people on their heels but many will reappraise and return to cities. I appreciate the theory but have not seen evidence supporting a long-term demographic shift to materially lower income renters in our portfolio.

Alexander Goldfarb, Analyst (Piper Sandler)

Second question: considering the upcoming election, there's rhetoric around progressive policies—do you have concerns about increased regulation on housing, moratoriums, rent control if there's potential changes in federal or state leadership? How is the industry preparing based on lessons learned?

Mark Parrell, President & CEO

Putting aside party labels, additional regulatory burdens being added in some markets—some tied to the COVID emergency and some from activist groups—will restrict investment in housing. We're trying to educate and engage in conversations about what effective regulation looks like. There could be zoning reform or approaches to increase affordable units with market rate development rather than rent regulation which economists generally say can create more problems than solutions. The industry is advocating for policies that uphold the system and encourage production of more housing.

Alexander Goldfarb, Analyst (Piper Sandler)

Thank you, Mark.

Mark Parrell, President & CEO

Thank you, Alex.

Operator, Operator

There are no further questions at this time. I will now turn the conference back over to Mark Parrell for any closing comments.

Mark Parrell, President & CEO

We thank you all for your time on the call and have a good rest of the summer. Good day.