Mid America Apartment Communities Inc. Q1 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to today's MAA First Quarter 2022 Earnings Conference Call. As a reminder, this conference call is being recorded today, April 28, 2022. I will now turn the call over to Andrew Schaeffer, Senior Vice President, Treasurer and Director of Capital Markets of MAA for opening comments.

Thank you, Ashley, and good morning, everyone. This is Andrew Schaeffer, Treasurer and Director of Capital Markets for MAA. Members of the management team also participating on the call with me this morning are Eric Bolton, Tim Argo, Al Campbell, Rob DelPriore, Joe Fracchia, Tom Grimes, and Brad Hill. Before we begin with our prepared comments this morning, I want to point out that as part of this discussion, company management will be making forward-looking statements. Actual results may differ materially from our projections. We encourage you to refer to the forward-looking statements section in yesterday's earnings release and our 34-Act filings with the SEC, which describe risk factors that may impact future results. During this call, we will also discuss certain non-GAAP financial measures. A presentation of the most directly comparable GAAP financial measures as well as reconciliations of the differences between non-GAAP and comparable GAAP measures can be found in our earnings release and supplemental financial data. Our earnings release and supplement are currently available on the For Investors page of our website at www.maac.com. A copy of our prepared comments and audio recording of this call will also be available on our website later today. After some brief prepared comments, the management team will be available to answer questions. I will now turn the call over to Eric.

Thanks, Andrew, and we appreciate everyone joining us this morning. MAA continues to capture robust leasing conditions across our portfolio, and we are carrying strong momentum in rent growth into the summer leasing season. Leasing traffic remains high, solid job growth, accelerating migration trends to our Sunbelt markets and the higher pricing hurdles for single-family ownership continue to fuel strong demand for apartment housing. Almost 14% of the new leases we wrote in the first quarter came from move-ins relocating to the Sunbelt. This is an increase of 190 basis points from the first quarter of last year. Resident turnover continues to remain low with move-outs further declining by close to 6% as compared to Q1 of last year. These trends continue to support our ability to capture strong rent growth. The rents in place at quarter end within the same-store portfolio were on average 12.4% higher on a comparable basis to the prior year. And encouragingly, the new leases that went into effect in the first quarter were 16.8% higher than the expiring leases. Pricing momentum remains strong heading into the important summer leasing period. Our largest pressures on property operating expenses were with personnel costs and repair and maintenance expenses as the tight labor market, inflationary pressures, and supply chain issues make an impact. But with the strong top line performance, we continue to see strong NOI growth. And as detailed in our earnings release, we have increased our performance expectations for the full year. Our new development pipeline continues to perform very well with 5 of the projects now actively leasing and capturing rents that are higher than assumed in our projections. As detailed in the earnings release, we have 3 other developments under construction that we expect to start leasing late this year. In addition to the development detailed in the earnings release, we are also expecting to break ground on another 3 projects later this year located in Raleigh, Tampa, and Denver. We're excited with the strong start to the year. Leasing conditions clearly remain very favorable. We have a number of initiatives underway with new technologies and redevelopment that will further fuel margin expansion and higher earnings growth from our existing portfolio, and expanding new development pipeline will also fuel additional FFO growth over the next 2 to 3 years. The balance sheet is in a strong position to support our growth plans. MAA strategy has consistently demonstrated more resilient performance during weaker parts of the economic cycle. But as a consequence of the many enhancements we've made over the past few years to the portfolio mix, to the operating platform, to the balance sheet and to our external growth capabilities, we're excited to now also see MAA's ability to post strong relative performance during recovery and the up parts of the market cycle. In closing, I'd like to extend my appreciation to our team of MAA associates for their continued hard work and consistently strong performance. I thought I have in the way of prepared comments, and I'll now turn the call over to Brad.

Thank you, Eric, and good morning, everyone. During the first quarter, we continued to make progress towards growing our new development pipeline. We finished the first quarter with $444 million under construction and $740 million combined under construction and in lease-up at an average expected stabilized NOI yield of 5.9%. The size of our total pipeline is up from $700 million at the end of 2021. During the first quarter, we started construction on a 352-unit project in Denver called MAA Park Central. This is the first phase of a 3-phase 1,000-unit project on land we purchased in late 2020. Predevelopment work at our 3 young sites in Raleigh, Tampa, and Denver is progressing. And subject to receiving acceptable construction costs, we expect to start construction on these projects this year. Additionally, we continue predevelopment work on several in-house and prepurchase developments that we hope to start over the next 18 months in Atlanta, Charlotte, Denver, Orlando, Phoenix, and Salt Lake City. This pool of future development opportunities includes an entitled site in Denver that we purchased in the first quarter of this year. The timing of planned construction starts can change as we work through the local approval and the construction bidding processes. But at this time, we expect to start construction on 1,600 to 1,800 units in 2022 and end the year with a pipeline of under-construction projects between $800 million and $900 million and a pipeline of total projects both under construction and in lease-up over $1 billion. Our operating performance at communities and their initial lease-up is strong, and we're achieving rents substantially above our pro forma expectations. Reflective of the strong leasing demand in our markets, we reached stabilization at our MAA Midtown Phoenix community 2 quarters earlier than our original expectation, while also achieving stabilized effective rents more than 7.5% above our original pro forma expectations. Our construction management team continues to actively manage all our projects and has done a tremendous job keeping labor and material cost increases from having an impact on our overall budgets. Material shortages and shipping delays are prevalent in the market today. And in many instances, necessitate us placing orders and making deposits much earlier in the process than we had to in the past to secure materials as well as our place in the delivery queue. Despite these challenges, we delivered our last units at both MAA Midtown and MAA Park Point on time during the first quarter. Our 2022 disposition plan is underway with 2 properties in the Fort Worth market currently under contract with an expected closing date later in the second quarter. Buyer interest was strong for these 30-year-old properties with one buyer winning the opportunity to purchase both. We plan to sell 2 additional properties later in the year. Our transaction team also remains engaged in the transaction market, and we're actively evaluating several acquisition opportunities, and we continue to believe that as we get later in the year, more compelling opportunities for acquiring stabilized and lease-up properties are likely to materialize. That's all I have in the way of prepared comments. So with that, I'll turn it over to Tom.

Thank you, Brad, and good morning, everyone. Performance for the quarter was once again robust, and we're off to a good start in 2022. We saw strong pricing performance across the portfolio during the first quarter. Blended lease-over-lease pricing achieved during the quarter was up 16.8%; as a result, all in-place rents or effective rent growth increased 12.4% on a year-over-year basis and 2.6% from the prior quarter. Average effective rent growth is our primary revenue driver. And with the current blended pricing momentum, we expect it to continue to strengthen. In addition, average daily occupancy for the quarter was a strong 95.9%. The strong demand environment continues to create new opportunities for our product upgrade initiatives. This includes our interior unit redevelopment program as well as installation of our smart home technology package that includes mobile control of lights, thermostat and security as well as leak detection. At quarter end, we have completed 1,098 interior unit upgrades and installed 11,018 Smart Home packages. In 2022, we plan to complete over 6,000 interior unit upgrades and approximately 23,000 Smart Home packages. By the end of the year, we expect our total number of smart units to approach 71,000. For our repositioning program, we're in the final stages of repricing leases at the first of 8 properties in the program that are now complete; results have exceeded our expectations of another 8 projects that are underway this year. The strong leasing activity continues into April. Lease-over-lease pricing on new rent leases for April is currently at 16.5% ahead of the rent on the prior lease. Renewal lease pricing in April is running 16.7% ahead of the prior lease. And as a result, blended lease pricing for the portfolio is up 16.6% thus far in April. Average daily occupancy for the month of April is currently strong at 95.7%. And exposure, which is all vacant units plus notices through a 60-day period, is just 8.5%. Both numbers are in line with our expectations and support our ability to continue to prioritize rent growth headed into the busy summer season. Our teams are well prepared and looking forward to the busier summer season. I'm grateful for their time and commitment to serving all of our stakeholders. Al?

Okay. Thank you, Tom, and good morning, everyone. Reported core FFO per share of $1.97 was $0.06 above the midpoint of our guidance for the quarter. And virtually all of the outperformance came from revenue growth as rental pricing, occupancy, and collections all combined to produce 150 basis points of outperformance to our revenue expectation for the quarter. As Tom outlined, pricing trends continue to be strong through the first quarter and into April, as both new leases and renewals becoming effective during the quarter through solid double-digit growth over the prior lease. We continue to expect stable occupancy and strong rent growth through this year and with some impact from prior year comps and a return to more normal seasonal patterns during the fourth quarter leasing season, which did not occur last year. Overall, same-store operating expenses were in line with expectations for the quarter, but we do expect continued inflationary pressure over the remainder of the year and particularly in personnel and maintenance costs, which I'll discuss just a bit more in a moment. Our balance sheet remains in great shape, providing both protection for market volatility and capacity for strong future growth. We funded approximately $43 million of development costs during the quarter towards projected $250 million funding for the full year. As Brad mentioned earlier, we expect to start several new deals this year and early next year, likely expanding our total construction pipeline to between $800 million to $1 billion by year-end, which remains well within our risk tolerance limits. We ended the quarter with low leverage. Our debt to EBITDA had a record low 4.27x, with virtually all of our debt fixed and well laddered over an average of 8.4 years and with $1 billion of combined cash and borrowing capacity remaining under our line of credit. Also during the quarter, Moody's affirmed our debt rating of Baa1 and revised their outlook from stable to positive, bringing all 3 rating agencies now to a positive outlook. And this certainly reflects the strength of our balance sheet and the potential for upgraded ratings over the next several quarters. And finally, given the first quarter performance and expectations for the remainder of the year, we are updating both our core FFO and same-store guidance for the full year. We increased our full year range for core FFO by $0.16 per share at the midpoint to $7.92 to $8.24 per share or $8.08 at the midpoint. This represents a 13% growth over the prior year. This increase is essentially all produced by higher revenue growth expectations as projected to continue strong pricing trends produce a 200 basis points increase in our effective rent growth, our expectation for the year to 12% at the midpoint compared to 10% in our prior guidance and 5.2% for prior year performance. As mentioned, our revenue projection for the full year is built on continued solid pricing performance and stable occupancy for the year with some impact from prior year comps in the second half and normal seasonal trends during the fourth quarter. The trends with our property operating expenses remained largely in line with our original projections with some increased pressure expected both from personnel and maintenance costs. The strong labor market, a robust development environment, and the continued supply chain issues are expected to continue to pressure our maintenance service salaries and materials costs. We increased our guidance for total operating expenses for this by 50 basis points at the midpoint to 6%, reflecting the continued pressure. However, it's worth noting this increase is more than offset by the revenue growth trends, which produced a revised same-store NOI expectation of 13.5% for the full year, which is above our prior guidance. The forecast for our largest property operating expense line on real estate taxes remains at 4% to 5%. I'll add also, as a result of the continued labor market inflation assumed higher performance-based incentives, given the strong projected performance, we have also raised the midpoint of our total overhead assumptions for the full year. And the only other change to our guidance was an increase in the dollar value of our disposition volume, which was increased $25 million to a midpoint of $350 million, reflecting higher pricing expectations on assets being sold. So that's all we have in the way of prepared comments. So Ashley, we will now turn the call back over to you for questions.

We will now open the call up for questions. We will now take our first question from Neil Malkin from Capital One.

First question, I just kind of want to touch on immigration trends. I mean, obviously, that's been something that's been talked about for particularly since COVID started. But I was wondering if you can give an update on how those trends are going on either property or market level. Are you seeing that inflow kind of remain steady? Is it increasing from the last couple of quarters in terms of people coming in from out of state? And then the second part would be, are those people from out of state also bringing with them higher average incomes compared to, I guess, you want to call it in-state move-ins?

Neil, this is Tom. Just to give you the broad trend for first quarter start and '19, move-outs from outside the footprint were 9.1%; in '20, they were 10.1%; in '21, they were 12%; and this quarter, they were 14%. So accelerating across the board. And then we see places like Phoenix are now 22%, Tampa 18%; Nashville, 29%; 15% Charleston. And yes, we see so those trends are continuing and they're coming in at higher salaries as well.

Yes. Makes sense. And then maybe I wanted to touch on the acquisition side. You guys have been kind of shying away from that, just given the low cap rates. And now with interest rates going up, I'm just curious about your comment about acquisitions, potentially pursuing some of those in the back half of the year. What are some of the trends that give you confidence that you might have some success there? Is it just elevated deliveries? Is it higher interest rates, maybe reducing competition? Any kind of color on the opportunities you see and why you have some more confidence versus the prior quarters?

Yes, Neil, this is Brad. I'd say, first of all, we've continued to remain active in the acquisition space for the last few quarters. Certainly, pricing has been very frothy in that area. And so it's really hindered our ability to execute in that area. And we've said the last couple of quarters that we do think that opportunities will increase as we get later into the cycle and into this year. And generally, what we end up seeing is something changes, and something changes to drive the market a little bit closer to us where our execution capabilities are a little bit more valued. And I think what we're seeing right now is that play out a bit where our ability to execute via speed, where we're able to come in and close on an acquisition within really 30 days. Our ability to close all cash certainly becomes more valuable to some of the folks in the market. And certainly, we're seeing that at this point. We thought that, that would likely be the case this year. And I think just given some of the geopolitical things that are going on, the interest rate movements, as you referenced, are playing out, where we do believe that we'll be able to execute in that arena this year.

Does that mean to do with potentially cap rates backing up at all? Or do you expect cap rates to be flat to even compress further?

We're really early. Interest rates have moved 100 basis points in the last 60 days. And so what I would say on cap rates is for well-located, well-executed properties, there's really no movement in cap rates. In fact, in the first quarter on the deals that we looked at, cap rates actually went down. Now that's the full quarter. That's likely not the case in March and April, where there have been some folks that high-levered buyers that have paused for the moment. But I would say that instead of getting 10 bids invest in finally, you're getting 4. And the deals that are well located, well executed, are still getting done. So I wouldn't say it's a result of cap rates changing. It's really a result of folks looking to certainty of execution more so than maximizing price. And I would say that where we are right now is bids have been blowing through the top end of broker guidance. Now they're getting the top end of their guidance. And deals are still getting done, especially for the asset types that we're selling and then the asset types that we're looking to buy.

We will now take our next question from Brad Heffern from RBC Capital Markets.

Can you walk through where rent income ratios are currently? And any changes?

Yes, Brad, this is Tim. If you look at our entire portfolio right now, rent income is about 23% that captures everybody that's in a unit right now. So it's gone up a little bit over the last couple of years, but still remaining fairly low and feel like there's still plenty of room to move in terms of our rent performance.

Okay. And can you talk about where renewal offers are being sent out currently?

Sure, Brad. April is, I think I mentioned, is currently running 16.7%. May in the 17% range, and June in 16% right now. But June's a little early for full understanding. So they continue to be very robust.

We will now take our next question from Austin Wurschmidt from KeyBanc.

So I was just trying to understand, I mean, we saw new leases now trending a little bit below renewals in the first quarter and a slight bit, I guess, in April. And you've seen average daily occupancy just now start to tick down here more recently. So I'm just trying to understand if this is a trend that you think can persist for some time, or if there's been just now to the point where you're receiving some pushback on the renewal pricing and that may ultimately lead to need to, I guess, bring those down as we move through the year.

Yes. I'll tackle kind of the first part of that. And I wouldn't see anything that I would characterize as a slowdown. It is very steady. We're few weeks into April or wrapping up April at mid-16s. And I'll tell you, we've certainly gotten some pushback on renewal increases. But those folks that are leaving for price, we're replacing with someone paying 27% higher. So what we see on this is good accept rates for renewals, both in terms of the number of people that are renewing and the increase. We are seeing closure below, and occupancy continues to run at a level that we're very comfortable with; our demand metrics on leads per exposed units are as high as they've been. So short term, we feel pretty darn good about where pricing is.

Austin, this is Eric. I'll also add that, obviously, we're just now getting into the peak leasing season and where demand tends to pick up and leasing traffic really tends to pick up. So I think the fact that we're carrying the sort of renewal rates that we are and the new lease rates that we are through the last 6 months of the fall and winter heading into now, the more robust part of the year, I'm feeling pretty good about the trends that we're seeing.

No, that's helpful. I guess just trying to understand, I guess, the opportunity cost or turnover cost associated if you're backfilling at a lower rent increase on average across the portfolio.

It's important to note that we're filling positions with individuals at a 27% higher pay, and overall turnover has decreased by 6%. Therefore, we are not experiencing an increase in turnover at this time, and we are adjusting compensation at a high rate for those who decided to leave due to salary concerns.

Understood. No, that's helpful color. And so what is market rent growth across the portfolio today? And could you give the current loss to lease?

Yes, Austin, this is Tim. I'll hit the loss-to-lease part. So if you look at the blended rents for, call it, March compared to our March effective rents, it would imply about 8% loss to lease. You've got about $1,600 was our effective rents in March versus effective rent up 14.84%. If you look at just the new lease prices where our absolute new lease prices are still running a little bit higher than renewals, it's actually about 10% based on that number.

And then as far as market rent growth, just curious where you are year-to-date? And I guess whether anything's changed as far as your projection across your markets for this year that led you to increase guidance 200 basis points this early in the year given we received guidance just a couple of months ago.

Austin, this is Brad. I'll begin, and Tim and Tom can add if they'd like. We always anticipated that we would see strength in the first quarter, moving into a phase where we faced strong prior comparisons as well as the fourth quarter. We expected to see some normal seasonal trends affect us this year that weren't present last year. That overall trend remains in our expectations, although the first quarter was noticeably stronger than we had predicted. Pricing came in at 16%, and you saw 16.8% for the quarter, which continued through April, as Tom pointed out, at mid-16s. It performed stronger and lasted longer than we expected, leading us to anticipate the same continued pattern for the year. This adjustment was reflected by a 200 basis point increase across all metrics.

Austin, I'll add that as I alluded to and Tim or Tom mentioned as well, I mean our move-ins from people moving from outside the Sunbelt into our markets continues to grow. But the other thing that's changed, frankly, in the last 90, 120 days or so is with the change happening on mortgage rates and in interest rates. The hurdles to home buying just continue to grow. And I think that is continuing to fuel some level of demand for apartment housing as well that is running than we expected.

We continue to anticipate mid-single-digit growth in the latter half of the year, based on prior year comparisons and the strength of the fourth quarter season we discussed, which remains robust relative to previous years, excluding the COVID period. We believe we can achieve this growth, and we will need to monitor our performance closely.

We will now take our next question from Nicholas Joseph from Citi.

Brad, you talked about kind of the inflation and supply chain challenges with development. So as you think about the starts for later in the year, how much of construction costs moved, I don't know, either on a year-over-year basis or from earlier in the cycle just as you think of pricing those deals?

Yes. Nick, this is Brad. So yes, we build into all of our projections, depending on when we expect those projects to start some level of cost escalation, and I would say that varies based on the market. And I would say also that the cost increase that we've seen varies based on market. And I'll tell you, some markets right now are seeing cost increases that are pretty substantial. But I'll also point out that the way that we approach our developments and the way we underwrite our developments is pretty conservative. As I mentioned, we do keep in our underwritings if we're going to start a project later this year, we've got cost escalation built in our construction costs, but we're also not trending rents until we get to that point. And based on what we're seeing in our markets across the board, there's a significant level of rent increases occurring between now or when we put our project under contract and when we ultimately move to construction that we're not recognizing until we get to the point where we start construction. So we're conservative in how we underwrite these, and we do expect construction costs to continue to rise. When we started this year, we kind of expected a construction cost increase of, call it, 8% across the board. And I would say that that's probably increased to 10% or 12% this year.

That's helpful. And that's kind of my second question, right? So if you think about, obviously, rents have moved up pretty meaningfully as well. So when you blend that together, how does kind of the underwritten untrended deals look today for some of those projects versus when you initially contemplated this?

Yes, I mean the projects that we have today that are under construction actively. I think we're averaging about a 5.7% yield right now on our underwritten rents. And on those that are under construction, we have construction costs that are locked in on projects that we are modeling going forward. We continue to expect those yields to be in the, call it, 5.25%, 5.5% range. So there is some movement there. But when you compare that to still what we're seeing on the acquisition side, where the yields are 3% to 3.5%, the spreads continue to be in that 150 to 200 basis points range. And so we still continue to believe that taking into account the risk associated with development and the costs and all those things that, that 150 to 200 basis point spread is still a good place for us to be putting our capital.

We will now take our next question from Nick Yulico from Scotiabank.

Just going back to the guidance on the year, particularly on the 12% effective rent growth. I mean, I know you talked a little bit about this, but I'm honestly still a little bit confused. I mean if you did over 12% in the first quarter, within that, I really struggle to see how blended pricing would be below 10%, mid-single digits, as you said in the back half of the year, and how you could still get to that 12% number for the year? I mean just any additional clarity on that would be helpful because it really feels like the blended pricing that's embedded in guidance on new and renewal leases is assumed to be pretty strong over the next couple of quarters.

This is Al, and I can try to address that, and perhaps Tim and Tom can explore it further. Essentially, it comes down to the fact that our average leases typically last a year. If you examine the pricing trends from the past several quarters, starting from 2021, we began the year with lending pricing at 2.7%, which then rose to 8%, followed by 15% and 16% in the third and fourth quarters. In the first quarter of this year, we increased it further to 16.8%. While we anticipate our blended pricing will be affected by both previous year comparisons and the seasonal trends we discussed, the strength we've seen in the last few quarters is expected to carry on for a few more quarters. When considering our leases over an average year, that calculation will hold. We expect that revenue, considering the leasing activity over recent quarters, will continue to improve. We anticipate that in the next quarter and throughout the rest of the year, performance will remain strong due to those mid-single-digit new pricing and blended pricing expectations for the latter half of the year. In summary, you have to view this in the context of how your leases accumulate and then decline over time.

Okay. I guess when you're saying that blended pricing getting down to mid-single digits. Is that a fourth quarter issue? Or is there any of that in the third quarter as well?

Now we have to see what happens, Nick. Obviously, we've projected a strong second quarter continuing because we started off well, and Tom mentioned that this is expected to carry into the third quarter due to the significant pricing acceleration we experienced last year. You can feel the impact from last year's comparable quarter, and the fourth quarter has a bit of last year's comparison plus seasonal factors, so it will be somewhat lower. Overall, the average is expected to fall within the mid-single-digit range for the second half.

And the other variable in all this to keep in mind, Nick, is that we're talking about blended assumptions here. But of course, what you see actually play out can vary a bit different between renewal pricing versus new lease pricing. And new lease pricing tends to be much more reflective of supply/demand dynamics going on in the market. But we've, as Tim has alluded to earlier, we've got some mark-to-market or capture to still continue to recover with our renewal pricing. And then if turnover stays low, and we continue to execute at a higher level of renewal versus new lease pricing, it can change the outcome a bit. So what Al has laid out is sort of our best guess as to how things will play out over the back half of the year when you do consider the prior year comparisons are a little bit more challenging, and we are assuming a return to more seasonal patterns next year, or later this year, which did not occur last year. But that mix between renewal and new lease pricing performance can change a little bit, and that can create some variation in terms of the ultimate result we get.

We will now take our next question from John Kim from BMO Capital Markets.

I just follow up on that line of questioning. So you're able to push rents 16% to 17% this quarter off a comp period where you had 8%. Third quarter of last year, you had 15%. So shouldn't your renewals be about 10% in the third quarter if market rents don't move?

Yes, that seems low to me for renewals.

I believe that renewals present a significant opportunity at this time. We are still experiencing a situation where our new lease pricing is approximately 2% higher than the pricing we are receiving on renewals. This suggests that if we consider a return to seasonality or normalcy, the renewals are likely to catch up and eventually exceed the new leases. Therefore, I anticipate that renewals will remain strong for an extended period.

At least 10%.

I would say so.

John, that's a great question. The markets are a bit volatile right now, with both rates and spreads increasing due to various concerns. However, we feel confident about our deposits and believe we don't need to make any changes to our balance sheet to ensure that. Our long-term debt-to-EBITDA target is around 4.5% to 5%, and we're currently below that. We have room for growth in some areas that Brad mentioned, so we don't feel the need to rush into any decisions. It may take some time for us to catch up with the business's strength, but we feel good about our current position. We'll see how things unfold in the next few quarters. If you consider it, transitioning from a B to an A rating can lead to about a 25 to 30 basis points change in borrowing costs over a decade. In the recent deals we've completed, we've managed to secure approximately half of that benefit, pricing at a BBB+ rating and nearing A- at times. We can expect to gain another 15 basis points in a stable market. The positive aspect of the work that Andrew and the team has done is that we don't have many financing needs this year; only $125 million is due. As we've discussed, we don't plan to enter the market, but if we do, we anticipate an additional 15 basis points increase from what we could have achieved.

We will now take our next question from Alexander Goldfarb from Piper Sandler.

Two questions. First, on the asset pricing and the center pool, I think earlier to some of the questions you said that instead of pricing through the top end, it's now pricing at the top end, and there are maybe fewer hitters coming forth to buy deals. Does that mean that multifamily is losing its luster? Or is there just a lot more supply out there? Or is the capital that was going to multifamily now going to other sectors outside of, let's say, the classic industrial and multifamily that was all the rage in the past few years?

This is Brad. No, I certainly don't think folks are going away from multifamily. And in fact, just given the strength of the fundamentals and the broader trends and migration and job growth and things like that in our region of the country, we're seeing as much capital today as we've ever seen in this space and then in our region of the country. So no, it's not that at all. What I think that is, is a couple of things. One is the highly levered buyers are sitting on the sidelines at the moment, just trying to figure out what levers they're going to pull to try to get back into the market. Interest rates have moved so quickly for those folks that they're entering these deals at a negative leverage position, the rent growth that's in place in our region of the country helps them overcome that. So that's really what it is at the moment. It's not a reallocation of capital. It's not capital moving to sectors or anything of that nature at this point. It is simply folks on the sideline at the time being is the first point. The second point is that there has been a flood of projects, deals come to market in March and April. Folks were trying to get ahead of some of the interest rate movements. So there has been a flood of deals that have come to market, frankly. And so I think that part has dispersed the buyer pool a bit amongst these deals. So that's the second component that I would say is limiting the buyer pool on individual deals. But in terms of the entire market, no, I don't think capital has moved away from this sector at all.

Okay. The second question is about gas prices. Are you noticing any effects on your residents? Some people suggest that since the Sunbelt has a lot of driving and less competition from customers in coastal markets, gas prices matter more. However, most of your residents are likely single and more focused on their entertainment budget than their gas expenses. So I'm curious if gas prices are affecting your renters or if it's really a nonissue.

I'd say it's a nonissue. It's one of many factors going on. And I think when you stack up sort of the different regions of the company or even the different of the country or even our submarkets, we're seeing steady performance in pricing, whether it's inner loop downtown walkable asset or a suburban asset with a drop. So just not seeing much on that on the renter side of things.

And Alex, we're also seeing wage growth take place at a pretty robust pace as well. So a combination of what's happening on the employment side and wages, I think, has muted any negative impact on the rise in gas prices so far.

We will now take our next question from Haendel St. Juste from Mizuho.

A couple of follow-ups here. I guess I heard you earlier mention that some markets are seeing very substantial development cost increases. I guess I'm curious which markets are those cost increases standing up more so and why more than other markets?

Yes. The two markets that come to mind are Denver and Phoenix. They are somewhat isolated in terms of their subcontractor and general contractor bases. In contrast, Texas has cities like Austin, Houston, Dallas, and San Antonio where contractors operate across all of those markets. However, Denver and Phoenix tend to function more independently. As a result, the available pool of contractors is somewhat more limited, leading to a different impact in those areas.

On the development pipeline overall, you mentioned reaching about $1 billion by year-end, and that you are still within your comfort threshold. I'm curious how much larger you might be willing to grow that pipeline, especially considering the rising rates and the increasing supply projects expected across the Sunbelt over the next year or two.

We previously discussed that our tolerance limit for our balance sheet is around 4% to 5%. Currently, we are significantly below that threshold. Therefore, reaching $1 billion would not be an issue for us considering the surface line. We are certainly considering the marketplace dynamics, but our leverage is low, and we are beneath our leverage thresholds, which provides us with ample capacity. This gives us the opportunity to continue funding in a changing market, and that's how we approach it.

Okay. Fair enough. And then one more, if you would mind just sharing some updated color on D.C. and Houston to your software market. I'm curious how those markets are faring its expectations coming into the year? And is there any optimism and maybe pessimism as you kind of think about this market.

Haendel, D.C. is now 10.5% on blended rent for April. And Houston is 9.6%. So if we were 3 years ago, I would be telling you how well they were doing, but those are improving. They've improved over time. They probably moved from the mid-4s. It's just that still puts them at the lower end of our portfolio's growth rate. So they're improving modestly, I would say.

We will now take our next question from Anthony Powell from Barclays.

So your rental growth and lease spreads have been higher than a single family for the past few quarters, which is good. But in a lot of cases, now some of your monthly rents are converging with single family. So do you see that as a risk as single-family inventory increases? And could that be maybe a potential just headwind as you have maybe larger, I guess, homes available at both semi/full rents to what you're offering?

No. I mean there's just no threat at all. In fact, our in-house is, I mean, down 117 move-outs and is now just 3.2% of our reason for move-out. So it's a total nonfactor. And home buying, as you would expect, is down close to 23%. It's now just 18% of our move-out. So the affordability in those areas seems to be driving people to stay, and that's a big part of our production in turnover.

I might add one point to that, that even with the rate increases we've been seeing, our new lease rates are up about 30% over the last 2 years. But single-family home prices in our markets are up almost 40% over that same period. So relative affordability has actually got lower for single-family than it was a couple of years ago.

We will now take our next question from Haendel St. Juste from Mizuho.

I have a question about development. One of your competitors in the apartment sector started in the single-family residential development business last quarter with attached units, I believe in Houston. I'm curious if you have any plans for similar developments in your pipeline and what your overall thoughts are on potentially adding that type of product to your offerings.

Haendel, it's Eric. The short answer is no. We don't plan to pursue that direction. We've spent considerable time analyzing it and concluded that we can achieve margin expansion and earnings growth through our existing operations by continuing to focus on our multifamily product. We are also employing new technologies, much of which is applicable in the single-family market. However, when applied to our larger apartment communities, which typically have 250 units with shared structures, we find that it is much more efficient from a capital expenditure standpoint. After extensive study, we've determined that it is best for us to remain focused on our core apartment product. As we explore external growth, we see ample investment and growth opportunities by concentrating on what we excel at, which is multifamily. So again, the answer is no; we are satisfied to maintain our current focus.

We will now take our next question from Chandni Luthra from Goldman Sachs.

What are you hearing these days on the subject of rent control? We've seen increasing dialogue here. We've seen rent margins in Atlanta and kind of with election coming around later this year. Basically, how are you thinking about managing this dynamic? Do you see heightened risk going into 2023 if 2022 was basically, let's say, done at this point from anything material transpiring from a rent control standpoint?

Chan, this is Rob. I'll start and then maybe turn it over to Tim and Al. But so across our markets, 13 of our states that represent about 90% of our NOI actually have in place state laws that prohibit rent control at a local level. So with that starting as a backdrop to it, it's very difficult to get rent control imposed across our portfolio. So we have a group that is active in monitoring these along with the various apartment associations and trade industries that we're part of. So don't really anticipate any significant impact from rent control across any of our markets.

No, I want to add to what Rob said and what Tim mentioned earlier. With our rent to income ratio currently around 23%, that level is still quite affordable in relation to income. Most economists suggest that problems start to arise when that percentage hits 30% or more. Given our current environment, the issues we face, and the fact that many states we operate in prohibit rent control, along with the affordability of our product in comparison to income, we are not seeing any real signs that we are at risk of significant rent control efforts or regulations aimed at managing this issue.

Got it. And a quick follow-up. So earlier on one of the questions, you talked about 2023 in terms of where you are from capturing that loss to lease standpoint, you expect basically that going into 2023, you're looking at a 5% pricing for now. So big picture kind of thinking about where you guys were pre-pandemic. When do you think the market gets back to that 3.5%, 4%?

I believe that the situation will differ somewhat by region and market. Currently, the fundamentals driving housing demand in the Sunbelt, mainly due to job growth and the increasing acceptance of remote work by employers, suggest this trend will continue for many years. The demand side of our business should remain robust for a while. However, we face challenges related to construction costs and the capacity of developers and construction companies to meet supply needs. Our primary obstacle is the comparisons to last year's performance, which will impact us this year. Looking ahead to next year, I expect a more stable environment. In terms of rent growth returning to normal, it seems unlikely to happen in the next two to three years. We're currently in a unique situation where the only major factor that could alter this outlook is a recession that significantly slows job growth and leads to an economic downturn, which would impact everyone. Historically, MAA has been resilient in such downturns, benefiting from our diversified presence across the Sunbelt and the affordability of our product. Overall, I believe the conditions will likely remain quite positive for an extended period, with a significant economic downturn being the only major threat to that outlook. In that scenario, however, I still feel confident about our position.

We will now take our next question from Rich Anderson from SMBC.

So regarding the recession, the GDP print for the first quarter showed a surprising decline of 1.4%. You have mentioned in the past how MAA has provided some protection during tougher economic times. However, should we be cautious about looking ahead a couple of years or even just a year, focusing on the positive developments happening now, and avoid experiencing a downturn once this situation resolves? I would argue that these favorable conditions may not last indefinitely. Given the broader economic context and the ongoing changes, how do you navigate this challenge?

That's a great question, Rich. We've been giving this a lot of thought because I agree that the economy is cyclical, as is our business. While it's difficult to predict a downturn definitively, there is considerable uncertainty and changes happening. As we prepare the company for a possible downturn, we've focused our efforts on four key areas. Firstly, our portfolio strategy aims to concentrate on markets that can endure downturns better than others. We believe our price point relative to other competitors provides an advantage in such situations. We have a unique diversification across the Sunbelt, with exposure to both secondary and larger markets, and we will continue to prioritize and protect this balance as we manage capital and growth. Secondly, we're closely monitoring our balance sheet, which is currently stronger than it has ever been, providing us with significant capacity. Thirdly, we're keeping an eye on the forward funding obligations we are creating through new developments, aiming to maintain those at no more than 4% to 5%. We're currently below that threshold and plan to stay there, ensuring that even if capital markets tighten, we can meet our obligations. Lastly, if we anticipate a recession a year from now, our operational strategy would remain the same. Now is the time to focus on pushing for rent increases. In a recession, having established rent growth from prior years can help stabilize revenues. Therefore, we believe this is the right moment to prioritize rent growth over occupancy, which is precisely what we are doing right now.

Okay. My second question is about the 14% of your leasing that came from outside into the Sunbelt. Your urban peers are also reporting in-migration these days, so we see a trend of everyone experiencing immigration. I believe that the 14% of leasing only provides part of the picture. What about the individuals who chose not to renew and are leaving your portfolio? Where are they heading? I wonder if the overall net is a positive influx to the Sunbelt. I’m not disputing that, but I question whether there’s a bit of a backdoor opening as some individuals might be considering urban options for better deals or higher-paying jobs. Is this a trend you monitor, focusing on where people are leaving rather than just where they are arriving?

Yes, Rich, we do. Move-outs from the Sunbelt area were only 4.3%, a slight decrease from 4.5% last year. It's not significant enough for me to focus on where they are going, so that works in our favor.

We will now take our next question from Tayo Okusanya from Credit Suisse.

My question is more around innovation and technology. Hoping you could talk a little bit more about what you're doing in that area? And ultimately, what kind of margin expansion you expect from these initiatives that may be comfortable that they're all positive NPV projects.

Sure, Tayo. I'll address the first part and then pass it over to Tim for the margin expansion details. Currently, we have made progress in enhancing our call center solution. We have implemented lead nurturing software, which is technology that automates engagement with prospects from an earlier stage, allowing us to automate follow-ups. We have upgraded virtual touring, added a prospect-centric CRM, and introduced mobile maintenance and mobile inspections. These developments have enabled us to restructure 30 office staff positions in 2021, which is benefiting us in 2022. We are also seeing better billing clarity and increased resident satisfaction due to the inspection process. Currently, we are working on improving self-touring, enhancing multi-location sales support, and simplifying online leasing. We anticipate another reduction of 30 to 50 staff positions in 2022, which will positively impact 2023. Now, Tim can provide details on margin expansion.

Yes. So regarding the margin, at least for 2022, we're expecting our total margin to go up somewhere between 150 and 175 basis points. Obviously, a lot of different factors playing into that, but a lot of the components, Tom mentioned, are included there. And so smart homes, one, for sure, the installations we're doing there that we can see on the top line. That's probably contributing 40 basis points or so this year to the margin. And then some of the efficiencies on the headcount side, the call center, the automated chat are contributing a piece of that as well. I think some of the foundational things we're doing now with the CRM that's currently getting rolled out and some of the other things that Tom mentioned will have more of an impact as we get into '23, and we'll define that more definitively as we move out to the next few months.

We have no further questions. I will now return the call to MAA for closing remarks.

Okay. Well, we appreciate everyone hanging with us today. And if you have any follow-up questions, obviously, just feel free to reach out to us at any point. So thanks for joining us this morning.

This concludes today's program. Thank you for your participation. You may disconnect at any time, and have a wonderful day.