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Avalonbay Communities Inc
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Good morning, ladies and gentlemen, and welcome to AvalonBay Communities Second Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. Following remarks by the company, we will conduct a question-and-answer session. [Operator Instructions] Your host for today’s conference call is Mr. Jason Reilley, Vice President of Investor Relations.
Mr. Reilley, you may begin your conference.
Thank you, Doug, and welcome to AvalonBay Communities second quarter 2023 earnings conference call. Before we begin, please note that forward-looking statements may be made during this discussion. There are a variety of risks and uncertainties associated with forward-looking statements, and actual results may differ materially. There is a discussion of these risks and uncertainties in yesterday afternoon’s press release as well as in the company’s Form 10-K and Form 10-Q filed with the SEC.
As usual, this press release does include an attachment with definitions and reconciliations of non-GAAP financial measures and other terms, which may be used in today’s discussion. The attachment is also available on our website at www.avalonbay.com/earnings, and we encourage you to refer to this information during the review of our operating results and financial performance.
And with that, I will turn the call over to Ben Schall, CEO and President of AvalonBay Communities, for his remarks. Ben?
Thank you, Jason, and thank you, everyone, for joining us today. I will start with an overview of our outperformance in Q2, speak to the limited new supply in our markets as compared to most other markets and then provide additional color on our guidance raise, our second raise of the year. Sean will speak to our underlying market fundamentals, including the progress we are making on bad debt and provide a further update on our operating model initiatives, which are exceeding expectations. And then Matt will highlight the continued outperformance of our new projects in lease-up and summarize our recent transaction activity, including the sale of three assets at a 4.7% cap rate. Our balance sheet is as strong as it has ever been with total liquidity of $3 billion, and Kevin is also here with us for Q&A.
Turning to Slide 4 in the presentation that we posted yesterday. We achieved second quarter core FFO of $2.66 per share, which equates to a 9.5% growth as compared to last year and which is $0.07 per share higher than the Q2 guidance that we provided in April. I’ll speak more to the underlying drivers of that outperformance in a second. We completed two new developments this quarter and started one new project. And as a reminder, early in Q2, we completed the exercise of our $500 million equity forward, capital we raised at $245 per share and has subsequently been investing safely at rates in the low 5% range.
In terms of our outperformance in Q2, it was primarily revenue-driven with same-store revenue growing 6.3% or 110 basis points higher than we had anticipated, as shown on Slide 5. Lease rates and other rental revenue were modestly favorable to our prior guidance, partially offset by slightly lower occupancy.
The most significant driver of the favorable variance was underlying bad debt, where we have been successful as our landlord rights have been reinstituted of getting back and re-leasing apartments that were previously generating no revenue. As we look forward, we continue to expect our portfolio, which is two-thirds located in suburban coastal markets, to benefit from significantly less competitive new supply coming online than in the Sunbelt and other parts of the country.
Slide 6 shows the magnitude of this differential, where starts in our established regions have remained stable over time, while Sunbelt starts have increased 50% since 2020. The ramification of this activity is that in 2023, new apartment deliveries will be almost 4% of existing stock in the Sunbelt as compared to only 1.5% of stock in our established regions. And this meaningful differential was set to continue in 2024.
Moving to Slide 7. We are raising our full year guidance for core FFO to $10.56 per share, which equals a 7.9% increase over 2022. As a reminder, we increased guidance by $0.10 in April to $10.41 per share, which was attributed primarily to Q1 outperformance and the earnings benefit of accelerating our equity forward.
The second increase of an additional $0.15 per share incorporates our outperformance in Q2 and reflects our latest revenue and expense forecast for the year, including improved expectations for bad debt. As part of this updated guidance, we have increased our same-store revenue growth expectation of 6%, kept expense growth constant at 6.5%, and the resulting same-store NOI growth outlook of 6% is up 175 basis points at the midpoint. For bad debt, we are now assuming underlying bad debt of 2.3% for 2023, an improvement of approximately 50 basis points from our initial estimates.
As it relates to operating expenses, while the midpoint of our guidance remains the same, we expect lower payroll costs driven by our innovation efforts and lower repair and maintenance and property tax expenses to be offset by higher legal, eviction and bad debt costs as we reclaim apartments from nonpaying residents. The further breakdown of the increase from $10.31 to $10.41 and now to $10.56 per share is shown on Slide 8, with $0.14 coming from same-store NOI.
We also continue to adjust our capital allocation approach based on the changing external environment. While our developments in lease-up continue to perform exceptionally well, we have raised our acquired returns on new development starts given our increased cost of capital and focused on maintaining 100 to 150 basis points of spread between underlying market cap rates and our projected development. Based on these factors and as part of our guidance update, we have reduced our expected level of starts in 2023 to 775 million from 875 million.
On the transaction side, as part of our portfolio repositioning, we continue to take the tack of selling assets first, locking in that cost of capital and then pursuing acquisitions in our expansion markets. Given this cadence and given that we are remaining selective on the acquisitions that we pursue, our guidance now assumes that we’ll be net sellers of assets this year with expected dispositions exceeding acquisitions by roughly $200 million.
And with that, I’ll turn it to Sean.
All right thanks, Ben.
Continuing to Slide 9 to address recent portfolio trends. We’ve experienced a steady improvement in underlying bad debt, primarily due to nonpaying residents leaving our communities. In Q1, underlying bad debt was about 20 basis points better than we anticipated. In Q2, that favorable spread grew to approximately 65 basis points and represented an underlying rate of 2.3%, which was roughly 70 basis points better than Q1.
The elevated volume of nonpaying residents moving out, which is certainly a favorable trend, led to an increase in turnover and modest decline in physical occupancy. Based on what we’re currently experiencing, we expect a continued steady flow of move-outs associated with nonpaying residents over the next few quarters, which will further reduce underlying bad debt.
As I’ve noted in the past, our historical bad debt range is 50 to 70 basis points. So based on the Q2 rate of 2.3%, we’re still approximately 170 basis points away from reaching what we might consider normal levels, which bodes well for revenue growth in future quarters.
Moving to Slide 10 to address our updated revenue guidance, we increased the midpoint of our same-store residential revenue growth outlook of 100 basis points to 6%, which is supported by three primary drivers. The first is better-than-expected underlying bad debt, which is projected at a full year rate of 2.3% versus our original outlook of 2.8% and consists of 2.7% from the first half of the year and roughly 2% in the second half of the year.
The second is a higher-than-projected average rental rate, which is primarily based on what we’ve already achieved through July combined with the rent growth we expect to realize for the balance of the year. And the third is an increased contribution from our innovation efforts, which is helping to drive our projected 16.5% increase in other income for the full year.
We expect economic occupancy to be modestly below our original expectations, trending in the mid-95% range in the back half of the year as we continue to recover homes from nonpaying residents. All our established regions are projected to perform at or above the high end of our original revenue growth estimate except for Seattle, which is projected to be modestly above the midpoint. Additionally, our East Coast portfolio is projected to outperform our West Coast portfolio by approximately 200 basis points for the full year 2023.
Transitioning to Slide 11, we continue to make meaningful progress related to our reimagined operating model. As we indicated at the beginning of the year, we expected an incremental NOI benefit of approximately $11 million in 2023, which is on top of the roughly $11 million we realized in 2022. Currently, we expect to exceed our original 2023 objective by $4.8 million for a total incremental benefit of almost $16 million for the full year.
The material drivers of the positive variance include the faster deployment and resident adoption of our technology services offering and the accelerated realization of staffing efficiency resulting from digitalizing customer-related processes. I’d like to thank our operating and technology teams for their continued effort to drive our reimagined operating model and look forward to sharing more about the next iteration of it in future quarters.
So with that, I’ll turn it over to Matt to address development.
All right. Thanks, Sean.
Turning to Slide 12, our lease-up communities continue to deliver outstanding results, laying the foundation for strong future growth in both earnings and NAV. We have five development communities that had active leasing in Q2, and those five deals are delivering with rents that are $520 per month or 18% above our initial underwriting. This, in turn, is driving a 70 basis points increase in the yield on these investments to 6.6%, well above current cap rates in the mid- to high 4% range and even further above the low 4% cost of capital we source to fund these deals when they started construction, consistent with our match funding strategy.
Looking ahead, we expect to start leasing on an additional six communities before the end of the year, many of which are positioned to exceed our initial projections by a significant margin as well.
As shown on Slide 13, with most of our development communities still early in lease-up or yet to open, we have clear visibility into a substantial future earnings growth stream from this book of business. Over the next six quarters, we expect to deliver an additional 3,600 homes, which are entirely match funded today, and which will drive incremental NOI growth and NAV creation on completion. To provide some additional insight into the transaction market, a summary of our recent disposition activity is shown on Slide 14.
While we were able to close on three asset sales in the past few months, transaction activity is still relatively muted with total sales volumes off roughly 70% from 2022 levels. In general, cap rates on the assets that are selling tend to be below prevailing debt rates, although there are also listings that are not proceeding to closing due to a bid ask spread between seller and buyer. We were pleased with the results on these transactions and we’ll look to redeploy a portion of the proceeds into some limited acquisition activity in our expansion regions as we resume our portfolio trading and continue to make progress on our long-term strategic portfolio allocation goal of a 25% weighting to our expansion markets.
And with that, I’ll turn it back to Ben.
Thanks Matt. To wrap up, I want to thank our 3,000 AvalonBay associates for their efforts and dedication and delivering very strong results in the first half of 2023. As an organization, we have also incorporated our ESG activities into much of what we do, and I’m proud that we are delivering on these initiatives with tangible and measurable progress across all of our key ESG metrics as shown on Slide 15. And as more fully described in our 12th annual ESG report, which we issued last Monday. Our final Slide number 16 summarizes our key takeaways for a very successful quarter.
And with that, I’ll turn the call back to the operator to facilitate questions.
Thank you. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Eric Wolfe with Citi. Please proceed with your question.
Thanks. Good afternoon. It’s actually Nick Joseph here with Eric. So we saw the news that you were released from the RealPage litigation and it sounded like from other participants that this kind of case typically takes many years. I was wondering if you could kind of walk through the rationale that you provided that got you released and I guess, dismissed without prejudice. And then is this the end of it or are there other related cases that are still outstanding that involve Avalon?
Yes, thanks, Nick. And for the wider group, what Nick’s referring to was the legal update that we provided in our earnings release yesterday. And as you pointed out, we are pleased we’ve been dismissed from that class action lawsuit. Nick, at this point, given its ongoing litigation in the wider industry, we can’t make any additional comments above what we included in our disclosure in the earnings release. The filings in the case are public. They’re out there, the extent that you or others want research the matter further.
Thanks. And is that the only case or were there other, I know there were a handful of kind of related cases. Is this – was this everything?
We were dismissed from the consolidation of the class action lawsuits.
Great. It’s Eric. Just a quick one on development, I think that I know you mentioned that this year you were seeing a little bit less accretion from developments versus history just with less developments delivering. Just curious historically, how much accretion have you generated per year from development and would you expect to get back to that in 2024?
Yes. Hey Eric, it’s Matt. I guess, I can speak to that one a little bit and then I don’t know if Kevin wants to talk to the longer term trend there, but I mean, probably the easiest way to think about it is that as that slide showed, we’re looking at 3,600 deliveries over the next six quarters. That’s about 200 deliveries a quarter and that’s – I’m sorry, 200 deliveries a month. And that is probably double the pace of what we’ve done over the last year or so. So, we’re going to be getting twice as many apartments that we’re going to be bringing online and ultimately generating NOI out of it.
Hi Eric. The only thing I’d just add - this is Kevin I mean, obviously, the level of accretion is a function of the volume of activity that we have underway and start and complete and the relative spread relative to our cost of capital. And so you kind of – you can look historically what that has been if we’re – historically, we’ve often started at our current size level, maybe 1.5 billion, maybe a touch less. We certainly aren’t doing that this year as you know. But at that run rate at 150 basis points spread that generates, probably about 150 basis points or so, give or take of incremental core FFO growth per year. Obviously that moves around as things are delivered and as volumes change and spreads change, but that’s just one way to think about that.
That’s helpful. Thank you.
Our next question comes from the line of Austin Wurschmidt with KeyBanc. Please proceed with your question.
Hey, good afternoon. As it pertains to lease rate growth trends, can you share a little bit more detail around how new lease rate growth trended in the second quarter to get to the 2.8% July? And then for renewals, how big is the spread been between asking rates and take rates? Because I think I recall in recent months you were sending out notices in the 7% range and it seems like maybe the take has come down a bit. Thanks.
Yes. Austin, this is Sean. Happy to talk through that a little bit. First on your second comment as it relates to renewals, the spreads do move around throughout the year and throughout various cycles. And so when we originally talked about offers kind of going out the 7% range and where we ultimately settled, you’re talking about spreads that are within normal tolerances, typically 150 basis points or so. Sometimes a little bit less, sometimes a little bit more.
I’d say July was slightly wider. Q2 is slightly narrower. So I think we’re in the relevant range as it relates to renewals, given the knowledge that it does move around depending on specific market conditions as the year evolves. As it relates to the first part of your question as it relates to move in lease rates, we did provide a breakout for the quarter as it relates to move-ins versus renewals, which is at the footnote on the bottom of that attachment.
And as it relates to how that’s trending going forward, what I’d say is that we were pushing pretty hard on rate through the first two quarters of the year. As we started to get back more inventory from those non-paying resident homes, we started to see the new move-in side begin to tick down, which is really what started to reflect in July, which was coming in at 2.8% for new move-ins as compared to what we experienced during the second quarter.
So that’s where we started to see a little bit of softness. But in terms of sort of baking the red roll for the full year and how it carries forward into 2024, I think we’re in pretty good shape based on what we realized through June and even July, frankly, even though we did see some deceleration on the move-ins – new move-ins side of particular in July.
And so just unpacking that as it relates to the guidance, you – I think you said your rent growth assumption in 2023 was revised hire to reflect the growth route by, but the back half lease rate growth, is that unchanged to - versus the original guidance? I guess can you just share what that revised rent growth assumption is for the year?
Yes. Here’s how I describe it is we expect the average lease rate for the portfolio for the full year to be about 70 basis points higher than originally anticipated. Most of that is the result of what we have already achieved in terms of the expirations that we had through the month of July that are then cumulatively carrying forward through the balance of the year and our original outlook, we talked about the fact that we expected some modest deceleration in rent change as we moved through the back half of the year that’s still the base case assumption for us. But what we’ve realized through the first seven months of the year has been strong and will carry us forward through the balance of the year and that’s how you get to that 70 basis point higher average lease rate for the full year.
That’s helpful. Thanks for the detail.
Yes.
Our next question comes from the line of Adam Kramer with Morgan Stanley. Please proceed with your question.
Hey guys, just wanted to ask about bad debt. Look, I think Slide 9 does really good job kind of giving the monthly trends. But it looks like July, what wasn’t disclosed. But I think given the commentary and kind of the occupancy, the physical occupancy disclosure in the bottom left of that slide, it looks like that kind of fell in July. And just wondering if I should kind of read that as a sign of, hey, look a bad debt it kind of continued to trend lower in July or maybe some – I’m missing something there and kind of extrapolating the occupancy into a bad debt read.
Yes. I mean we haven’t provided July bad debt data just yet because it hasn’t been fully closed out. We provided some preliminary estimates for July as it relates to rent change and things of that sort, which is what was included. So I think what probably is the easiest way to think about this is first half our underlying bad debt rate was 2.7%. In the second half, we expect it to be 2%, which reflects 2.2% in Q3 and dropping down to 1.9% in Q4.
As it relates to occupancy, occupancy is correlated with the change in bad debt as we see skip and evict activity throughout the portfolio. So where we are for the second half of the year, as I mentioned in my prepared remarks, is an expectation that economic occupancy will average roughly 95.5%, which is modestly below our original expectation, but it can grow with the fact that we are getting back more non-paying resident units that we anticipated that’s flowing through the turnover into occupancy, but is also helping bad debt. So the two are correlated. And so the expectation is again kind of mid-95s for economic occupancy in the second half based on our forecasted receipt of those non-paying units in the second half.
That’s super helpful. Really appreciate that. And just maybe on kind of I guess a little bit of a follow-up to Austin’s question, but just on the new move-in like term effective rent change, it looks like a bit of a decel [ph] I think the 2Q number is really strong, a little bit of a decal going into July. Is that a year-over-year kind of comp issue? Is that a mix issue just with which leases kind of came up in the month? Is there maybe something else that’s kind of driving that, that decel?
Yes. I think the primary driver is what I was referencing as it relates to Austin’s questions, which is, we pushed hard on rate as it related to the first two quarters of the year. As you may recall, the eviction moratorium for LA expired at the end of March. So as we processed cases, we started to see more availability come into the portfolio in the latter part of the second quarter. And therefore, we started to ease on rates to then prompt more velocity in terms of leasing velocity of those incremental units.
And so what you’re seeing on the new move-in side in particular is in places like LA as an example, where there is more inventory coming back to market. As we get into July, we wanted to push that inventory through the system, get it turned, get it released, get it occupied before we get into the slower and softer frankly fall winter seasons. So that pressure on new move-in specifically is to help spur leasing velocity to absorb more inventory than normal as a result of those non-paying units coming back to us.
Great. Thanks again for the time, really appreciate it.
Our next question comes from the line of John Kim with BMO Capital Markets. Please proceed with your question.
Thank you. On your bad debt, I just wanted to clarify is the 2% in the second half of the year on a gross basis or net of the resident relief funds you may expect to get. And then how long do you think it takes to get to a more normalized level? I think you mentioned 50 to 75 – 50 to 70 basis points was kind of normalized.
Yes. John, the 2% I mentioned is the underlying bad debt, ignoring the impact of rent relief, so to clarify that one. And then in terms of duration, I mean, it’s a good question. We essentially process about, call it, 1,400 skips and evicts the first half of the year. Our expectation is for roughly similar pace, maybe slightly more on the second half. And but based on the number of outstanding accounts that we have at this point in time and the pace of activity, particularly in a state like New York, which is moving more slowly. I do expect it to carry through into at least, I’d say, the first half of 2024. And then as you start to get to the back half of 2024 and 2025, I would expect to see normalization based on the pace we’ve experienced thus far.
Okay, great. Thank you. Second question is on operating expense, I think you mentioned lower property taxes as part of your expectations for the second half of the year. Is that related to Washington state or are there other markets that are driving the lower taxes?
Yes, Washington state is a big chunk of it, John.
Okay, great. Thank you.
Our next question comes from the line of Alan Peterson with Green Street. Please proceed with your question.
Hey guys, thanks for the time. Sean, maybe a little bit more of a longer term question for you. You guys are ahead on a lot of the operation initiatives, particularly on the labor efficiency side. Does that start limiting the opportunity set in 2024? And if possible, could you quantify what the margin expansion opportunity is in the portfolio if it were fully optimized?
Yes. Good questions. So as it relates to the operating initiatives, when I talk about them first more holistically. At this point, based on what we have projected for 2023, we’ll be about halfway through our plan as it relates to achieving about $15 million in incremental NOI with the balance of that to come through 2024 and into 2025. Beyond that, there are other things that we’re investing in that we haven’t talked about in significant detail as it relates to the use of AI, which you started several years ago and have been in R&D mode and other areas of the business, some other automation efforts and various other things that will help drive additional value NOI to the portfolio, which we would – we will be happy to talk about as we get further along with those. But I would say, as of right now, if you think about what’s coming in the way of NOI assume there’s another roughly $25 million or so to come as it relates to 2024 and 2025. That’s kind of the high level summary where I’d leave it, that includes more than just the staffing side of it. That includes all of it, that’s underway at the moment.
Appreciate that. And then just transitioning to the transaction market, Matt, across the conversations you’re having with owners and brokers, are you expecting more distressed opportunities to appear within your established markets or in your expansion regions today?
There’s not a lot of distress that we’re seeing out there yet in multi of any kind, honestly. I think if it shows – my guess is, it would be more likely to show up in some of our expansion regions where people were buying maybe with short-term value add business plans, where maybe they were borrowing short-term floating rate debt, thinking they were going to invest some money and improvements get a rent roll pop and then flip the deal out. So that business plan is not working for folks the way it had been.
So there could be some pressure there or some kind of larger portfolios that people may have bought at a higher leverage point. There was just more of that transaction activity happening in the Sunbelt than in our coastal region. So maybe that means there’s more opportunity there if some of that goes sideways, but it’s pretty speculative.
Appreciate that. Thanks for the time, guys.
Our next question comes from the line of Sanket Agrawal with Evercore. Please proceed with your question.
Hey, good afternoon guys. Thanks for taking my question. So as you saw that you guys brought development starts down by $100 million, so we just wanted some color on that. Like does it fall through the next year or like, did you guys cancel on couple of projects regarding that?
Yes. Hey, it’s Matt. I’ll speak to that one. Yes, it was really just one project that honestly, the returns got a little too tight relative to what’s happened with cost of capital and asset values. So I wouldn’t read too much into it as it relates to next year. We have a pretty robust pipeline, so we think we have the opportunity to increase our starts activity next year if things go the way we hope they will. So that was really just a deal specific situation there.
Overall, this is – I just – this is Ben, just to add a couple of comments on our framework here. Overall, like you’ve seen from us the last couple of years, the discipline that we’ve had both around adjusting our capital allocation approaches based on the changing external environment, including our cost to capital, and then also a discipline around maintaining the spreads that we want between underlying market cap rates and our stabilized development yield. So when you hear Matt talk about a deal that we’re moving from the system, that’s us having those hard conversations to make sure that we feel like there’s sufficient value being created for shareholders.
That sounds right. And I had a follow-up to that. Like we were talking a couple of guys on the private side and they said that developers have pulled back on the development team. Do you guys see the same things on the ground? Are you guys pulling back on development side or something like that?
I think if you’re talking about kind of personnel and overhead, we have seen a lot of the private merchant builders start to cut back in some markets, particularly the markets where start activity had been really elevated, some of the really hot markets. We have not been in that position. Fortunately, again, we’ve had a relatively measured pace of start activity really for the last three or four years relative to our long-term kind of averages. And we’re across a number of different markets and a lot of our markets honestly are less volatile. And so if you look at actually where our starts are heavier right now, at this moment, it tends to be in some of those northeastern markets where things didn’t run up quite as hot and they’re more steady kind of in a more stable environment as well. So we’re not seeing those same kind of overhead pressures.
Thank you.
Our next question comes from the line of Jamie Feldman with Wells Fargo. Please proceed with your question.
Great. Thank you. Sticking with that last comment about the northeast markets, I mean, you’ve been particularly well positioned in both northeast markets and suburban the last couple years. How long do you think that outperformance of those markets can continue? And what are you watching that’ll continue to give you confidence in that situation?
Jamie, I’ll make a couple of comments. As we think about the prospects for the various markets, and particularly our established regions versus the Sunbelt markets, the supply dynamics in our minds are going to continue to be a factor and a factor at this point into 2025. And that’s just simply a function of start activity, the time it takes to then complete those deals and then the lease up of that activity coming through the system. So this will be something in our minds. And particularly if we are faced with an environment of flat or softening demand, the reality is those markets and sub-markets with higher level of supplies in our minds are going to face a softening operating environment.
But I guess – yes, I mean that’s helpful in terms of the data to watch. But like northeast has been incredibly strong versus other regions. What do you – what gives you confidence that it’s going to continue? Or do you think like it does start to revert to mean at some point?
I think we feel fairly confident on the demand and supply dynamics in our suburban coastal markets and that includes the northeast. On the demand side, there are elements of rent versus owning economics today, which stay very prevalent. And to some degree are – if you look at the rent versus own spreads, the northeast has some of the highest levels there. It could be $1000 more a month to own a home versus rent a home given where you see home prices go and borrowing costs run. And those are markets where it’s very difficult to build new single family supply, right, once that part of the process starts back up.
So yes, I think we – that’s a factor gives us confidence. And then as you think about kind of reversions to long-term means, the northeast and other suburban coastal markets just haven’t had the run-up that we’ve seen in other markets. So there’s an underlying stability there that also gives us confidence.
Jamie, one thing I would just add to that to give a specific example, if you think of Boston, which is a market that we’ve been in for a very long time, very active developer. Certainly, there have been very good demand drivers there as it relates to a number of different industries, highly educated workforce, good income levels. Our predominantly suburban portfolio is pretty supply protected. Most of those towns have fulfilled their 40B affordable requirements. So there’s not a lot of developments in the pipeline. That’s the kind of environment where we can be successful in development, but also our existing portfolio is pretty insulated as it relates to exposure to supply and tends to produce solid growth.
So that’s a good example of one of those markets. If you think of New Jersey, parts of New Jersey, we’re the first development going in, in 30 years. So while it may not have the growth rate on a stabilized basis that is as attractive as some West Coast markets when they’re really moving along, the additional yield on that development and the total returns are quite attractive. So we’ll continue to allocate capital there. So those are a couple of good examples as to why we think those markets are attractive.
Okay. That’s great. Very helpful color. And then you talked about having, I think you said the best balance sheet in your history, $3 billion of liquidity. The SIP activity was relatively light in the quarter. It sounds like from your comments on the Q&A that you’re not seeing a lot of distressed activity out there. Just how do you think about putting capital -- more capital to work in that SIP book?
And can you talk about the actual transaction you did during the quarter? Or what’s in the pipeline? Maybe that will give us a sense of where distress might be coming? Or am I reading too much into that?
Yes, sure. This is Matt. I can speak to that. And I would say the SIP business is not a distressed business. Basically, we are lending to developers who are building multifamily assets, very similar to the multifamily assets that we build and own and operate. And we’re just providing capital between the first mortgage construction loan and their equity. And where there’s been distress is in the lending world. And so the amount of proceeds they can get off that first construction loan are lower than they would have been a year or two ago. And therefore, they either have to put in more equity or borrow a little bit more money from somebody else.
So in that sense, what we’re seeing that’s changed is, we’re going lower down the capital stack. So we’re lending from maybe 50% to 75% cost instead of 60% to 85% cost like we would have been doing a year or two ago. And we are happy with the fact that we’re just building that book of business today, and so we can underwrite it in today’s environment.
The deal that we just closed on is a suburban garden community in Charlotte, actually fairly near the DFP deal that we started construction on in the first quarter, north of Charlotte. And that’s with a sponsor who is really first-class sponsor who actually have a DFP deal working with as well that we hope to start next year. So it’s a repeat business situation. And that’s pretty representative of the type of business that we’re looking for. That rate is kind of 12-ish, yield is around 13, a little bit more higher than 13. Just given the fees involved, that would have been 10 as opposed to 12 or 13 if it had been a year or two ago.
So we are seeing a lot of inbound inquiries on that program. The challenge is finding deals that underwrite, just given kind of where asset values are relative to replacement cost. And that’s part of what we’re seeing in terms of developers finding it much more difficult to put their capital stack together, which ultimately is slowing start activity. But the good news is, we have our pick of the litter and really top quality sites and sponsors. The challenge is finding deals that underwrite because we’re not really bending in terms of the quality of the underlying collateral and how high it will go in the capital stack to lend against it.
Okay. Have you set a limit on how much you’d want to do that, assuming or did come your way, whether it’s a balance sheet or anything else?
Our long-term goal is to have that plan be a $300 million to $500 million book of business and build that up over the course of several years. I think today, we’re at a little bit less than $100 million in commitments total. So, we’ve got room to run there.
Okay. All right. Great. Thank you.
Our next question comes from the line of Josh Dennerlein with Bank of America. Please proceed with your question.
Hey guys, thanks for the time. [Technical Difficulty] what’s driving the thinking behind that decision?
Josh, you cut in and out on the question. Can you repeat that, please?
Yes, sorry. You mentioned in your opening remarks, you’re now a net seller in guide. What’s driving the thinking behind becoming a net seller this year?
Part of it’s just been our approach and we made this shift last year to selling first the market. There’s uncertainty there. There’s not a lot of capital that’s in play. So we wanted to take some assets to market, execute on those, lock into that cost to capital and then make the decisions around how we’re going to redeploy that capital. We are remaining pretty selective today in terms of our new buying activity. And part of that is, while to Matt’s point, we’re not expecting distress. Our view is that over the next six months to 12 months, there likely will be a greater set of motivated sellers and potentially in our growth areas, in our expansion markets that could be particularly true. If you take a softening operating environment and combine that with a capital environment where capital is less abundant that could provide some attractive opportunities for a platform and a balance sheet like ours.
Okay. Appreciate that color. And then for guidance, what are you guys assuming for new lease rate growth in the back half of this year? Does it turn negative at any point on 4Q?
Yes, Josh. This is Sean. We didn’t provide specific guidance as it relates to new lease rate growth, excuse me. Well, we did say at the beginning of the year, which I would just reaffirm now, is that we did expect to see solid rate growth for the first half, which we have realized, and then begin to see some modest deceleration and blended effective rent change in the back half of the year. And I think that’s appropriate at this point in time in terms of where we are and what we’re seeing in terms of the inventory come back to us from some of the [indiscernible] I think that’s appropriate.
Thanks, Sean.
Yes.
Our next question comes from the line of Alexander Goldfarb with Piper Sandler. Please proceed with your question.
Hey, good afternoon. So two questions. First just going back to the RealPage, Ben is – are you guys totally out of any RealPage related litigation or is this just the consolidated? I’m just, sorry, just want to get clarification. Is this just a consolidated case or are there other litigations that you guys are still party of related to this RealPage?
There are no other litigations related to the RealPage that we’re aware of that we have not been dismissed from.
Okay, thank you for that. Second question is on your outperformance of the developments, I’m assuming a lot of this is based on your land basis. So as you look at your, the options that you’ve struck on your development land pipeline, how many more years do you think that you’ll have above average development returns based on how much rents have moved? Just sort of curious, is this just a one or two year phenomena? Or do you think this could be several years where your developments are outpacing traditional because of where you bought the land versus where rents are now?
Hey, Alex. It’s Matt. Really the outperformance that we’re talking about is relative to our pro forma when we start the job. So the land price is already baked in there. It’s really about the rents and the fact that we had rents run up pretty significantly over the last two years, at a pace particularly in some of these locations, again, some of these suburban coastal locations that were well above trend. We don’t trend rents in the first place. So whenever we quote a yield, it’s the yield as if, it’s at today’s NOI, today’s cost, and then we don’t remarket until we’ve leased at least roughly 20%. So it is a little bit of a unique moment in time in the sense that we started those jobs. The hard costs were good because we bought them out kind of at the trough, if you will really maybe in front of when some of the hard cost inflation that we’ve seen kicked in.
But we enjoyed it on the rent side. So the going in yield on those, the underwritten yield I think was maybe a 5.9% and the rent growth has driven it to a 6.6%, so that’s the 70 basis points of outperformance. When you look at the deals, the next six deals to start lease up as I mentioned, those deals also should have a pretty significant lift because again, there was a nice runup in rents between when we started them and when we’re going to start leasing them. So we still should beat pro forma on those, maybe not by as much, but by a nice margin. And then when you start thinking about the deals that we’re going to start in the next however many quarters, there it’s more about just is it a good land basis? And is it a good hard cost basis? And are those underwriting to an initial 5.8, 5.9 [ph]? No, we’re now looking for mid-6s typically, given what’s happened to the cost of capital.
Okay. Thank you.
Sure.
Our next question comes from the line of Brad Heffern with RBC Capital Markets. Please proceed with your question.
Hey, good morning, everyone. Matt, can you talk about how construction costs have trended of late? And what you’re underwriting for increases in the future when you’re underwriting new deals?
Sure. I guess to the second part, how we think about the future, again, we tend to look at everything on a spot basis, so today’s NOI, today’s hard costs. Now there are some deals that we have in our system, which we signed up in the last couple of years that are thin at today’s hard cost. And so in some cases, we are making the decision to continue to invest modestly in those deals to get them ready to go to see what happens to hard cost by that time because the reality of it is, it’s very difficult to know where hard costs are until you actually have a deal ready to bid and subcontractors see that it’s real.
Ideally, there’s even some demo or something going on so that, everybody is constantly asking them if I had a job to build today, what would it cost, but that’s different than I do have a job ready to go today. I have the permits in hand; give me your best number. So what we’ve seen is in some markets, particularly again, some of those markets that maybe didn’t see quite the same excesses in terms of subcontractor capacity, again, particularly in the Northeast – suburban Northeast, where a lot of our dev starts are, we have seen costs come back maybe 5% to 10% and we’ve enjoyed some buyout savings on some of our more recent starts.
And so once we bought that out, then that is reflected in the way we underwrite the next deal in that region. There are other regions where hard costs, it seems like they’re flattening out, but they haven’t fallen yet, particularly some of the regions that saw – were just really struggling to keep up with all of the demand and all of the elevated start activity over the last couple of years. I would put Austin in that category. I’d put Denver into that category. I’d actually put Seattle into that category, where we saw hard costs run up a lot and have not yet come back to us. And so we’ll see. We’re certainly hoping that they do. We’re seeing start activity start to slow down in those regions, but that may take a while before that plays through.
Okay. Thanks for that. And then maybe for Sean; you say in the slides that two-thirds of the increase in turnover in the second quarter was driven by recapturing the delinquent homes? What’s the other one-third and is there anything unusual in there?
Yes. No, good question, Brad. Nothing terribly unusual kind of it’s a mess here and there across different categories, but nothing that stands out as sort of oh, there’s a – there’s something going on as it relates to relocation or things of that sort. Home condo purchase is still less than 10%, which is a historic low for us. So there’s not much else in there other than sort of the normal stuff, family status, roommate changes, nothing else material I’d say.
Okay. Thanks.
Yes.
[Operator Instructions] Our next question comes from the line of Michael Goldsmith with UBS. Please proceed with your question.
Good afternoon. Thanks all for taking my questions. On Slide 10, you show the performance of the rent growth in different markets, and what’s clear is that the expansion regions are kind of at the lower end of where you initially projected compared to pretty much every other market is at the higher end. So when you think about the expansion markets, does this – the fact that it kind of ended up being kind of at the lower end of your initial projection, change your view on the rate of expansion? Or how quickly you want to move there? And just your thoughts about diversifying the portfolio overall? Thanks.
Yes. Thanks, Michael. I’ll make a couple of comments. One, reaffirm our goal of moving 25% of our portfolio to the expansion regions over a period of five or six years. We’ve talked before about some of the drivers behind that, too, just quickly to call out. One, our core customer, the knowledge-based worker, we recognize is in a more dispersed set of markets today than they have been in the past. And second, just think about an expanded playing field to take what we do well across operations, development to those new markets in order to create value for our shareholders.
In terms of kind of pace and execution, goes to my comment earlier in the call, could be an opportunity here where there are some attractive – more attractive opportunities for us to enter into those markets, given some operating softening and given there’s not a lot of other institutional capital that’s active today. And so we’ll continue to be selective, but I think we’ll have the choice of what we want to own.
On the acquisition side, we’ve been tending to focus recently on assets that we think are going to complement our development portfolio in those markets. And so it’s had us looking at acquisitions that are generally a little bit older in nature, lower in density, lower in price point with a particular focus on micro locations that we expect to have more limited supply coming.
And then on the development side and gets in the land and the conversation we’re having around construction costs, our hope is construction costs will start to come down. There are merchant builders who were accumulating large portfolios of land, and we are starting to see some of those deals come back.
And so selectively, and I talked about this last quarter, we – in Boston and a recent deal in Florida, we’ve been able to take land back at 30% to 40% from where it traded a year ago. So those are the types of opportunities that we’re looking at, but this is a longer-term vision, and we remain focused on moving in that direction.
That’s very helpful detail. And my follow-up question is just on the performance of the suburban versus urban, are you seeing any differences in terms of how the tenant is reacting or kind of how the consumer is positioned in these markets and how that has translated to the results in those two different types of regions? Thanks.
Yes. Good question. And nothing unusual in terms of underlying trends that indicate any significant movement. I mean, we may – that may be different over the next two, three quarters. We are hearing more about people being called back to the office.
Obviously, the Amazon announcement, which would have some impact on the – not only urban portion of downtown Seattle, but also urban Bellevue, where they have a large campus. So I think it’s probably not a broader urban, suburban trend other than as it relates to where people are going to work. If it’s a suburban job center location versus an urban building, that would be something that in the future may shift things a little bit one direction or another, but it’s a little too early to tell.
Thank you. Good luck in the back half.
Thank you.
Our next question comes from the line of Anthony Powell with Barclays. Please proceed with your question.
Hi, good afternoon. Just a question on some of the markets, where you’re getting back the apartments. You mentioned New York is one where it’s moving a bit slower. Are there any other markets where you’re seeing either delays or obstacles in getting back units?
I’d say New York is really a little bit the outlier at the moment in terms of the processing of cases, whether it’s Long Island or city or Westchester, it’s just moving – everything is moving more slowly. The backlog is significant, but it’s also significant in L.A., and L.A. seems to be moving along a little faster.
So those are really the two markets and maybe to a lesser extent, a similar phenomenon is in the District of Columbia. We’re seeing things move more slowly. So I’d say New York is probably the outlier to the slow end followed by DC in terms of what’s going on. The rest of them is sort of just chipping along.
Got it. Thanks. And maybe a more basic question. When a tenant skips or is evicted, are they eligible for a new market rate apartment? I’m wondering where these people are going and if we’re going to see like lower demand overall for apartments given the elevated activity in this area across the industry in the past few months.
Yes, it’s a good question. Different companies use different types of screening criteria, so I can’t really speak to the market specifically on that subject. That really is something that from an industry perspective, you acquire a lot of conversations in terms of how people screen their applicants to make that decision.
Are you seeing any more doubling up at any time as maybe some tenants who are living apartments have to live with roommates or anything like that in your portfolio?
Not any significant trends. That actually went the opposite direction through COVID. And we haven’t seen a significant trend indicate people are doubling up.
All right. Thank you.
Yes, you’re welcome.
There are no further questions in the queue. I’d like to hand it back to Mr. Schall for closing remarks.
All right. Well, thank you for joining us today, and we look forward to speaking with you soon.
Ladies and gentlemen, this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.