AvalonBay Communities Q2 2022 Earnings Call Transcript

Participants

Corporate Executives

• Jason Reilley, Vice President of Investor Relations
• Benjamin Schall, President, Chief Executive Officer & Director
• Sean Breslin, Chief Operating Officer
• Kevin O'Shea, Chief Financial Officer
• Matthew Birenbaum, Chief Investment Officer

Analysts

• Nicholas Joseph, Smith Barney Citigroup
• Austin Wurschmidt, KeyBanc Capital Markets
• Stephen Sakwa, Evercore ISI
• Chandni Luthra, The Goldman Sachs Group, Inc.
• Bradley Heffern, RBC Capital Markets
• Alan Peterson, Green Street Advisors
• Adam Kramer, Morgan Stanley
• Richard Anderson, SMBC
• Joshua Dennerlein, Bank of America Merrill Lynch
• Connor Mitchell, Piper Sandler & Co.

Presentation

[Operator]

Good morning, ladies and gentlemen and welcome to AvalonBay Communities Second Quarter 2022 Earnings Conference Call. [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.

[Jason Reilley, Vice President of Investor Relations at AvalonBay Communities]

Thank you, Kyle and welcome to AvalonBay Communities second quarter 2022 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?

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Thank you, Jason and thanks, everyone, for joining us today. Kevin, Sean and I will share some prepared remarks and Matt is with us as well for Q&A. I'll start by discussing our financial and operating performance as well as our latest approaches to capital allocation.

On operations, we had a very strong second quarter with core FFO of $2.43 per share, exceeding our prior guidance by $0.12 per share or more than 5% above expectations. This magnitude of outperformance is atypical, particularly since we increased Q2 guidance at the end of April and was driven by continued asking rent growth, above-average occupancy and favorable net bad debt.

As shown on Slide 4, core FFO increased roughly 23% during the second quarter, bringing our year-to-date core FFO growth up to 19%. And as Kevin will describe more fully, we're raising core FFO guidance for the year to $9.86 per share at the midpoint, an increase of $0.28 per share over our prior guidance. As we will highlight later during our remarks, there are a number of meaningful tailwinds that support our strong earnings guidance for the back half of the year and support continued growth going into next year, or if the macro environment were to erode in a way which impacts our operating fundamentals, that should serve as a ballast.

Switching over to capital allocation. Our balance sheet is as strong as it has ever been, providing strength in an uncertain macro environment and allowing us to maintain our focus on creating shareholder value over time and across cycles. We've also responded to the changing capital markets in certain ways. We issued a $500 million equity forward in April at $2.50 -- $250 a share which we can draw down through the end of 2023 to fund our future growth.

As we communicated in Q1, we also shifted from being a net buyer to a net neutral trader of assets in 2022, as we continue to optimize the portfolio and rotate capital from our established regions into our expansion markets. We continue to selectively match dispositions with acquisitions at market cap rates which we've seen widened by approximately 50 basis points in many markets.

Consistent with prior activity, our dispositions are generally of older assets with higher capex profiles in our established regions which we're utilizing to fund acquisitions of newer assets in our expansion markets. And while we remain active on the development front with $2.1 billion under construction and a $4.7 billion development rights pipeline, we have reduced our projected 2022 starts based on some project-specific delays. For new potential projects, we are focused on maintaining flexibility so that we can ramp up or down our overall 2023 development start volume, depending on how macro conditions evolve.

Before turning it to Sean, let me quickly provide some additional color on our Q2 revenue growth. Slide 5 provides a breakout of our 12.9% Q2 same-store revenue growth with the vast majority coming from growth in lease rates as well as the reduced impact of concessions as compared to Q2 last year. Net bad debt also improved relative to last year with additional rent relief payments offsetting the change in underlying bad debt.

Turning to Slide 6. Net bad debt was a meaningful component of our outperformance relative to Q2 guidance with rent relief payments via the federal government's emergency rental assistance programs continuing into May and June as compared to our prior expectations that these government funds would run dry earlier in Q2. And while net bad debt remains elevated, we are pleased to see improving resident payment behavior with underlying bad debt currently in the low 3% of revenue range, down from mid-4% in Q4 2021 and compared to 50 to 70 basis points historically.

And with that, I'll turn it to Sean to review the operating backdrop in more detail.

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

All right. Thanks, Ben.

Turning to Slide 7. The strong revenue growth Ben noted was supported by very healthy trends in the business throughout the quarter. Turnover remained below historical norms, even though it ticked up in absolute terms in June, given normal seasonal patterns but occupancy was above 96% each month of the quarter. Additionally, like-term effective rent change trended up during the quarter and averaged roughly 14%, supported by healthy demand across all of our regions. Lastly, we started to see some improvement in noncollectible lease revenue, excluding rent relief, during the second quarter as residents who were chronically delinquent started moving out from communities, particularly in some of our more challenged markets like L.A. and New York. While we expect the number of delinquent accounts to continue to decline in the back half of 2022, the rate of improvement will likely be modest from month to month.

Moving to Slide 8. The outlook for the business remains quite positive. Asking rents continued to increase throughout the second quarter and are up more than 9% since the 1st of the year, supporting loss of lease of roughly 15% at quarter end. And with the continued trend of historically low availability and resident incomes growing in the double-digit percentage range, we're well positioned to capture higher rent levels as we move further into the second half of 2022 and look ahead to 2023.

Turning to Slide 9. Our lease-up portfolio continues to post very strong results. Leasing velocity exceeded 30 leases per month during the quarter at rents that were on average about $350 or 12% above initial projections. As a result, stabilized yields are projected to be in the mid-6% range on almost $700 million in business, producing significant value creation relative to underlying cap rates.

Now, I'll turn it to Kevin to address our updated outlook for 2022 and the balance sheet. Kevin?

[Kevin O'Shea, Chief Financial Officer at AvalonBay Communities]

Thanks, Sean.

On Slide 10, we provide a revised financial outlook for 2022. We now expect full year core FFO per share of 9 86 or a 19.4% increase over last year's earnings. If achieved, this would represent the company's strongest growth in full year earnings in over 2 decades. This also represents an increase of $0.28 relative to our expectations in April, reflecting continued strong revenue growth across our business.

Drilling down a bit further, this $0.28 increase represents $0.31 in higher same-store residential revenue, partially offset by a $0.03 decrease in other categories, as described on Page 5 of our earnings release. This $0.31 increase in same-store residential revenue is in turn driven primarily by higher-than-expected growth in lease rates and by lower-than-expected bad debt with $0.09 of the increase having already been recognized in the second quarter and the remaining $0.22 divided roughly evenly over the third and fourth quarters.

As it relates to bad debt and rent relief, we expect underlying bad debt before the impact of rent relief to decline from 3.9% in the first half of the year to about 2.7% in the second half. We also expect rent relief to decline from the $28 million we recognized in the first half of the year to $7 million in the second half, nearly all of which is expected in the third quarter. As a result, we expect net bad debt will increase from 135 basis points in the first half of the year to 215 basis points in the second half for a full year rate of about 180 basis points.

Keep in mind that net bad debt for 2021 was 210 basis points, so the change in bad debt on a full year basis is projected to contribute roughly 30 basis points to revenue growth in 2022. Thus, for overall same-store portfolio, at the midpoint of our revised guidance, we now project same-store residential revenue year-over-year growth of 11.25%, same-store residential operating expense growth of 5% and same-store residential NOI growth of 14.25%. Finally, we expect to start about $850 million in new developments in 2022, down slightly from the $1.15 billion expected in their initial outlook as starts for a few planned developments have shifted into early 2023.

Turning to Slide 11. Nearly 90% of current development underway is already match funded with long-term debt and equity capital. Locking the cost of this investment capital helps ensure that these projects will provide earnings and NAV growth when they are completed and stabilized.

Turning to Slide 12. As we look ahead, our balance sheet remains exceptionally well positioned to provide financial strength and stability, while also giving us the flexibility to continue funding attractive growth opportunities across our investment platforms. In this regard, we enjoy low leverage with net debt-to-EBITDA of 4.9x which is below our target range of 5x to 6x. Our interest coverage ratio in unencumbered NOI percentage are at record levels of 7x and 95%, respectively. And our debt maturities are well-laddered with a weighted average years to maturity of about 8.5 years.

And as shown on Slide 13, our liquidity position is excellent with $1.3 billion in excess liquidity relative to our remaining unfunded commitments of about $400 million as of quarter end.

With that, I'll turn it back to Ben.

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Thanks, Kevin. As we look forward, we wanted to emphasize a number of additional tailwinds, as described on Slide 14, that support continued value creation and our strong earnings outlook.

To start and focusing in on development, Slide 15 highlights the historical spread between our development yields and stabilized cap rates, a core measure of how we generate meaningful value for shareholders through our industry-leading development platform. With our strong balance sheet and match funding approach, we're able to ratchet down or ratchet up our start activity at particular points in time but do so in a way that provides consistent incremental value creation and earnings growth.

On completion so far this year, projects at yesterday's cost and today's rents, we are realizing an exceptionally strong spread between stabilized yields and current cap rates of over 200 basis points, generating significant value creation and earnings growth. For projects in our development rights pipeline, we're seeing this spread range from 100 to 200 basis points based on our most current underwriting which we believe continues to provide appropriate risk-adjusted returns.

In the near term, as shown on Slide 16, our developments underway are expected to provide meaningful incremental earnings with roughly $125 million of incremental NOI to come from these projects over the next 2 to 3 years.

Moving to Slide 17. And as we previously outlined, we are in the midst of transforming our operating platform with significant investments in innovation and technology that we expect to generate 200 basis points of margin improvement or $40 million to $50 million of NOI. Slide 17 provides incremental disclosure on certain of these initiatives, including the projected progress year-by-year with $20 million of additional revenue associated with the rollout of bulk Internet, managed WiFi and smart home technology and an additional $20 million in expense savings to come from the digitization of a number of customer experiences, including self-touring, maintenance, renewals and others.

We also introduced our structured investment program last quarter which is off to a solid start. As shown on Slide 18, we've closed our first 2 investments, providing preferred equity to third-party developers on new construction projects. By leveraging our intimate knowledge of development, construction and operations, we believe that we can achieve attractive risk-adjusted returns on $300 million to $500 million of capital, a book of business we will build up over time and providing incremental earnings growth.

Before closing, I also want to highlight, as shown on Slide 19, our continued ESG leadership given the recent publication of our 11th Annual Corporate Responsibility Report. On the E, we are one of the first REITs to set numeric, science-based targets for emission reductions and we're proud that we've achieved actual reductions through these initiatives, 30% reductions in Scope 1 and Scope 2 emissions and 20% reductions in Scope 3 emissions, so far. On the S, our investments in our people and culture, including advancing our inclusion and diversity initiatives, remain a priority with progress being made and more to come. We also continue to invest in our local communities through volunteer time and direct donations, a key part of how AvalonBay associates connect around our evergreen culture, including our spirit of caring.

In closing, on Slide 20 with a summary of our key takeaways. We're very pleased with our operating results to date, have meaningfully lifted our earnings expectations for the year and believe that there are a number of tailwinds specific to AvalonBay that set the table for strong continued growth looking ahead.

And with that, I'll turn it to the operator to facilitate questions.

Questions and Answers

[Operator]

[Operator Instructions] We take our first question from Nicholas Joseph with Citi.

[Nicholas Joseph, Analyst at Smith Barney Citigroup]

Maybe starting on the transaction market and I'm looking on Slide 15 here. Obviously, there's the pretty widespread between the development initial yields and the transaction market looks -- and I recognize these are annual numbers but cap rates come down in 2022. So just curious what you've seen over the last 3 or 6 months in terms of movement in cap rates and asset values across your markets.

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Nick, it's Matt. Yes, certainly, in the last couple of months, there's been a shift in the transaction market with the rise in rates. And so we are pretty active in the market and so we've had some good -- it's changing quickly. So the first thing I'd say is nobody can be real sure but the data that we -- points that we've gotten recently would suggest, as Ben had mentioned in his prepared remarks, cap rates are probably up, call it, 50 basis points, maybe a little more in some regions, a little less than others and depending on the asset type.

There are definitely deals which are just not transacting where they may have seen a more significant move, particularly if they were targeted more to highly levered buyers. But most of the assets that would be in our portfolio are more kind of institutional-grade type assets. It's probably been more in that range. NOIs continue to grow. So in terms of overall asset values, maybe down 5% to 10% because you're getting some lift in the numerator that offsets some of the increase in the denominator.

[Nicholas Joseph, Analyst at Smith Barney Citigroup]

That's helpful. And then just as you start to execute on some of these structured investment program deals, how did the first few deals come about? What sort of competition are you seeing? Just kind of any color on at least the entrance into this market.

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Yes. Nick, it's Matt. I guess I can speak to that one as well. So the first 2 deals we have, one is actually in the East Bay in the San Francisco area and the other one is in Denver. And then we have a others working their way through the pipeline actually on the East Coast. So we're seeing a nice geographic mix. I mean it's typically local merchant, builder, developer sponsors. And we do think the deal flow, there is a lot of leverage there given our deep presence in our markets. So some of these are sites that we knew from kind of looking at them as land. Some of them, they certainly -- there's good deal flow from the brokerage community and folks we're talking to about asset acquisitions or asset dispositions.

The other thing we're seeing is pretty strong relationship alignment with first lenders. All these deals have obviously first construction lenders. And they really take heart in the fact that we're in there with them and such an experienced capital provider further up in the capital stack than they are, given our expertise in development and construction and operations. So we're looking to get repeat business from a pool of lenders. And I think the deal flow is probably increasing as capital gets a little harder to find. So we like our position going forward that we should be even more competitive.

[Operator]

We take our next question from Austin Wurschmidt with KeyBanc capital Markets.

[Austin Wurschmidt, Analyst at KeyBanc Capital Markets]

So I was wondering if you guys could provide where you expect your '23 earn-in to shape up at this point. And I'm just curious, given that we're starting at presumably a historically high earn-in entering year, you still got the sizable loss to lease in place today. I guess I'm trying to understand, if conditions do soften materially from here, I mean, what's the probability that you'd actually see revenue growth turn negative if, again, if things soften materially and I recognize all recessions are different but just using kind of historical data maybe as a little bit of -- to give some idea of what that downside risk could be.

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Austin, this is Sean. I'll take that one. As it relates to the earn-in, there's still obviously a lot of leasing to do, a lot of transactions to execute between now and year-end. The guidance I give you is that coming into 2022, the earn-in that we had in place at the beginning of the year was about 2.5%. And so as you look forward to 2023, given the leases that we've executed thus far this year, what you could sort of expect based on the guidance we provided for the second half of the year that the earn-in going into 2023 would be well above where we started 2022.

So keep in mind that, obviously, it's one variable in the whole puzzle. There are some other factors that could be headwinds and/or tailwinds, including, obviously, the normalization of bad debt in terms of underlying collection rates should be a bit of a tailwind. The loss of rent relief from this year will be a bit of a headwind. So you've got to kind of keep all those things in mind as it relates to how the embedded growth kind of translates to total revenue growth when we get to next year.

And then in terms of your other question about kind of our loss to leases and what might have to happen, yes, I think you make a fair point that even if the macro environment continues to sour, there's still a lot of room between where rents are today and where rents would need to go to, particularly given how our leases expire throughout the year to end up in a position where you'd have negative revenue growth. It really would have to be -- I think I would probably characterize it as a pretty severe economic shock to really see that happen that quickly in terms of the whipsaw with a lot of cushion kind of between us and any kind of negative revenue growth. So that's how I'd describe that.

[Austin Wurschmidt, Analyst at KeyBanc Capital Markets]

Great. That's helpful. And then just secondly, you guys had talked about a NAREIT 2023 starts in the $1.3 billion to $1.8 billion range sort of depending on the environment. Obviously, some deals got pushed into next year. So is that upside to the $1.3 billion, $1.8 billion? So could you provide an update there? And then just also curious how you're thinking about the additional debt capacity that you have today given leverage is below the low end of your range?

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Sure, Austin. I'll speak to the -- this is Matt. I can speak to the development volume and then maybe Kevin wants to talk to the debt part of the question. Yes, I mean, so our development starts this year are going to be less than what we had thought going into the year. And that's really just based on some deal-specific factors. So all else equal, that activity would roll into '23. And so -- and obviously, our development rights pipeline picked up this quarter to $4.7 billion which is I think as large as it's ever been.

So what I would say is if the deals continue and the economics on those deals continue to look attractive, we certainly could start anywhere from $1 billion to $2 billion next year depending on how those deals come together when we get final costs in. We're really focused on preserving flexibility based on if we do see changes there but we certainly have that possibility. And of course, we have the equity forward. So we have a fair amount of that capital already raised, so to speak. But Kevin, do you want to speak to that?

[Kevin O'Shea, Chief Financial Officer at AvalonBay Communities]

Sure. Yes. Thanks, Matt. Austin, I mean I think your point is a good one. We -- I mean the first point I'd make is we enter the environment we're in and we're expecting to enter 2023 from a position of terrific strength from a balance sheet point of view. Leverage, as you pointed out, is below our target range of 5 to 6x. In a normal market environment, the combination of free cash flow which is typically around $300 million a year and is around now and selling assets for retaining capital which is usually between $400 million and $700 million.

And then on normal levels of EBITDA growth, leveraged EBITDA growth kind of adds another $300 million to $400 million, $500 million on top of that. So you end up with kind of having around $1.25 billion or more, give or take, in leverage-neutral funding capacity for investment, primarily development, in a typical year. And with tremendous amount of NOI and EBITDA growth that we're experiencing right now, you can -- you're correct to point out that we would have even more capacity beyond that, call it, $1.25 billion of leverage-neutral funding capacity in 2023 just by flexing up in terms of debt issuance.

Obviously, current rates today don't look attractive relative to where they were a year or so ago. Currently, if we were to do a 10-year debt, it would be in the low 4% range, given where the treasuries are right now. That is sort of reasonably attractive if you look back over the last 10 years. But most of the -- but if you look back over the, as you say, over the last 20 years, if you look back over the last 10 years, it's 4.25% unsecured debt cost for us would be relatively high. But it is reasonably attractive compared to development and development uses.

So I think as we look into 2023 and put together a capital plan, we've got lots of choices between free cash flow, ability to sell assets, the equity forward that Matt just pointed out and our ability to leverage up. But I think how much debt we take on will, at that time, be a little bit of a function of how attractive debt costs are relative to both development yields as well as what our sense is to the cost and other choices in terms of the other capital markets.

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Austin, this is Ben. I'll add a couple of comments that speaks both to your question, Sean, on operating fundamentals and then also how we're looking forward next year in terms of development starts. And what I'd emphasize around our strength is also our portfolio positioning and particularly our orientation to the suburbs, right? With 2/3 of our portfolio in the suburban markets, we believe that's going to provide a level of durability that may not be seen in other markets. Demand drivers, our expectation is going to continue to be relatively strong there.

And then supply relative to national averages is definitely low. It's projected to be in the range of 1.5% of stock. So on the operating side, we think that provides us with some additional resiliency and durability going into next year. And then from a development perspective, as you've seen from us over the -- really over the last couple of years, the bulk of our new development activity will continue to be in the suburban markets.

[Operator]

We move to the next question from Steve Sakwa with Evercore ISI.

[Stephen Sakwa, Analyst at Evercore ISI]

Sean, I was wondering if you could just provide a little color on where you're sending out renewal notices for, I guess, what you got in July and maybe August, September and kind of what your thoughts are for the balance of the year?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Sure, Steve, happy to address that. I mean July, we were basically in the low double-digit range in terms of where the offers went out. And that remains relatively constant as we look forward over the next 60 to 90 days kind of in that low double-digit range. And keep in mind that as it relates to renewals, we are slightly more constrained than normal given some of the COVID overlay regulations that remain in place in markets like California, as an example. So there's more to come on renewals but it's probably going to be in the next year before we're able to get all of it is the way I'd probably describe that to you, Steve.

[Stephen Sakwa, Analyst at Evercore ISI]

Okay. And maybe just circling back to, I guess, to Page 15. We've gotten a couple of questions on the development. I'm just curious, as you sort of look at the major input costs, whether it's lumber in certain areas or steel and concrete, I just -- what are you seeing on the inflation front there? And I realize that you guys -- I guess the current development through the beneficiaries of higher rents with costs from 1 year or 2 ago but the environment today to start in '23 is a little different. So how much have yields come in on kind of the future pipeline and I guess how are you thinking about costs moving into next year?

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Sure, Steve. This is Matt. As it relates to cost inflation, it's still out there. It's still significant. It feels like we're at the top and then it may be starting to downshift. For sure, obviously, lumber prices are down. For sales starts, seem like they're coming off pretty quickly now. So I guess I'd say I'm guardedly optimistic that buyout will start to become a little more favorable. I don't think that means hard costs are necessarily going to drop. But the days of 1% per month increase is maybe behind us, maybe not in all markets but definitely in some markets.

As it relates to how that affects the economics of our development book, our development rights pipeline today on today's rents and today's hard cost is running into kind of a typical mid-5% yield. And if you look at the developments that we're starting this year, that's probably around where they are as well, the 3 or 4 we've started so far and the 2 or 3 we expect to start in the second half year.

Compared to 2 years ago, that was probably high 5s. So it is probably down 30, 40 basis points but that still provides a pretty strong spread. And I do think that those cap rates are probably representative of where they are today. Frankly, the development that we completed late last year, the cap rates were probably sub-4% but we're always a little conservative in how we quote these things. So I'd say 4% cap's probably a good representation for our best guess as to where those deals would trade today if they were stabilized in the market.

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

And Steve, from a sensitivity standpoint, we emphasized this last quarter but just to reiterate it again, as you think about hard cost increases, rent increases and NOI increases, roughly, if you're keeping pace with 10% construction cost increases and hard costs being 60% of our overall project cost, you need approximately 6% NOI uplift. And so if you get both of those in those levels, you're able to maintain yields at that 5.5% type of range that Matt referenced.

[Operator]

We take our next question from Chandni Luthra with Goldman Sachs.

[Chandni Luthra, Analyst at The Goldman Sachs Group]

Could you guys talk about what you're seeing in your sort of more tech-oriented markets, if there have been any signs of the broader malaise that we are seeing everywhere reflect in the business? Any early reads around that?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Chandni, this is Sean. At this point, the answer is no. We're kind of reading in the media the same things you are in terms of particularly some of the start-ups trying to lean things out, some of the larger companies slowing the pace of hiring. But based on the demand that we're experiencing coming in the front door, it is not impacting the renter population in terms of their desire for the types of apartments that we offer.

[Chandni Luthra, Analyst at The Goldman Sachs Group]

Understood. And my follow-up question, in the event of a recession, how would you view the relative positioning of development versus acquisitions if we go into a tougher economic backdrop?

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Chandni, I'll start. This is Ben. Our acquisition activity, at least to date and this is the expectation going forward, it could adjust if the market got further dislocated. But it's an approach really based on trading of assets, right and the movement from selling of assets in our established regions and then reallocating that capital into our established regions. And it ties very much into the portfolio optimization initiatives that we've been focused on as well as our diversification initiatives. So that's the primary element.

On the development side, as we think about capital allocation there, at a high level, it's really a triangulation where we're thinking about what's the opportunity set, right? Matt talked about sort of the spreads that we need to maintain. So how do we think about a sufficient spread that is there and probably in the -- at the bottom end in that 100 to 150 basis point type of range to appropriately provide the return on that risk.

And then we're thinking about the -- what's -- the other component of it is how do you think about the relative attractiveness of that development and the other relative sources there. So we're triangulating those 2 dynamics along with our source of capital. And that will really continue to -- that's been our approach and that will continue to be our approach as we think about our capital allocation choices going forward.

[Chandni Luthra, Analyst at The Goldman Sachs Group]

Are there any lessons to take from the last financial crisis as we think about the relative positioning of those 2 areas of capital allocation?

[Kevin O'Shea, Chief Financial Officer at AvalonBay Communities]

In terms of acquisitions versus development?

[Chandni Luthra, Analyst at The Goldman Sachs Group]

Yes.

[Kevin O'Shea, Chief Financial Officer at AvalonBay Communities]

Well, I mean I think probably the lessons we probably have taken is, first of all, always have a prepared balance sheet so you're positioned to be able to respond to the opportunities that emerge in the market. So in a normal operating environment, we typically enjoy developing and that's our highest and best source of shareholder value creation. But obviously, in a dislocated market environment, you can see acquisition opportunities emerge in certain circumstances. As you saw us engage in, in 2020, there are opportunities that are pretty attractive from a standpoint of buying back our stock.

So that's part of the reason why you'll see, Chandni, we're operating at below our target level of leverage and with quite a bit of excess liquidity available to us. Because we need -- when there's more of a greater dispersion in macroeconomic environments that can unfold in front of you, you want to be prepared to be able to respond positively to the large majority of them. And so we're in a position to hunker down if we need to. But more likely, we're in a position to really act and use our capital strength in order to invest in whatever the opportunities that may emerge over the next year or so.

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Chandni, one thing just to add to that. Keep in mind on the development book. And this is not just a reflection of our experience following the GFC but prior downturns. As it relates to development, those typically are some very good times for us as it relates to new land deals, either renegotiating deals that we have, sourcing new land. And importantly, if there is a reset in construction costs, as Matt pointed out, that is a very good time to buy out jobs. You only buy it at once, you only build it once, you release it every year, so that tends to be a very good time for us to source opportunities and get them started. And then when they would mature and deliver, they tend to be very, very nice yields on that book of business. So that is one thing that is relevant to the development side of the equation.

[Operator]

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

[Bradley Heffern, Analyst at RBC Capital Markets]

On the delayed starts, is there anything in common with those? Is there something that's specific to each of them individually? And I guess what's the likelihood that we'll see further delays next quarter from projects that are further out, et cetera?

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Brad, it's Matt. No, I wouldn't say -- I mean the thing that's in common is just what we're seeing across our -- everywhere, really which is just jurisdictions backed up. Honestly, even the design professionals backed up a little bit in terms of getting final permit drawings in and so on. So I think that's a general trend we're seeing across the space. And it probably is likely to continue. I think that we have started to factor that in as we think about kind of start activity and as we think about predevelopment schedules that things are taking a little longer to get through. So the deals that are teed up for the second half of the year starts, those are all tracking solidly and I don't see anything at this point that would create any further delays in those.

[Operator]

We take our next question from Alan Peterson with Green Street.

[Alan Peterson, Analyst at Green Street Advisors]

Sean, can you remind us the magnitude of the year-over-year reduction in on-site headcount that's helping keep overall payroll costs only growing at 1% year-to-date? Are you guys anticipating any additional reductions over the next year?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Alan, Sean. So the numbers that I quoted is on -- and we parse it between office and maintenance. But on the office side of the house, in the second quarter, the headcount was down about 6%. On the maintenance side, it's about 4%. And then yes, as you look forward, Ben touched on it in his prepared remarks in terms of the benefit that we expect for the various initiatives that we have ongoing and the digital initiatives, in particular, that bucket of activity that you referenced will result in additional efficiencies at the site level, both on the office and the maintenance side, over the next couple of years.

[Alan Peterson, Analyst at Green Street Advisors]

Perfect. And just one more on development philosophy question. Ben, you touched on the low end of the range for development economics to continue to pencil being roughly 100 to 150 basis points. Is there a scenario where that spread is tighter than 100 basis points where you would still start a new construction project?

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

It is possible. Yes, I mean, that's a general range so it is very dependent on our view on specific markets. It would be coming -- our approach would come from a position of are we creating the appropriate long-term value creation relative to the risk, right? So when you start to get down around that range, you're going to be asking yourself those tougher questions and make sure that you have a higher level of conviction around the value proposition.

[Operator]

We take our next question from Adam Kramer with Morgan Stanley.

[Adam Kramer, Analyst at Morgan Stanley]

Kind of want to ask maybe a bit of a bigger picture question about kind of rent growth. If you think historically, right, kind of pre-COVID and long term, I think kind of 3% -- and correct me if I'm wrong but I think kind of 3% rent growth typically per year is kind of a decent proxy to use. And obviously, we're in this high inflationary environment and even with the year-over-year numbers which kind of should cool off here, we're still kind of going to be on an elevated level on inflation basis kind of relative to historical. So kind of wondering what you guys think will kind of be a good kind of rent growth proxy to use? Is 3% still the right number? Or should that be higher? And kind of where do you think that might land when we kind of think about longer-term rent growth?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Adam, this is Sean. I'm happy to start and anybody else can chime in. But I think the number that you're quoting, it is really a function of just underlying inflation in the economy. Over a long period of time, though, if you look at it, rents in our markets with our customer segments have grown faster than inflation. I think the number I recommend -- or recall is around 70 to 100 basis points or so, plus or minus above kind of headline inflation. Again, over a long, 40 years kind of time frame, there are times where those spreads compress and there are times when they widen. So I think it really is a function of how you want to think about the underlying inflation rate and therefore, what you might expect in terms of rental rate growth on a nominal basis across our markets, again, serving our segment. So that's, I think, how you need to think about it as opposed to in absolute number terms.

[Adam Kramer, Analyst at Morgan Stanley]

That's really helpful. I appreciate the color there. Maybe just a quick follow-up on just kind of a guide in what it assumes for maybe second half blended lease growth or second half new lease rate growth. But then also kind of where you think -- and I know it's somewhat tough to predict that far out but where do you kind of think new lease rate growth or blended growth may kind of end the year at, right? So you kind of have the number that the second half is based on but maybe a lower number, different number where we may end the year. Just kind of thinking about kind of growth next year, right and kind of back to those earlier earn-in questions.

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Adam, good question. Essentially, what's built into our reforecast for the second half of the year is some deceleration in like term effective rent change primarily as a result of the comps from the second half of 2021. I think as I referenced earlier, if you look at what happened in 2021, we still had negative rent change through the second quarter. And then it quickly flipped to almost up 8% in the third quarter, so the comps get tougher. As you look into the second half, so our expectation is that you'll see a deceleration on average of roughly 150 basis points from the first half, effective rent change to the second half. That's sort of at a high level how I think about where it's going to trend as we move through the balance of the second half of the year.

[Operator]

The next question is from Rich Anderson with SMBC.

[Richard Anderson, Analyst at SMBC]

Just following up on that last question. What about the like term sort of cadence for the second half is optics? Meaning, this year, you have this tough comp scenario that we don't normally have. In absolute dollars, are rents in November meaningfully lower than rents are today? Or are they -- is the pace of market rent growth just decelerating but your actual rents are still above where they are today in your forecast?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Rich, good question. So to date, I've mentioned we've seen a nice run up in asking rents more than 9% since the beginning of the year. So the question you're really asking is maybe around seasonality in terms of what's likely to happen. We do expect some seasonality in the back half of the year. We haven't seen it yet. But in terms of the second half reforecast, what we have assumed is that the normal seasonal decline in that we should see in the absolute level of rents would be about half in 2022 as compared to sort of pre-COVID periods.

So if you remember last year, we didn't really see that, rents rose and then they sort of just flatlined the last 4 or 5 months of the year. For this year, we've assumed that they actually will decline, just at a more modest pace than pre-COVID periods would typically dictate. That's an assumption. We'll see if that's the case but that's the assumption we have made so far for this year.

[Richard Anderson, Analyst at SMBC]

Okay. And second question, back to the tech kind of headlines. What's better for you in terms of the multifamily business, tech hiring during the pandemic with no commitment to being anywhere near the office? So that's, I guess, a nice feeling but I don't know how it affects multifamily since they can live in Nebraska if they wanted to. Or tech layoffs or at least hiring slowdowns but now giving some leverage to employers to say, okay, well, if you want to essentially keep your job, you got to come back to the office at least some portion of the week. Is the latter a better scenario for you? Or is just the pure hiring -- accelerating hiring a better scenario for the market overall?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. That's a multivariable question, Rich. And given we don't typically go through a pandemic, that's -- I'm not sure I can give you 100% certainty on that. Certainly, we have been through tech layoff cycles following the tech rec and such in the past which were painful, as you know. In terms of...

[Richard Anderson, Analyst at SMBC]

I'm sorry, Sean, I guess the question is layoffs sort of moves employer negotiating leverage back to the employer and so more people in the office and then more people having to be near the office and so more people using multifamily is the essence of the question.

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. No, I agree with you on that. So I think -- sorry, I was going to head to it. Obviously, even if there is -- just as the employment base declines by some modest amount, whatever the number is, to the extent all of that employment is still concentrated within our markets where there are urban submarkets or our suburban job-centered markets, that is highly relevant to the demand for our portfolio. And just to give you an example, we have seen some meaningful reversion to any out migration. And if you look at our move-ins even in the second quarter for the same-store bucket, historically, in the second quarter, move-ins from greater than 150 miles away is around 10% to 11% of the move-in activity. It was almost 30% in the second quarter. So it's up 250% from normal levels.

And certainly, job-centered suburban which is very favorable for us and urban which is less favorable as it's only 1/3 of the portfolio but still relevant, we're seeing that trend come back as opposed to during the pandemic where it was -- there's a lot of out migration to various other markets. So that's a trend that has been in place for a couple of quarters and certainly accelerated very meaningfully in the second quarter. And hopefully, that trend will continue in the third quarter as employers do start pulling more people back into the office in those markets to benefit us.

[Operator]

[Operator Instructions] We take our next question from Joshua Dennerlein with Bank of America.

[Joshua Dennerlein, Analyst at Bank of America Merrill Lynch]

I saw on Slide 8 you had details about the level of your loss to lease and how it was growing from April, May and then into June. Curious, is that the normal dynamic that you see at that time of year? I'm just kind of thinking about -- just trying to think about like how extraordinary that 15% is these days?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

Yes. Josh, this is Sean. In absolute terms, 15% is, to use your word, extraordinary, way above average. To the first question around, does it normally trend up during the second quarter? The answer is yes, just not normally at that kind of pace. So hopefully, that's helpful.

[Joshua Dennerlein, Analyst at Bank of America Merrill Lynch]

So even the pace of the growth is a lot higher than you would normally see as like a normal seasonality?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

That is correct. And what I'd point you to, as I mentioned, rents being up more than 9% since the beginning of the year. Normally, that slope when you look at it from January to, call it, mid-July type range is weaker than that in an average year. It still trends up, just you wouldn't see that same change.

[Joshua Dennerlein, Analyst at Bank of America Merrill Lynch]

Okay. And sorry, just one follow-up. Is that just because -- is the growth in the loss to lease really a function of just how fast rents have moved? Or is it also because there was like restrictions earlier in the year on being able to push some rate?

[Sean Breslin, Chief Operating Officer at AvalonBay Communities]

It's really the combination of the 2. So we're able to push rents hard. And on renewals, we can't capture all of it. So for people that are -- if they cap at a 10% rent increase and rents are up more than that, that spread will accrue to loss to lease, of course.

[Operator]

The next question comes from Connor Mitchell with Piper Sandler.

[Connor Mitchell, Analyst at Piper Sandler & Co.]

I have two questions. First, just thinking about the general acquisition market. Has the pullback of levered buyers also extended to merchant developers? And has this given you guys some additional opportunity for acquisitions?

[Matthew Birenbaum, Chief Investment Officer at AvalonBay Communities]

Conor, it's Matt. I would say, typically, the merchant builders, the buyer of those assets since their brand-new class assets is usually not a highly levered buyer. So there's probably been less of a pullback there than there has been in the value-add space but there has been some pullback there. And particularly, there are some folks that want to sell early before maybe the lease-up is fully complete. So I think it does create an opportunity for us. And we do feel like that we are better positioned as a buyer going forward, there's less competition. And where for a seller, it's less about getting the absolute highest price as it is about certainty of execution in this environment and that's something we offer. So I do think that it's going to lead to a more favorable buying opportunities for us.

[Connor Mitchell, Analyst at Piper Sandler & Co.]

Okay. Great. And then my second question is you guys have talked about capital allocation of acquisitions and development a couple of times. I was also just wondering how you guys think about your structured investment program. And if you might ramp that up, if you're hitting it on developments or if you wanted to speed up developments once again, if you would kind of carry the same level of the investments within the structured development program?

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Connor, this is Ben. To a certain degree, we think about that as a separate business. It's $300 million to $500 million of finite capital and we'll build that book of business up over the next couple of years. We may pull a little bit harder, a little bit less based on the environment. But I would expect a pretty consistent approach there to the fill out of that business.

[Operator]

It appears there are no further questions at this time. I'd like to turn the call back to Mr. Ben Schall for any additional or closing comments.

[Benjamin Schall, President, Chief Executive Officer & Director at AvalonBay Communities]

Thank you and thank you again for joining us today. We appreciate your support and engagement and have a wonderful rest of the summer.

[Operator]

[Operator Closing Remarks]