Multifamily Market Forecast with Ben Schall, Chief Executive Officer and President of AvalonBay
Willy Walker: Good morning, everyone. Nice to see you all here, Ben. Thank you for joining us.
Ben Schall: Yeah. Thanks for doing this, Willy.
Willy Walker: So I'm from the D.C. area, and when I come to town, I stay with my parents. And I think most of my friends who hear that I stay with my parents get a big chuckle that I don't stay at some fancy hotel and stay with Mom and Dad. But I raise this story because this morning I woke up to get out here at quarter of seven, and I'm in the shower and all of a sudden, I hear a knock at the door. And it was my 86-year-old dad making sure that I was up in time to be here. And it made me feel like I was in sixth grade back at St. Albans. And I don't know. I think no one has worried about whether I'd gotten up for an alarm in many years. But it was a really cute moment this morning. Where did you grow up, Ben?
Ben Schall: I grew up in New Jersey. Most of the time, it is in southern New Jersey in the Cherry Hill area suburbs of Philadelphia. I'm on the other end of the spectrum. I woke up at 5:45 this morning to get my older son up so he could get early basketball practice.
Willy Walker: at GDS. How did you end up going to Swarthmore? You were a basketball player in high school. How did you end up going to a small liberal arts college in Pennsylvania?
Ben Schall: I have a long family connection there. That was at the core. But up until my junior and senior years, it was not my expectation. It winded up being a great fit academically, I place I could go and play sports. Small intensive academic environment. I loved it, got a ton of value out of it, and I've stayed very close to and connected with the school since then.
Willy Walker: And when you were at Swarthmore, did you think that you wanted to go into commercial real estate, or was it on that path?
Ben Schall: Not anywhere on the radar, Swarthmore traditional liberal arts education is a great place to learn a great foundational set of skills. But at the time, I only had one business class, let alone one in real estate. This advances a little bit further. I really didn't get my first taste of real estate until I was a couple of years out of college, and I was working for the New York City Economic Development Corporation. One of the roles of that organization was to sell city-owned land to private developers. And I quickly decided I want to be on that side of the table, seeing how the developers were buying land from a city organization, and then using business school to really make that transition to get into the space. But I didn't grow up with somebody who grew up in a family of real estate people. Didn't really have exposure to it. And it's why I ended up being a great fit for how my mind works, what I enjoy, and what gets me passionate about, particularly today, how we can create places. This is AvalonBay's purpose of creating a better way to live, increasingly spoke to me as a leader.
Willy Walker: Was Shaun Donovan running the New York Housing Authority back then.
Ben Schall: No, I was there a couple of years earlier.
Willy Walker: You end up going to HBS. I took a look and there are 112 Swarthmore grads who have gone to HBS. Was there another Swarthmore grad in your class at HBS?
Ben Schall: There was, actually. And it was actually my college roommate. And he's out there.
Willy Walker: College roommate.
Ben Schall: My college roommate. We took two different paths to get there, and we're in two different industries, but we did wind up there at the same time.
Willy Walker: And what did it feel like showing up in that section for the first day when everyone from Yale and Stanford was sitting there talking about their resumes, and you're saying, “I went to Swarthmore and worked for the New York City government before coming to Harvard Business School.”
Ben Schall: Yeah, I was definitely on the outside. It winded up being great for me because I went there to get the harder set of skills. But as you're sitting there with the private equity guys and the investment bankers of the world, and they've been driving hard in that way for a while. I loved HBS, and it was an awesome place. I enjoyed it socially and made some great friends in network business training. And then the power of it allowed me to make the switch. It gave me the opportunity to make that switch, particularly during my summer, and we can get into the story. But I winded up banging on a ton of doors and got into Vornado as a kick-off in the real estate space. People probably know Sandeep Mathrani. We did GGP, and then WeWork and lots of other things. But he was the guy that gave me my first shot in the industry.
Willy Walker: I'm sure you were a star on the intramural basketball court at HBS.
Ben Schall: We played a lot of basketball there. I don't know if I would say star. An everyday activity.
Willy Walker: Yeah, that competitive nature runs deep there. So you are at Vornado, and then you go to the Rouse company. Talk for a moment about the move from Vornado over to Rouse. And you were COO at Rouse, correct?
Ben Schall: Yeah. And for folks in this room and from this area, it's critical to differentiate between the original Rouse and the new Rouse. And people associated with the original Rouse don't necessarily love using the new Rouse's name. I'll give a little bit of my time with Vornado was an amazing experience. It is a super entrepreneurial type of place that would give young executives tons of varied experience. I'm thankful to people like Steve Ross, Mike Santoli, and Sandee for effectively giving me opportunities that I was not ready for. And it really did help accelerate my career. The reason I start there is one of my primary functions at that time, as an early buck in the space, was Steve had a lot of old, decrepit shopping centers. They were occupied by Bradleys. And it was originally the old two guys from Harrisons. And in all this real estate, they needed to get redevelopment. And I cut my teeth there, I was really somebody who could organize a team to think about repurposing space for higher and better use. And that's the early part of the theme of my career, which is being able to be a guy who can kind of bridge the world of development, re-envisioning space, thinking about what's going to drive customer demand by doing it in a world of a public company setting. And I was there for ten years. I winded up running their suburban retail business. After I left, I wound up being spun off. It's now known as Urban Edge for people who know that business. But all of that was a build-up to Rouse, which the new Rouse was a spin-off from GGP. People referred to this new company that I joined as the Dead Mall Company. You were going to go to this dead mall company. But the purpose of it was generally a set of malls in smaller markets that had been forgotten about. What we tried to do was to reconnect those malls back to the communities in which they operated. And they had been owned by this big corporate behemoth of GGP and really had gotten no attention. I started going out to these sites, and I'd be the first executive that these teams had seen in ten years just completely forgotten about. The other premise of it was we needed to re-envision what we were going to do with these old mall boxes. That was the early throes of the end of the department stores as the anchor of these boxes. And we were thinking we've got to be early on that journey of thinking about new uses, alternative uses, and retail, non-retail. And again, continuing my career journey down the path of re-envisioning space through this development angle and how to best reconnect it to the communities in which it existed.
Willy Walker: Then you go to Seritage and become CEO there, mixed-use developer, retail. What were the challenges going from it sounds like going from Vornado, which was extremely well established and had a great market presence, to Rouse, where you were dealing with the kick out of GGP to then Seritage. Talk for a moment about A, being CEO of a publicly traded company for the first time, and then B, the portfolio you stepped into.
Ben Schall: Yeah. It was a really unique opportunity. For folks that don't know, Seritage was formed as a spinoff of Sears. There was 40,000,000ft² of real estate that was being spun out to figure out how to redevelop and into higher and better.
Willy Walker: Did Eddie Lampert have a role in it?
Ben Schall: He did, yeah. He wanted to be the largest shareholder in it. If you were a shareholder of Sears, you got a share of this new company. And he was a large shareholder. He was the chairman of the company for a long time as well.
I’ll start with, it was my first seat and first time in a CEO seat. What was really unique about it was we started it from scratch. I was employee number one. The assistant I brought with me was employee number two. Part of that journey started to inform me of what then brought me to AvalonBay. But it was the first time where I could really think about the culture that I wanted to build in an organization and how to bring together a group of people who believe similarly about the cultures of an organization, how we wanted to lead, and what was critical there. Pretty rare in your career that Vornado has a very established culture. AvalonBay has a very established culture that was a spot point in time where I could think about what was it meant to me to be a leader of a real estate organization and really try to create something that I thought would inspire a group of people to come together. And we were doing it in a super entrepreneurial type of environment.
The real estate side 40,000,000ft² blank canvas was the ultimate redevelopment opportunity. And a lot of it was repurposing in and around retail. But it did start to get me involved in thinking about housing uses for a lot of these sites, which is my early entry and the more significant time that I started to spend in and around potential apartment opportunities and meeting folks in that world as we thought about repurposing from some of the real estate.
Willy Walker: And as I look at your background and look at Vornado, into Rouse, and into Seritage and the asset classes that you were working on, multifamily is not completely out of the picture, but not really there. As the board of directors sits around it, AvalonBay says, “Who's going to replace Tim?”
Ben Schall: Yeah.
Willy Walker: How did Ben get to the top of that list?
Ben Schall: Yeah. I was very clearly not a multifamily guy. Touched it, as I talked about and as you referenced, but not a multifamily guy. And this brings it back to culture. AvalonBay has a long-standing evergreen culture that actually goes back to our original founders. Some of you from the region probably know him, Dick Michaud, and Chuck Berman. In the mid-90s, they were a Trammel Crowe company, and they were thinking about creating a separate company, and they asked themselves what would create an evergreen company. They were HBS guys at the time. Jim Collins was obviously big, Good to Great. And what they landed on in terms of what was going to separate AvalonBay over time was our culture. The cultural values that they set then remain the cultural values that we have today.
The three leading cultural values are a spirit of caring, integrity, and continuous improvement, which for me means to think about wanting to wake up every day and think about being your North Star. If you focus on those three items, you'll get to the right place. Three items really spoke to me as a leader. And this goes back to the culture I built at Seritage. A lot of connections in terms of how I think about leadership and how I think about bringing together partners of leaders as an organization. And that at the end was as AvalonBay was going through and thinking about who they wanted to have in the seat. There are aspects of having someone who runs a public company, dealt with strategy, and dealt with capital allocation. But at the core of it was this: as we started, Tim and I started spending more and more time together, and I spent more time with the board. It was that connection around culture. I very much see my role at AvalonBay, we've been around for 30 years, amazingly successful throughout cycles. One of my key roles is being one of those next stewards of our culture.
Willy Walker: And when you looked at AvalonBay from outside of taking the CEO role, as you looked at the assets when you were looking at it in 2021, you're in coastal and coastal suburbs. In ‘21, those weren't the hot markets to be in, the hot markets to be were in the Sunbelt and big growth was happening in the Sunbelt. As you looked at that, right now you're really happy where you are, and I want to talk about that in a second, but as you looked at it in ‘21, did you sit there and say, “We've got assets on coasts and in gateway cities and suburbs of gateway cities that could be a drag versus being at some of the other REITs that have assets in the Sun Belt.”
Ben Schall: Yeah. When I joined AvalonBay end of ‘20 and early ‘21, people thought back like there was a question of whether we people were going to live in urban apartments generally. What's that environment going to be like? Are people going to feel safe? It's been a roller coaster through the apartment industry and also in our portfolio.
To your question, Willy, our movement to both the suburbs, which has been a big push, continuing our push to the suburbs, and our push to what we refer to as our expansion markets, which are a subset of Sunbelt markets, started before I was there. We kicked off moving to southeast Florida in Denver. This is now 5 or 6 years ago. The process was underway. I'd say, “As we brought the management team together and as I stepped in as a CEO, this was a very successful business.” This is not a broken type of situation. This was a very successful business. What I focused on and what we focused on as a team is how we need to continue to evolve our business given the changing environment. When we talk further about our movement into these expansion markets, and the reasons for it, it is just a continued evolution of our business and will better position us for superior growth in the years ahead. A lot of portfolio allocation is optimization and really tailoring our portfolio to those markets. And I can talk some more about the themes there. A big part of it is following our customers. We recognize that more and more of what we think about the AvalonBay core customer, that knowledge-based customer, workers are in a more dispersed set of markets. Let's find the markets where those customers are going to be. That have the attributes that we think about delivering strong long-term apartment growth, and let's take what we do well and bring it to those new places. It's an expansion of our opportunity set.
Willy Walker: You talked about your client being the knowledge worker. What have you done from an amenities standpoint to match up what an AvalonBay community is offering to that knowledge worker?
Ben Schall: Yeah, that is definitely in the realm. We're constantly evolving it based on customer feedback. Curt Conway is in the room who runs that part. We're constantly out talking to our existing residents. For every new project, we're constantly getting feedback, and it is a constant evolution. The amenity space transition, I'd say, over the last 3 to 4 years, has a couple of different themes. One is flexible space, the old model of defined leasing office space from common area space, and we've broken down those boundaries completely. It is now a flexible space where our associates are out interacting with existing residents or prospects, that's one. In a lot of climates, that flexible space also creates indoor and outdoor space. Spaces that can flex over time, everything from fitness being indoor and outdoor, and how people want to spend their time when they're in our amenities. More recently, we have spent a lot of time thinking about where people if they're spending more time at home working, where do they want to spend that time? And that's led us down a couple of different paths.
One is that the apartments we're building are actually different. This is an interesting differentiation for AvalonBay as a developer. We're the most active public developer by far. But also as long-term holders. It leads us to development decisions that are different from what I would refer to as a typical merchant-build model. And so what I'll call out there is apartments that we're building today are 100ft² larger than they were four or five years ago, which is actually not where a lot of the industry is going. I reference that because, as you think about people want to spend more time at home. We're actually building larger units where we can, build in lofts, dens, and those types of spaces. And we're able to do that with a little bit less of a mentality on thinking about maximizing per-unit values and thinking about what's going to really retain and drive rental growth over the long term. And then bring it back to the common area of space. We've evolved to if people are going to come out of their apartment. They want an individual quiet space for them to work and do their calls. We've drifted away from the big communal table where you're expecting people to be working there. Now, as much as we can, we're building 50-square-foot glass-enclosed areas for people to have their quiet time. That's what's going to get them out of their apartments that come down and work. And there's real value that customers place for that amenity.
Willy Walker: Anything from a technology standpoint?
Ben Schall: Yeah, huge amounts on the technology side; maybe I'll describe this. Generally, our operating model journey has probably been the most significant change at AvalonBay over the last five or six years. I'll describe it this way, “We now lead in our interactions with customers and prospects through AI.” We were very early people, probably aware that what used to be called Meet Elise is now EliseAI, and we're now using that technology. We were early investors, and early adopters really helped shape that technology. That technology now handles 95% of our prospect interactions. We're now using that type of technology throughout the customer journey. But I start there and emphasize that if you're a customer of ours, your first interaction with us, we want to be AI-based. If AI can't handle your situation, the other big shift is we're continuing to invest in centralization. We're one of the first in the industry to have a centralized service center. Typically, it was very back office oriented. It's now shifting to both the back office and the front of the house and continues to get a lot of investment. That's the second landing spot. Then you get to a team, and you get to an on-site team. The big shift is the old model of having dedicated staff at individual properties. We are moving, as well as others in the industry, to neighborhooding. They're now a team that's handling four or five assets in a neighborhood. And it's allowing us when you put that together with the technology centralization and the neighborhooding we feel we can deliver a higher value proposition to customers. We measure that through NPS and other factors, delivering a higher value proposition and doing it much more efficiently.
Willy Walker: A lot in there that I want to dive into. One of the things that you were talking about is using AI to screen your tenants. I've looked at two companies recently regarding the impact of AI. One of them is a company called Teletext, which is a big call center company. And the other one is a company called Chegg, which is a big online learning company. Two years ago, both Teletext and Chegg were $5 billion market cap companies. Today, Teletext's market cap is $250 million, and Chegg's is $240 million. If you pull both of them up on your phone, they're just straight down to the right. The reason is that exactly you would have theoretically used a Teletext call center previously to potentially prescreen AvalonBay clients. Today, AI is doing it. They're not calling a Teletext call center. We went straight down, and then my kids who are in college would use Chegg to help them with their homework, writing a paper, and pulling it all together. It was online help related to an online tutor. Now, you can go to AI and get all that stuff for free. And as a result of it, Chegg stock prices just crater. And I think it's really interesting to watch how AI is both enabling companies to do certain things and also the consequences of being an industry in which AI could potentially completely disintermediate.
Ben Schall: Yeah, for sure. And when it works well, I'll use EliseAI, you get the strategic benefit, you get the operational benefits and you get the investment benefit.” EliseAI was nothing of a company. it had a very small valuation had a funding raise north of $1 billion. It works for them by getting a strategic partner like us involved early, early adopters, and constant feedback. And it's great for us because we're at the table with them. “We need you to tailor the product in this way to help us execute what we need to execute.” We do a decent amount of proptech investing, those are the types of relationships that we try to find. We can have both a strategic benefit as well as a financial benefit.
Willy Walker: You are the only large-scale operator who's an investor in EliseAI or did they go out to a consortium?
Ben Schall: Early on, the two were EQR and us. Those are the two of us. Now, it's a much broader customer base. But it was really the two of us early at the table coming together to make the investment and spend the time with them.
Willy Walker: And you talked about your neighborhood teams, Ben. Does that mean that as you look to either buy assets or develop assets, you're very focused on co-location in certain MSAs rather than more diverse development and acquisitions?
Ben Schall: For sure. I'll take it further, which is that we're now taking the combination of technology, centralization, and neighborhooding and incorporating that into our underwriting of assets. And we now are the typical asset; if we can have it in the correct neighborhood, we feel like we can generate 30 to 40 basis points of incremental yield by having that asset on the AvalonBay platform. We were not on the operational journey was there a couple of years ago, but we were not underwriting that type of benefit. And so it speaks to my view and our view that in our industry, in the multifamily industry, scale is going to be increasingly important, particularly driven by the investments that are needed to be made in technology, centralization, and then the benefits that are increasingly going to come through having clusters of assets together.
Willy Walker: A couple of things related to your growth: You mentioned some of the new markets that you're going into previously. If you think about the portfolio today, it's gateway suburbs.
Ben Schall: Yeah.
Willy Walker: Which, as I said previously has turned out to be a fantastic place to be over the last two years during the great tightening as we've had massive oversupply to Sunbelt markets. As you look at that footprint, continue to invest in that, if you will, suburban coastal footprint or go more towards the large Sunbelt markets that have had so much supply recently.
I know, for example, you've got a shovel in the ground in Austin, Texas. That is a market that has gotten 8% new supply in 2024 to it. You are very bold in going in there. But I consistently sit around and talk to people and say, “You give me an option today to buy in Cleveland, Ohio, which has been a great market for the last two years as it relates to being able to push rents. Or Austin, Texas, which has not been the greatest market in the last two years. I'm going to Austin, not to Cleveland, Ohio. I'm clearly putting a shovel in the ground in Austin has got being able to do that; you're one of the few that can do that given your balance sheet and your ability to finance it.” Why Austin? First of all, I will go back to that first question I had as it relates to where the growth is going to come from.
Ben Schall: Let me dig in a little bit. Our conviction on the suburban coasts remains very strong. In the near term, and in the near term, we will benefit and continue to benefit from steady demand and just low levels of new supply. That's what you're seeing coming through our operating results, the momentum we had in the business. This year, we're posting the public sector leading revenue growth in the 3.5% type range. But it's not just the near term. We've been pushing this way. We're constantly going back to my evolution theme. We're constantly thinking about what are the trends that are going to be influencing our business over the next 10 to 20 years. Demographic trends, and particularly the aging millennial trends, along with what's happening from a regulation standpoint, are two main factors that continue to have us push to the suburbs. Nate Birnbaum, CIO, puts it this way: “To a certain degree, are we seeing our suburban and coastal portfolio as better positioned to capture rental demand over the next ten years than it was over the prior ten years?” You're going to continue to see that as the core of our portfolio.
Today, we have about 90% of our portfolio in suburban coastal markets and 10% in expansion markets. And as we think about optimizing that portfolio, we want to get that 10% to about 25%. As we're making that shift and pursuing that growth, it's through multiple channels, acquisitions, development, and funding from other developers. Then, we turn to the Austin example because I think it speaks to what I consider one of the true strengths of AvalonBay, which is our detail-intensive focus on both which markets and how we think about the timing of entering those markets. We announced that we wanted to be in Austin three or four years ago. We started our first development project two months ago. We bought our first deal 30 days ago. We're positioned as the type of company that can be patient in determining when we should think about the right time to enter that market. And when I look at Austin today, I see that the next couple of years will probably still be some continued pain. There are still a lot of deliveries that are coming through, particularly in certain submarkets there. But as we think about the next cycle and where rents were to where they are today, when I think about where asset values and cap rates were to where they are today, we feel like it's an attractive entry point. And I'll give one data point which we were looking at a couple of months ago, and actually we're living and breathing it every day, and actually surprised me, which was Austin rents relative to pre-COVID only up 9%. You think about that trajectory that they've been through, only up 9% relative to something that's actually a couple of percent of growth a year. Relative to lots of other markets. We look at that and think about the price, the point in time, and the basis we can get in those assets, and then think about growth going forward over the next 10 to 15 years. We feel like it's a relatively attractive time to be entering markets like that.
Willy Walker: Talk about that rent growth in Austin is a really interesting data point because I've heard you talk about in the markets where you are that the delta between living in an AvalonBay apartment and owning the median-priced home is currently at $2,000 a month. Talk for a moment about that gap between renting and owning and what that makes you think as it relates to whether we if you will, are going to continue to become a renter nation, given that gap, or do you think that gap comes back down to the point where people can jump from multifamily to single family?
Ben Schall: It's a huge dynamic and a huge driver of demand at a spot point in time. As Willy said in 2000, $2500 per month is more expensive to own a home than rent a home in our core markets. Now, that's driven primarily by our concentration in the suburban coasts, where you've seen both huge price appreciation and high mortgage rates.
Willy Walker: And limited supply of new homes because the homebuilders haven't been building there.
Ben Schall: Exactly. Can't find the land. It's too hard to have that type of competition. And what that's translated down to us on the demand side is typically, if you look historically, we track why people leave us when they're leaving us as a renter and traditionally call it 15% to 17% of people that would leave us to go buy a home. Today, in the last 18 months, that figure has been 8% to 10%. We've never seen those types of figures before. There is for sure a portion of our customer base that is having to stay with us longer. That's one of the reasons you're seeing in the overall industry: retention is high, and turnover is as low as it is. As we look forward, it's tough to know where things head over a multi-year period. I think this dynamic is providing a pretty significant cushion or margin of safety. There's a large movement. You think of what has to happen both in terms of home prices and mortgage rates to even close a portion of that gap. I do think it's going to be a tailwind for the business over a multi-year period going forward.
Willy Walker: Last night, I was looking at a chart that Zelman, who's our research organization, put out, and at the beginning of the Obama second administration in 2012 and the beginning of the first Trump administration in 2016, 45% of renters in America could afford to buy the median-priced home; that today is at 25%. Only a quarter of the tenants in an AvalonBay community can actually afford to buy a single-family home. To exactly what you were talking about, that protection, if you will, in the markets where you are particularly given the undersupply on the single-family side. If you go to Nashville or Austin, you're getting a lot of both single, and it's oversupplied, both single and multi. That Delta isn't nearly as wide as it is in your core markets.
Ben Schall: Agreed. The other let me take us this way, another new growth channel for us given some of these population trends, and challenges of owning a home. We announced on our last earnings call we are formally moving into the BTR space.
Willy Walker: 25 sites right now for BTR?
Ben Schall: No. We have existing communities that are townhome-ish. Part of this, as I describe it, is that we think about the BTR space as an expansion of what we already do, an expanding part of our business. I don't think about it as a new business line for us. We've been building garden and townhome products since the beginning of AvalonBay.
Willy Walker: Are you partnering with single-family developers on that, though.
Ben Schall: We've got existing products in the portfolio that we build up over time. In the near term, it's going to be both buying BTR products as it is completed and funding BTR developers. We have a program that we use on both multifamily, and now we're using it in the BTR space now. We call it our developer funding program. We provide a full capital stack to third-party developers. They've got sites ready to go. We own it. We show up at closing. We buy the land, we fund the entire project, and the developer has a typical LP/GP deal, but they're not putting in the upfront capital. They do get to participate in the value creation and earn a typical type of promotion. We've taken that program, which has been successful for us on the apartment side. And now we're bringing that over to the BTR side so we can activate it more quickly. We don't have a presence. We don't have control over that land. We can leverage third parties who do. There are aspects that are similar to the apartment development space, but there are aspects that are different. It is a product that's built differently, with different subs. And so we're going to use those relationships to get smarter and learn more about the business over the next 12 to 18 months.
Willy Walker: I think you have a CapEx plan for ‘25 of about $1,000,000,005. How much of that $1,000,000,005 is in BTR?
Ben Schall: We haven't said it specifically. We are leaning into development today, which not everyone's saying. Our objective is it feels like a spot in time where AvalonBay can capture an outsized share of what will be an overall lower level of development starts. I think about our cost of capital. We raised through the public equity markets $850 million at an initial cost of capital of 5%. Looking at leveraging the scale that we have with our teams in the market, we are seeing construction costs come down. Think about the spread between development yields, which, for us, we're finding development yields and the 6.5% type of range relative to our cost of capital relative to underlying cap rates. All of that has us leaning in. The bulk of the $1,000,000,005 is going to be apartment-oriented. But of that $1,000,000,005, the potential to take it higher would be through more DFP business, more funding from third-party developers, and further acceleration of our BTR program.
Willy Walker: I know you're building to six yield on cost. What happens if rates move up from here? Does that $1,000,000,005get pulled back for ‘25?
Ben Schall: Yeah, for sure. Given where rates are and the uncertainty in rates, we're going to need to stay nimble. That's the message and theme that I use with the team. We're in a continued period of heightened uncertainty. And we can't get stuck in a plan.
What we focus on at AvalonBay, and we've done this over multiple cycles, over 30 years, is triangulating and on and making sure that when we're starting new developments at that point in time, we don't trend rents, we don't trend costs. We focus on the spot point in time. What does that yield look like relative to the underlying market cap rate and our cost of capital? We maintain 100 to 150 basis points of spread between those two, effectively provides the protection that's required from development risk. A little bit of is rate risk. The other part, which is unique to us, and does come with a cost, but we typically lock in our capital and new development upfront. At any point in time, we're generally 75% today and we're actually overfunded on our new development activity. One of the ways that we protect against the risk on rates is when we decide we're going to shovel in the ground. We're matching that project up with discrete capital at that point in time to take the capital cost risk off the table. That doesn't mean there's no development risk, but we're taking the capital raising cost risk off the table when we say go.
Willy Walker: When you think about 600,000 units being delivered in 2024, 400,000 units being delivered in ‘25, and then we drop down to right now, the projections are 250,000 units delivered in ‘26, which is shovels going in the ground now. As a developer, you've got to like the step down to 250,000 in 2026. And there are few who can go after it right now like you can because of your financing and the capability for you to raise capital around that. But talk for a moment about absorption and whether you think that ‘26 is going to be the Shangri-La that lots of people are thinking it's going to be because it's undersupplied versus that oversupply in ‘24, ‘25, lagging into ‘26 and not allowing owners to push rents as much as many are projecting in ‘26.
Ben Schall: One call that I'll make upfront, and hopefully this resonates with the developers in the Mid-Atlantic, is there's a ton of focus on supply coming down in the Sunbelt. Supply is also coming down on the coasts and coming down, particularly in the suburban coasts. I do think it's going to be a benefit as you look out over a multi-year period. There's less starting, and there's going to be less competition. But I think there's an over-heightened focus on supply coming down in certain markets where I think it will happen in the overall industry. That's point number one.
Point number two is I'm generally of the view that there is going to be a longer tail from the supply, particularly in places that are seeing, you know, go into the Austins of the world, historic levels of new supply coming through the system. I think as we get into 2025, we start to be a little bit of a bifurcation. I think some of the high-supply markets in some of the Sunbelt markets. Some of those will make their way through the bulk of new deliveries in 2025. You still have challenges with maintaining occupancy and rent. The roll through of that in terms of NOI into 2026, I think people, at least in the public arena, our investors get very focused on rent change, and we're trying to reorient them like that. Rent change: You have to build your rent roll over a year, like the dynamics that exist today, which are going to roll through rent rolls over the next 12 months. And then there'll be certain markets. I think there'll be a set of Sunbelt markets that return to normal as we get… Maybe rents will start to increase in the back half of ‘25. The NOI impacts roll through in ‘26 by the time you get to ‘27, and things feel a little bit normal. But there's also a set of markets where it's probably another year behind. We're in one of them, and we went there consciously knowing there was going to be a lot of supply. But people have been to the south end in Charlotte as an example. Go and look at the cranes that are still in the sky. There are deliveries, that will be coming there for the next 12 months. In that first category, I described that you have to advance another 12 to 18 months before you're on the other side of a more normal supply-demand dynamic.
More broadly, our outlook for next year has got a lot of flavors of sort of similar to this year. What we saw this year was that the East Coast continues to outperform the West Coast both in the East and West Coast outperforms the Sunbelt. And next year, as you think about it from a jobs perspective, generally, things are changing a little bit, so there is sort of a little bit more momentum around potential jobs next year. But jobs are expected to come down to ‘25 relative to ‘24. Supplies are also coming down to 25 to 24. But if you look at the job-to-supply ratios, we spot a point in time. They're pretty similar year over year. And so for us, when we think about what markets that are going to underperform or outperform in an environment like that, it's going to continue to be driven primarily by where there are higher levels of supply. And as we think about next year, our expectation is at least for another year, where you've seen momentum in markets, which is likely going to be the places where you continue to see that momentum.
Willy Walker: And when you think about either the new administration or local governance in the markets where you all are, obviously, rent control in California didn't pass, which is huge for you all. And some of the other large REITs that have significant assets in the state of California. As you think about the Trump administration coming in from either a general economic standpoint or, more specifically, to housing, are you excited about it? Are you concerned about it? What's your sense as it relates to the economic backdrop and, more specifically, to housing?
Ben Schall: I'll make a couple of comments on the regulatory front. See it as a net positive. Now, as everybody knows, most of the regulations that we deal with are at the state and local municipal level. But there was a lot of rhetoric coming more and more at the national level in and around rent control. We continue to be big believers in solving our housing problems in the country they need to be supply-based solutions. I think that'll be a net positive.
As it relates to the economy that's very challenging to forecast. What policies are going to be implemented, and what the implications of those are. It seems economists are generally now expecting slightly higher growth, which may come with higher interest rates. On the growth side, I think that growth should benefit apartments. I think there's a case to be made, particularly for our type of customer, that more of that growth and more of the wage and income growth that will come from it should be our type of customer. You think about deal activity, financing activities, or the parts of the economy that potentially could get going that have been a little bit subdued. I think that's a potential net positive there. Rates staying higher likely translate over to cap rates staying higher for a period of time. That's a headwind on value. An absolute net negative. Now, at the same time, in my AvalonBay seat to a certain degree, it extends out the period of time where I've got a pretty significant cost of capital advantage. From an absolute level apartment values, higher rates are a net negative. But you think about where I'm raising the cost of capital relative to where a private developer could raise the cost of capital, which is pretty wide today. If we stay in that type of environment, we will probably extend the period of time we can use that advantage to capture our share of growth.
Willy Walker: And Ben, given your background of having been in other asset classes and now being focused solely on multifamily. Bear with me as I give a couple of data points and then ask you the question. But I went out and looked at office, retail, Multifamily, data centers and industrial and picked up five REITs to look at how they performed over the last ten years. If you look at Boston Properties, for instance, this won't surprise anyone. The $14 billion market cap down 40% over the last decade. You then go to Mid-America. A competitor of yours has a $19 billion market cap and 120% growth over the last decade in their stock. You then go to Simon Properties' $70 billion market cap flat over the last decade if you'd bought Simon Properties a decade ago. Equinix's $92 billion market cap company, data center focused and won't surprise anyone in the room 320% growth in their stock price over the last decade. And then finally, Prologis is a $108 billion market cap company. And if you invested in Prologis, you're up 170% over the last decade. A couple of things there: first of all, Mid-America is 120%, and AvalonBay is up 42% over the last decade. What are you going to do to have the growth of AvalonBay beat Mid-America? That's my first, star on that and then I'm going to go back on others.
Ben Schall: I take a long-term perspective on it. We've been at this for 30 years. We've delivered an 11.5% annualized compounded return to shareholders over that time period. And to be able to do what we do and deliver that type of consistency, both dividend growth and share growth, it's an amazing platform. And underneath that is multifamily. We're in an amazing asset class. We're connected to the growth of America. We're connected to the wage and income growth of our country. And I look at that longer term, and I think we're in an amazing business. And of all the asset classes, I look forward to a lot of the other ones you touched on, even the ones that are everybody's favorite asset class today, and people have a harder time envisioning what those asset classes look like 10, 15, or 20 years from now. And our business will evolve. But in terms of being disrupted by some other changes, I think we've got the least risk associated with that. And when I think about both from a shareholder perspective, wealth preservation plus growth, come to multifamily. I want to do that over a long period; we're a beautiful place.
Willy Walker: And then on that, if I said to you, “You've got $1,000 to invest in the stock of either an office REIT, I said Boston Properties down 40%. A retailer like Simon Properties has been flat over the last decade. Equinix that's in the data center space, and Prologis that's in the industrial space. Where would you put your money?”
Ben Schall: Outside of multi.
Willy Walker: Outside of multi, a recovery in office, growth in retail, further on data centers, or more industrial?
Ben Schall: As much as it is more than the flavor of the day. As much as there's an intense focus on capital flowing into datacenters. The time I spent with some people who lead our industry and hear them say, “If they had that dollar, they would put every dollar they had into the data center space. Outside of apartments, at least over the next couple of years, I think there continues to be momentum to ride in that wave.”
Willy Walker: I was at a conference in New York two days ago. It was Milbank and Goldman Sachs on data centers. And they had 80 CEOs of the big data center, either investors or operators. I was completely a fish out of water, completely. Wes Edens from Fortress was up talking about the data center space because New Fortress Energy is a big energy supplier to data centers. Wes was having a conversation with Andy Jassy at Amazon a couple of weeks ago, and he said, “Andy, what's the trajectory for growth in data centers?” Andy Jassy said, “Wes, I don't know,” and Wes said, “If there's anyone on the face of the planet who should know the trajectory for data center usage, it should be you.” But what Andy said was, “Every single time a new unit of capacity is created, it is gone instantaneously.” And from a supply-demand standpoint, that's not a bad place to be. That's really not a bad place to be.
Ben Schall: I don't miss your question about Mid-America. I do, and we admire them as an organization. I think highly of Eric Bolling. Our focus as an organization, and we actually did a big Investor Day last November, is that we are laser-focused on delivering superior growth over the long term. And what we're focused on is a series of activities that we think can consistently drive that growth. It also goes to the operating model transformation that I talked about before. A quick tidbit there. Currently, over the next couple of years, we think there will be $80 million in annual incremental NOI, both from increased revenue and from operating efficiencies, to come out of the investments that we're making in our operating model transformation. Continuing to leverage our development capabilities, we are really unique in the public sphere; there are a lot of private developers, but in the public sphere, I'll give you guys this stat. Over the last ten years, we've developed more than all of our public multifamily peers combined. We have a self-generated way to generate external growth that we're going to continue to lean into and take into some new product classes and new arenas. We also need to constantly adjust and think about portfolio allocation and asset management. I think there are opportunities as we optimize those activities. They should also lead to superior growth, and then I will bring it all back to them. Mid-Atlantic has a strong culture as well. But at the core of it, if we're going to have best-in-class teams and best-in-class people, we need to continue to have a unique culture that keeps people engaged. We're able to grow their careers. That is what this core is going to lead to our long-term success.
Willy Walker: I would underscore the fact that your market cap is $32 billion. MAA’s is $19 billion. You have $13 billion more in market cap, and they have more units than you do. If you will, your value per unit is significantly higher than they are. That is exactly what you're talking about there. You have a huge opportunity there, given your size and scale. You're bigger than EQR. You're bigger than them, and you're the largest apartment REIT in the country. It gives you a big advantage from a cost of capital standpoint and a growth standpoint.
Ben Schall: Yeah. It goes back to the level of investments that I believe, and we believe are going to be necessary in and around technology and centralization, and the benefits we can increasingly drive through the cluster, such as owning clusters of assets, can be increasingly important. And I think there'll be some separation there relative to the public peers. But to a certain degree, we're all headed down a similar journey there, all of us in significant size and scale. We can make those investments, and I look forward to them. I think likely more of the differentiation is going to happen between some of the smaller private operators where those assets are on our platform, and we will be able to generate outsized growth. That leads me to everything, as we are seeking out development deals, as we're thinking about portfolio opportunities. It's the asset specifics, but I'm really focused on finding opportunities where I can leverage our scale to generate outsized growth.
Willy Walker: And my final question for you, Ben, if you look at your competitive set as it relates to a Mid-America to EQR, the big publicly traded REIT. Then they're the private equity owner-operators of the Blackstones and the Greystars of this world. And then there are if you will, someone like Monarch, that's Bob Nichols. He raises money from a non-private equity-type model, which he's getting various investors to come in. And Bob's now a top ten owner. As you think about that competitive landscape, who's the real competitor? Is it the other REITs? Is it the private equity firms, or is it the smaller operators that can niche the market?
Ben Schall: It's all of the above. The private equity guys, given their scale. The capital that they've been deploying in space, they built up some very sizable platforms. And I think increasingly they will be seen as a competitor of ours. But it's different. They're generally investing through third-party managers. Some of the other models you described. People at the center of operating the assets have lots of different capital partners. I think what distinguishes us partially from the remodel, but then also AvalonBay, is we are wholly owned and we're wholly owned for the long term. It also allows us to make investments at a level that a lot of the competitors in the multifamily landscape just can't make.
Willy Walker: Ben, thank you very much. It's been a real pleasure.
Ben Schall: Thanks for doing this.
Willy Walker: Thanks, everybody.
Ben Schall: Thanks for coming.
