American Campus Communities, Inc.
Q1 2017 Earnings Call Transcript

Published: 25 Apr 2017

[Operator:]

Good morning and welcome to the American Campus Communities’ First Quarter 2017 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Ryan Dennison, Senior Vice President of Corporate Finance and Investor Relations. Please go ahead.

[Ryan Dennison:]

Thank you. Good morning and thank you for joining the American Campus Communities 2017 first quarter conference call. The press release was furnished on Form 8-K to provide access to the widest possible audience. In the release, the Company has reconciled the non-GAAP financial measures to those directly comparable GAAP measures in accordance with Reg G requirements. If you do not have a copy of the release, it's available on the Company's website at americancampus.com in the Investor Relations section under press releases. Also posted on the Company website in the Investor Relations section you will find a supplemental financial package. We're also hosting a live webcast for today's call which you can access on the website with the replay available for one month. Our supplemental analyst package and our webcast presentation are one and the same. Webcast slides may be advanced by you to facilitate following along. Management will be making forward-looking statements today as referenced in the disclosure and the press release, in the supplemental financial package and in SEC filings. Management would like to inform you that certain statements made during this conference call which are not historical fact may be deemed forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities and Exchange Act of 1934, as amended by the Private Securities Litigation Reform Act of 1995. Although the Company believes the expectations reflected in any forward-looking statement are based on reasonable assumptions, they are subject to economic risks and uncertainties. The Company can provide no assurance that its expectations will be achieved and actual results may vary. Factors and risks that could cause actual results to differ materially from expectations are detailed in the press release and from time to time in the Company's periodic filings with the SEC. The Company undertakes no obligation to advise or update any forward-looking statements to reflect events or circumstances after the date of this release. Having said that, I would now like to introduce the members of Senior Management joining us for today’s call. Bill Bayless, Chief Executive Officer; Jim Hopke, President; William Talbot, Chief Investment Officer; Daniel Perry, Chief Financial Officer; Jennifer Beese, Chief Operating Officer; and Kim Voss, Chief Accounting Officer. With that, I will turn the call over to Bill for his opening remarks. Bill?

[Bill Bayless:]

Thank you, Ryan. Good morning and thank you all for joining us as we discuss our first quarter and 2017 financial and operational results. As you read in the release last night, and will hear further details on the call today, we had a productive quarter related to our external growth initiatives, with five new on-campus public private partnership awards. Along with the acquisition of a core pedestrian property in an existing market. We're also pleased with the continued solid operational performance and internal net asset value creation, having achieved a 55% margin on a trailing 12 month basis for our total portfolio, along with strong pre-leasing velocity to date for our same store portfolio with regard to the upcoming 2017, 2018 academic year. With that, I'll turn it over to Jim Hopke to discuss our first quarter operational results in detail, along with our areas of focus moving into Q2 and Q3.

[Jim Hopke:]

Thanks, Bill. our 2017 operating results were in line with our internal expectations. First quarter same store property NOI increased by 3.3% over Q1 of 2016 on a 3.3% increase in revenue and an increase in operating expenses of 3.4%. Also notable and highlighted on the seasonality page of the supplemental, is that our operating margin eclipsed 55% for our total portfolio for the trailing 12 months ended March 31. The 3.4% year over year growth and same store operating expenses, was slightly better than our expectations for the first quarter as expense growth in our payroll, utilities, G&A, property taxes and insurance categories, were all slightly better than or in line with our expectations. While our property tax results for Q1 were in line, in the past few weeks we received the initial 2017 assessments for our Austin properties, which were 24% above the final 2016 assessments. Taxes for our Austin properties represent approximately 15% of our total property tax expense and we're working with our consultants to minimize these increases through appeal. It is early in the year and we've not adjusted our annual tax forecast as we evaluate the ability to additionally offset these increases through savings in other markets. in our repairs and maintenance category, expense growth was more than expected due to funding of repair costs for weather related events up to our insurance deductibles at several properties and non-routine work at three properties, which will be taken offline at various times later in the year to perform comprehensive repairs, and in one case, reconstruction of 41 beds destroyed by fire. Lost revenue from taking these properties offline will put pressure on same store revenues in Q2 and Q3. We are closely monitoring our vacancy backfill initiatives for spring semester leases which have the ability to further pressure same store rental revenue growth. Turning to leasing, as of Friday April 21, our 2018 same store wholly owned portfolio, is 78.7% leased, 10 basis points ahead of the 2016, 2017 lease up. We are still projecting an overall rental rate increase of 2.9% for the 2018 same store portfolio. Our new store properties are 55.3% pre-leased for academic year 2017, 2018. As we mentioned on our last call, our guidance assumes new store occupancy of 88% as we expect certain of our development projects will take two years to stabilize. With that, I will turn the call over to William to discuss our investment activity.

[William Talbot:]

Thanks, Jim. We are pleased to announce strong external growth this quarter, with five new on-campus awards, including two new on-campus ACE projects and three third party awards. Turning first to the ACE awards, we executed an eight year ground lease and commenced construction for a residential honors college on the campus of Northern Arizona University in Flagstaff. This is our fifth ACE development on the campus of NAU and is targeted for delivery in 2018. Our fall 2018 owned developments and pre-sales are now all under construction. In total, seven projects encompassing 5,486 beds and $433 million in cost. In addition, we have entered into a pre-development agreement with the University of Arizona for a 1,000 bed residential honors college under our ACE structure. The transaction remains subject to final lease negotiations, feasibility and scope and is targeted for a fall 2019 delivery. With the two new ACE projects, our own development and pre-sell pipeline for 2017 through 2019, now totals 19 projects, over 14,700 beds and represents in excess of $1.28 billion of development costs consisting entirely of core class A communities located either on campus or pedestrian to tier one universities. We are targeting between 6.5% and 7% stabilized nominal yield for these developments. We also announced three new third party developments during the quarter. First, we executed a pre-development agreement with the University of California at Irvine for our 1,441 bed student housing development. This is our fourth development on the campus of the University of California at Irvine and our fifth with the University of California system. The development is expected to start construction in late 2017 for a fall 2019 delivery. We were also selected to develop a 525 bed project on the campus of the University of Illinois, Chicago after a competitive RFP process. The project is targeted for a fall 2019 delivery, with start of construction expected to begin in late 2017 or early 2018. Lastly, in conjunction with our ACE project at the University of Arizona, ACC will also provide third party development services for an adjacent office building and student recreation center to be funded by the university. These three third party awards and associated fees that will be earned over the development period, are subject to final scope, feasibility and negotiations. These awards are an integral component of our guidance range of third party fees of $6.2 million to $9.6 million. The P3 pipeline remains vibrant as colleges and universities look to modernize their student housing stock without impacting their balance sheet and debt capacity, as evidenced by our five newly awarded projects this quarter. Turning now to acquisitions. In April, we acquired the Arlie, a 598 bed core student housing community located adjacent to our campus edge property in a pedestrian location to the University of Texas at Arlington. The asset is currently 96% occupied in its first year of operation. After $1.7 million of upfront capital improvements and enhancements, the core pedestrian acquisition represents a 5.5% nominal and 5.3% economic cap rate on year one pro forma and offers the potential for 25 to 50 basis points of additional yield through multi-asset efficiencies of campus edge. We continue to evaluate core pedestrian acquisitions that can offer attractive returns through management upside, operating performance or existing market efficiencies. Lastly, we are currently under contract on the sale of The Province, serving Wright State University in Dayton, Ohio for $25 million. The asset is eight years old and although located adjacent to university land, there's over a 1.5 mile drive to the academic core. The buyer has waived their financing contingency and is expected to close in the next few weeks. The sale will represent a 6.1% economic cap on in-place revenue, escalated T12 operating expenses, and historical capital expenditures. With that, I’ll now turn it over to Daniel to discuss our financial results.

[Daniel Perry:]

Thanks, William. FFOM results met our internal expectations for the first quarter of 2017 as we reported total FFOM of $83.2 million or $0.62 per fully diluted share. While FFOM per share was equal to the prior year quarter, total FFOM for the quarter increased $5 million or 6.4%, even with the loss of $11.5 million of NOI from the 21 properties sold during 2016. The growth in total FFOM dollars was driven by a $3.2 million or 3.3% increase in same store NOI. The production of $5.4 million of NOI from developments and acquisitions completed throughout 2016, as well as a $7.9 million reduction in interest expense resulting from the equity and disposition capital raise last year. It's important to remember that the company has raised over $2.1 billion in equity and disposition capital in the last two years to fund a very vibrant development pipeline that would internally total $1.8 billion in deliveries between 2015 and 2019 and is still continuing to grow. While the timing lag between capital being raised and development deliveries producing NOI has slowed the growth of our earnings per share over the last two years, it has created significant NAV for our shareholders, and will ultimately translate into attractive and sustainable earnings per share growth on a stronger asset base and a balance sheet position for continued external growth. Moving to capital structure, as of March 31, 2017, the company's debt to enterprise value was 25.4%, debt to total asset value was 31.7% and the net debt to run rate EBITDA was 5.6 times. As disclosed in the capital allocation and long term funding plan on page 15 of the supplemental, these future ratios are anticipated to range within our targeted levels of 30% to 35% debt to total asset value and in the low five times area for net debt to run rate EBITDA. In terms of capital activities since our last call, we raised approximately $30 million under our ATM program at an average issue price of $48 per share, match funding over 65% of the Arlie acquisition. Remaining debt maturities for the next three years are $189 million or only 8.6% of total outstanding indebtedness. Our floating rate debt did increase slightly this quarter to 15.3% as the interest rate swap on our $150 million term loan expired. However, we intend to manage our floating rate debt exposure with the bond offering currently planned for the fourth quarter in our guidance. With regards to our 2017 guidance, for the balance of the year, the most significant factors that will impact where we will end up within our FFOM guidance range are as follows. For property NOI, we previously communicated total owned NOI of $405 million to $412 million. Our ability to meet our NOI expectations is dependent on our success with backfilling any vacancies that occur in the remainder of the spring or summer months and the success of our fall 2017 lease up. Management feels positive about the current pre-leasing status, but as we discussed, we are closely monitoring the leasing progress of a few of our upcoming fall development deliveries. Of course the NOI produced for the year is always dependent on achieving our budget expense growth, including more controllable operating expenses such as payroll, marketing and repairs and maintenance, as well as more non-controllable operating expense items such as property taxes and utilities. In thirty third party services revenues, the fee range included in guidance for 2017 is primarily dependent upon successfully structuring and closing the three third party development awards during the year that William discussed. recognizing the fees associated with these awarded projects, would put us at the midpoint of our third party development revenue guidance, with the potential to achieve the high end through additional closings of awarded or to be awarded transactions during the year. In summary we are maintaining our previously stated FFOM guidance range of $232 to $2.42 per fully diluted share and we’ll update you on future calls if we need to make any adjustments to this guidance range. With that, I'll turn it back to Bill.

[Bill Bayless:]

Thank you, Daniel. In closing, as many of you know, the next 120 days is the most critical period in our annual operating cycle. As Jim noted, we're currently focused on backfilling vacancies for the spring and summer periods, as well as the successful completion of the 2017, 2018 academic year lease up for our same store and new store portfolios. As always, I'd like to thank the American Campus team for their hard work and dedication and ask the team to stay focused on execution in the coming months. With that, we’ll open it up for Q&A.

[Operator:]

[Operator Instructions] And our first question what comes from Nick Joseph of Citigroup.

[Nick Joseph:]

Thanks. Just wondering if you can give more color on pre-leasing in terms of the leases plus applications. You’re slightly trailing last year and that’s quite contracted from the update you provided earlier in April. So just any additional color on that would be appreciated.

[Bill Bayless:]

Sure, and Nick, let's go ahead and drill down into the overall velocity of the portfolio and we’d love to take this opportunity because so often we talk about where are we at a moment in time from a velocity perspective and what does that tell. And what we always talk about is what the goal is at the end of the day is to maximize the combination of rental rates and occupancy o give the greatest revenue. So when you look at the 65 markets that we're in, in 28 of the markets we are actually ahead of where we were in last year's velocity. And the other thing we look at is looking at any impacts on new supply in markets coming in. When you look at the 28 markets that we're in, in 12 of those markets we actually have new supply coming in. and in those markets, we're averaging 4.5% rental rate growth and about 600 basis points ahead in velocity. And so it’s actually the highest category that we have. There’s then 16 markets where there isn’t new supply coming in where we're ahead, and a lot of these properties just happen to be those that are in the category of below 95%. And in that arena, right now we're at about 2.2% rental rate growth, but we're running 1,200 bps ahead, demonstrating there the big focus is on increasing that occupancy. When you then look in the 37 markets where we're currently trailing behind, in 19 of those markets, we are strategically slowing velocity. And this is why we always try to caution the market on, don't read too much in the velocity. And that in 37 of the markets that we're currently behind, 19 of those markets we're averaging over 4% rental rate increase and a slow velocity, 500 to 600 bps, places we filled early where we feel very comfortable in terms of doing that. And then there's 18 markets that we are currently trailing behind in where we're very strategically manipulating rate and spending marketing dollars to maximize the revenue in that. And so we really look at it on a very, very myopic basis, property by property that rolls into those categories. And so overall we feel very good about where the lease up is as relates to the same store properties and balancing that combination of rental rates and occupancy. And so I hope that level of detail gives you a little insight into what you were asking.

[Nick Joseph:]

Thanks. It does, but just in terms of guidance, you have a 220 basis point range for occupancy for I guess the final lease up. And the midpoint actually assumes about a 60 basis point increase over what you achieved last year. Clearly you’re still within the range, but do you still think the midpoint is achievable, recognizing that the previously update is just a snapshot in time.

[Bill Bayless:]

No, absolutely and at the end of the day, and I think, Daniel, the implied rental rate at the midpoint is 2.8, 2.9?

[Daniel Perry:]

2.9.

[Bill Bayless:]

And so we're still trailing downward. Certainly from an occupancy perspective, we think we're right on track given the data that we just went through. Of course as I mentioned in my comments, there's a theme. This is the most important 120 days in terms of filling every bed until the end of the season and focusing on it all the way through the process.

[Nick Joseph:]

Thanks. And just William maybe, in terms of cap rates, it seems that at the Interface Conference earlier this month, there was a debate of cap rates have moved and if they’ve moved on core or more drive properties. So just wondering if you can give any color in terms of what you're seeing in terms of cap rates in the market today.

[William Talbot:]

Yes. Sure, Nick. I mean we’re constantly talking to the brokerage community and tracking cap rates. We've talked to Seabury. We’ve talked to HFF. They’ve seen stability in the cap rates, certainly on the core pedestrian. We’re still seeing it at that low 5% to sub 5% have not seen a real expansion there. as you look, we're selling an asset that we just announced cap rate at the low sixes for a value add asset, very consistent with what we've seen as well. So we're not seeing dramatic movements on cap rate.

[Nick Joseph:]

Thanks, and just finally in terms of the deliveries for this academic year. Are all of them still on time? Is there any risk of missing a deadline?

[Bill Bayless:]

No. We're doing it - we're in good shape from a delivery perspective, although we will say, we mentioned this a little bit on the last call, we are seeing a national trending in terms of in markets where in prior years developers have missed openings. There’s some apprehension in students as they look at properties under construction, even when you’re going to make it. We mentioned on the last call that at the midpoint of our guidance, Lubbock and Waco we expected to be at 70%. And in the case of Waco, it is a direct correlation to the marketplace having apprehension regarding prior year misses. And so the other thing also that's kind of a dynamic change that we key are keeping in mind as we look at all new development going forward and how we approach the marketing and the messaging, a lot of the development that is now taking place today, is more the urban infill. We’ve always done that, but now you see our competitors moving toward that. And unlike when five, 10 years ago when people were building two to three miles from campus and you had more of a multi-family clubhouse and the residential buildings rolling on where the front buildings all look five months ahead of where the buildings are in the back, and it alleviated the perception, when you're building more of the urban infill and the way those buildings come together and construction methodology being all one building and one configuration, it's harder for a drive-by student and parent to understand what is the level of construction completion. And so for example in Clemson there was some concern over another property in the market not getting done. We actually where we have no fear, we started marketing a construction completion guarantee to just overcome students misperceptions of that. So that's something that we're looking at on a longer term basis in terms of a potential change in how we have to message marketing relating to that. So we are not in jeopardy, but something we are paying attention to from that messaging perspective.

[Nick Joseph:]

Thanks.

[Operator:]

The next question will come from David Corak of FBR.

[David Corak:]

Good morning everyone. Could you give us some color on the overall P3 environment, what you're seeing out there in terms of deal flow for 2019 and maybe how that stacks up against what you guys saw for 2017 and 2018. And then maybe just an update on the California system, if there is one.

[Bill Bayless:]

Yes and David, as we - Jamie on the last call gave an update that at that moment in time we had 40 active transactions we were tracking either through our RFP development or direct conversation and negotiation. So we commented then, that's the highest number we had ever seen at any point in time. And so I would say the general environment certainly is colleges and universities looking more and more to P3 structures, whether it's equity, whether it's third party project based financing or in some cases maybe even geo for the efficiencies that the private sector brings. But it is becoming more and more the established mainstream delivery vehicle. And so we see that only as a positive in all fronts of our on-campus P3 initiative, both for equity investments and for third party. Certainly you saw that evidenced in the release last night with five new announcements, two ACE deals, three third party. As it relates to University of California system, what we talked about there, UC Irvine as we announced on this call, which is really where the P3 structure was pioneered within the University of California system, we're pleased there to be starting our fourth transaction as those are very large projects. Of the remaining system projects that are coming out, they have prequalified, as we talked about earlier, eight companies to partake in that process. We do have an inclination, although certainly I don't want to say this is a definitive, the University of California system our work at Irvine, has been more predisposed toward the third party project based financing structure and that's one they know. It’s been proven at UC Irvine, very successful. And so I think there may be a predisposition that more of those transactions will be third party in the UC system than ACE, not that that's the case certainly at Cal Berkeley and what we've done there under the ACE structure, that may play into the thinking of some of the universities as they look at what's best for them. But certainly what's happening there is just a little bit of a microcosm of what's really happening on a much broader scale nationally.

[David Corak:]

Okay, that's helpful. And then switching the page a little bit here. you touched on this a bit in your prepared remarks, but can you just talk about your kind of summer leasing initiatives and the May ending leases, if you're planning on doing anything differently this year and then maybe kind of help us try to quantify the impact that that could have on NOI.

[Bill Bayless:]

Yes, and Jim mentioned this in his prepared remarks. On the last call, Daniel mentioned that we don't have a material increase in the percentage of on-campus leases in the portfolio. This year was right at about 2% where I think last year was about 1.2%, 1.3%.

[Daniel Perry:]

That’s May ending leases.

[Bill Bayless:]

I’m sorry. That’s May ending leases. And in that regard, that's about 500 to 600 more. And so it's a little bit of an increase in the number we're focused on. We also look at where those May ending leases are. The top properties for the number of May ending leases are at the four to five properties that we have continued targeted for sale in the portfolio. some of the tier 2 markets, the Waldorf States, the Wright State Universities, some of those that are probably long term exit plans for us in that regard. The other thing that we're looking at within those May ending, this is a little unique in that our Drexel properties in Philadelphia, Drexel has a very large co-op program where every quarter students go out for an internship and come back off. We now have 3,100 beds at Drexel and are now the majority of their on-campus housing. And so we're actually are working more in meeting the market's needs in terms of the roll off of those co-ops and releasing students from liability on those leases, that when you're an off campus property or even a one off property, you don't have to do. You can force the market to administer that and people to replace themselves. This is where we love ACE properties and all the benefits and stability of cash flows. some of the things that we see in those ACE properties, when you have 3,000 to 4,000 beds on campus, you have to be a more I’ll say student friendly lease administration policy, more mirroring how the university handles that. And so at Drexel we were back filling those leases, but it's more open market backfilling with new lease terms. And so little a little bit more of a challenge this year than in years past that we're focused on in administrating that.

[David Corak:]

Okay, thanks a lot guys.

[Operator:]

And the next question will come from Alexander Goldfarb of Sandler O'Neill.

[Alexander Goldfarb:]

Good morning and appreciate Chuck Berry ahead of the call. Just two questions here. First, on the developments, Bill, you guys - you talked about Waco. You talked about Lubbock. at the recent Interface Industry Conference, a number of the private developers spoke about just delays in getting projects open in time and how the private developers are holding deals longer before flipping them or some of them end up keeping them for their own account. So given your comments around the complexity and the appearance of delivering infill all in one apartment buildings versus a more suburban approach, is this something that we should more expect and that going forward we're going to see more sort of two year stabilizations of development instead of the traditional it stabilizes when it's delivered?

[Bill Bayless:]

Alex, I do think on a global and macro basis within the industry, yes you are going to see that. We certainly always attempt to focus on the earliest stabilization possible. Some of the things that we've talked about based on what you did hear at Interface and some of the more national. And again, what causes all this is developers new to the sector that don't understand you have to really get it done. And opening to two to three months late and causing havoc for students and parents and being in hotels, it causes our market to be somewhat speculative of what comes in. again, it doesn't affect long term stabilization once you're up and running. All those properties that folks have missed that are good assets in good locations have fully stabilized typically to their performance. Some of the things that we have talked about internally, one I mentioned is marketing a construction guarantee where you know you're not going to miss the open. Do a financial incentive that if we do miss, we'll give you this and make it a big monetary number that you know you don't have to pay. the other things that we've talked about doing internally are actually targeting May openings instead of August openings and that one, you’d be starting construction three months earlier and therefore you have more visibility of the type of structures coming to the market that eliminate any concern, and you also have a little potential of carrying summer occupancy with students moving out of the residence halls in May. So we're looking at things strategically on the long term to always attempt to stabilize our assets in the first year, but we do think yes, I mean what you heard at Interface, there has been more of a national trend that some properties or some developers are having more of a year two stabilization. So it doesn't impact - certainly there's a little bit of a drag on first year yield, but it doesn't really impact long term IRR or yield requirements as it relates to what we're looking at from an investment thesis.

[Alexander Goldfarb:]

Yes, Bill. I mean and where those comments came from was from some of the dedicated student housing developers who it didn't seem to be development delays as far as opening. It seemed to be more just dealing with whether it's competitive supply, but it seemed to be that it's just taking actually longer for the asset to stabilize versus construction delays.

[Bill Bayless:]

Yes. You know, in that year two stabilization though, I would say is related to the others that have missed their openings and what creates the apprehension till the second year that allows us to fully stabilize in year two.

[Alexander Goldfarb:]

Okay. And then just going back, Jim, can you just go back through the NOI stuff that you spoke about earlier? I just want to get a sense that this is something new or this is something that you guys are just repeating. Earnings - yes, fourth quarter earnings seems a while ago, but you mentioned some fires or things that are impacting NOI in the second and third quarter. So I just want to make sure that this is something that was already there versus this is new.

[Bill Bayless:]

No, Alex. Some of it is new and that there's three properties that Jim mentioned that we're going to be taking out of service for occupancy during some of the summer months to do some repairs. One was a fire that occurred during the first quarter at The Province in Tampa. And so we lost 41 beds to a fire. Thank God, most importantly, no one was hurt. it was actually an international student smoking on the balcony where they should not have been smoking. And in that regard, we lost 41 beds. Ultimately we have business interruption insurance, but we're not allowed to recognize that per GAAP as rental revenue. So that will certainly be a diminishment. We have two other properties. One is bare at Honors College. We’re going to be undertaking some plumbing repairs that are necessary. Now, that's a normal residential vacancy period, but Barrett does do $300,000 to $400,000 in summer business and camp conference that we’ll be foregoing. And that was a decision that we made post guidance as to when we were going to initiate those repairs. We’ve got one other property at the University of Illinois in Champaign where we have some roof and façade issues. It’s one of our 2012 acquisitions. The amenities are on the roof and we're going to have to go in and redo that roof and some waterproofing on the façade and we're going and we have structured the leases in the summer so that we can perform that work. So that will cause a little bit of pressure that was unforeseen that Jim wanted to telegraph there that we're focused on.

[Alexander Goldfarb:]

That’s helpful. Thanks, Bill.

[Operator:]

And our next question will come from Ryan Meliker of Canaccord Genuity

[Ryan Meliker:]

Good morning guys I just had kind of a big picture question tied to the ACE deals and on-campus public partnerships. and that was, as I'm sure you're aware, a few weeks ago, EDR announced that their University of Kentucky assets were going to be leasing up at a lower level this year than past on issue of getting upperclassmen to live on campus. I'm wondering if across your portfolio as you think about ACE deals, and obviously this is, you've got a bunch of different deals at the University of Arizona now, along with several deals at other schools, are you at a level where you might see a need for upperclassmen to live on campus in your facilities? Are you far from that, anywhere and do you see that as being an issue that might be an impediment to continuing to expand ACE deals across some of the larger universities that you play in?

[Bill Bayless:]

No, and let us talk - first of all we actually pioneered ACE with upperclassmen development. And so let's talk about ACE though and we always talk about ACE is a great investment and on campus properties represent a wonderful, stable cash flow stream. But you really have to dissect it as a real estate investment. and so many of the ACE transactions that you hear us announcing today, have evolved more toward the replacement of the residence hall beds that colleges and universities need to replace that really have a very, very low open market risk about half of our universities have a first year housing requirement where there's really no risk of a vacancy occurring, and even in the markets where that housing requirement does not exist, universities are highly effective in encouraging and first access to students to capture basically 90% of the first year market, even when there's not a requirement. And so projects like we're doing a residence hall at the University of California, Barrett Honors College, all the residence halls at ASU, those at ANU, there's virtually no market risk. Now, what you always have to be sensitive to and this is the type of thing we're mentioning at Drexel, when you are building large prolific programs on campus where you become 3,000 to 4,000 beds, the affordability of that housing to support the broader enrolment base of that mission is critical into how you pro forma and structure the deals. and so even where you have a captive audience from a residence hall perspective, what we always refer to as build for the masses, not the classes and ensuring that you have a affordable range across a spectrum of products, that you can grow in a 2.5% to 3% rental rate increase over the long term. You have to build in. Now, when you move into upperclassmen housing, it's the exact opposite of what I just described. An upperclassman is making a consumer choice to live on campus and when they're making that consumer choice, it comes down to exactly like any other off campus decision. and if they are going to factor location, product offering as compared to the open market choices they have and rate, you then have to look at what is the size of on campus upperclassmen housing that you're building and is the number of beds that you're building in a large community enabling those beds to be absorbed and then have sustainable long term growth? And so when you look at Arizona State is the perfect example of how you approach upperclassmen housing on an ACE transaction, especially at that large scale, at ASU we have 2,200 beds of upper classman housing. Our price points range from $563 a month to just at about $800 a month, $794 per month and averages in the low 700s. The four top off campus properties average rent is $875 and ranges all the way up to $1,079. And so our properties are the best located and incredibly competitive designed and at an affordable price point and spread to the market where we can capture from the entire student enrolment population base in an open market choice and then grow rents. And so the thing you have to always focus on in the ACE transactions when you're targeting upperclassmen is the open market decision parameters of product, location and price. Now, given that many of these structures permits you to not pay real estate taxes like we do at ASU and that you have the best location, you usually can structure those winning formulas from day one. And so the key to the upperclassmen housing is taking the open market parameters that you approach off campus development with into that superior location. And again, that behaves differently than the residence halls you develop for first year students that are not subject to open market conditions.

[Ryan Meliker:]

No, that's really good color. Thanks, Bill. So it sounds to me like the first year residence halls that you guys are developing on campus offer very low risk, but some of the housing that you're being built for potentially upperclassmen is much more open market conditions with a location benefit. Is that a fair way to summarize?

[Bill Bayless:]

With a location benefit and usually a uncontrollable cost benefit. And that again, you look at the margins on those on-campus apartments. Make no mistake, if you structure an ACE transaction properly and the university allows you to bring open market parameters into the transaction, upperclassman housing on campus can be. We think our on campus beds at ASU are the best apartment upper campus investment anyone could decide to make in that marketplace. And that proved itself out through the economic downturn when you saw vacancy off campus and rental rate demolition and we had none, because our price points were initiated at an appropriate level to the open market.

[Ryan Meliker:]

All right, that's really helpful. And then to take that one step further. So you guys still see ample opportunity for ACE developments going forward. The pipeline is still pretty rich and there's the universities that you've looked at in the past, you’d still continue to look at going forward.

[Bill Bayless:]

Oh, yes and again the one evolution in ACE that has been beyond what we ever expected and as I mentioned, ACE began with upperclassman housing. the thing that has come to fruition that was beyond our initial expectation is surprise, surprise, the replacement of the on campus residence hall that have a median age of 51 years in the market we serve. And so just the replacement of that first year housing, is a significant market opportunity that the colleges and universities are facing. The upperclassman housing has become more of a secondary byproduct that again we love when it makes sense to do. We’ve done the same thing at Northern Arizona University where we have both product types and have taken the same approach and done extremely well. The one thing we always focus on, we always remind our university partners, when we're undertaking large scale development and in essence becoming the majority of on campus, we bring that same pricing strategy of build for the masses, not the classes to the university, that at the end of the day, when you control the university housing stock, the beds that you bring to their campus have got to allow the recruitment and retention of students by having a multitude of affordable price points.

[Ryan Meliker:]

Got you. Thanks, Bill. I appreciate all the insight.

[Operator:]

And next we have a question from Juan Sanabria of Bank of America.

[Juan Sanabria:]

Good morning. Thanks for the time. Just a question on the construction delays and being willing to have construction guarantees. is there any color you can give as to - I think you mentioned one university, what percentage of the development pipeline you’d be willing to offer that on and does that change your targeted yields with presumably some risk to the downside, if for whatever reason you do miss how you underwrite developments.

[Bill Bayless:]

Yes and the short term question is no, there's not a financial negative impact. And you would only do it in markets where there is a true concern from past misses that exist. And we would also candidly only offer where we knew we had no chance of missing the opening. And so you're basically creating a phantom messaging to reinforce what you know is your delivery. And so when you think about - and so what we did at Clemson, we offered $1,000 construction guarantee. If we don't have your unit ready on your lease begin date, we’ll give you $1,000. And so again we don't believe we're at risk of paying that on a single unit. However, let's say we had to. You have a total contract value that maybe $10,000, $11,000 that your worst case scenario is you got that student to sign that contract, of which you gave up 10% of that to secure it, versus their concern of the unit not being done leading to zero revenue. And so it is only an enhanced or two versus something that we actually think we have to do in a situation where we're going to miss. Candidly the best decision that you make, if you ever think you're in jeopardy of missing, you push your schedule a year and you move to the following period.

[Juan Sanabria:]

Great. Thank you. And just on - a question on Jim's comments on the NOI and kind of a couple of things have come up at Barrett Honors and Champaign, is there a quantum you can give and has that contributed in any way to the same store rental growth not coming up from that midpoint of 2.9%?

[Daniel Perry:]

Juan, this is Daniel. So with regards to the properties that we're expecting to come offline, it's up around $400,000, $500,000 of potential risk we think we have related to that. It's really not an impact to the 2.9% rental rate increase if those properties come offline because they would come offline in the summer months and be back online for the fall.

[Juan Sanabria:]

Okay, and then just one last one for me. For the University of California, the potential RFP, it’s sounding like it might go more third party versus ACE. I mean would you guys be interested in owning Santa Cruz and Riverside assets ACE, an ACE structure? Just how do you think about those versus your traditional - those particular universities versus your traditional power five kind of focus?

[Bill Bayless:]

Yes. I mean certainly the fact that they're - let me start with the investments we've already made at the University of California Irvine. We would have loved to have owned everything we did on the campus of University of California Irvine under an ACE structure. And having managed the prior phases for the last 12 years, it would have been one of the best investments we have ever made. And so we're always open to analyzing on a case by case situation whether or not we will invest our equity. Now, take the conversation we just had in terms of how you approach ACE from a business perspective. Ultimately whether or not you're willing to invest your equity, comes down to those individual negotiations and what is built and how it's intended to be priced. And so I would not say yes or no off the cuff, versus getting in to see how the RFP is written, how they come about and what the parameters are. But certainly the University of California system as a whole was one of the more prominent clients and we believe when you look at the demographics of higher education in that state and the campuses that are targeting, are going to be long term vibrant institutions within the system and this is going to be the critical on-campus housing component. So they're very attractive transactions across the board in that regard. Again, whether they end up equity or third party will be RFP by RFP. And after the universities have gone through those processes and made those individual valuations and we’ll approach each one independently.

[Juan Sanabria:]

Thank you.

[Operator:]

The next question comes from Austin Wurschmidt of KeyBanc Capital Markets.

[Austin Wurschmidt:]

Good morning and thanks for taking the questions. Just wanted to touch back on some of the pre-leasing detail that you provided, Bill, particularly on the 16 markets that are tracking 1,200 basis points ahead. I think you said 2.2% rental rate growth there. Any opportunity there to potentially push rate a little bit higher given how far you're tracking ahead? And then just separately, on the 19 markets that you're strategically slowing, you said you’re 500 to 600 basis points behind. Was curious how those are tracking maybe relative to the market in general.

[Bill Bayless:]

Yes, and first of all, your first question on the 16 that are currently tracking ahead with the 2.2% rate, the majority of those properties are actually in the current occupancy category of 95% and below. And so the modest rental rate pricing it is what is driving a 1,200 basis point velocity outperformance. And so there you have more upside in occupancy gains than you do rental rate. And so this is where you see that delicate balance and that decision of where you push rate and the occupancy, this is what we always talk about if we caught up - it is unit type by unit type, property by property. You really can't make a generalization in either of those categories. And so in every category that we broke down and gave in terms of the broader segment, those individual analyses of where to tweak the velocity and the rate, are done unit type by unit type, asset by asset. And so it's hard to make a general statement in terms of the actions you’ll take of the group, but it's rather the individual actions that then drive what that property group falls into.

[Austin Wurschmidt:]

And then on the 19 that you strategically slowed, any sense how that velocity is tracking (indiscernible) comparable?

[Bill Bayless:]

No, I’m sorry. We’re doing very well to the market in all those cases. And again these are places where we filled up early last year and had plenty of market opportunity left to where slowing it down is a strategic objective to maximize revenue.

[Austin Wurschmidt:]

Great. Thanks for the detail. and then as far as you guys have mentioned in the last few quarters on the pullback in construction lending, could you just give an update on what the - what you guys’ appetite is and what the backlog looks like for potential mezzanine opportunities. And then how that balances I guess versus more straightforward acquisitions.

[William Talbot:]

Sure, Austin. This is William. We have seen quite an increase in interest in our mezzanine program. As you would expect, with the lending constrictions, our mezzanine programs become very attractive. And so just like we evaluate core acquisitions, we look at the real estate first and if the real estate is something that meets our investment criteria, then we’re able to expand and offer the mezzanine financing and ultimate pre-sale structure. So we're absolutely seeing an overall increase in those. As it relates to just overall acquisition environment, our pipeline remains vibrant. We see a number of opportunities, both one off and portfolio that meet our investment criteria that we're currently underwriting and pursuing. And then as you look back in Q1, CBRE, as they tracked first quarter transactions, you actually saw about $1.7 billion trade in the first quarter. That’s up from $1.1 billion last year first quarter, if you take out the Campus Crest transaction. So you're continuing to see a very active transaction market, a lot of interest. About 55% of the investment in the first quarter was from institutional. So again as we thought you would see, are continuing to see investment from that institutional group and our opportunities remain vibrant and our pipeline remains strong.

[Austin Wurschmidt:]

So on the mezz deals, would you typically look for those to ultimately be more of a presale type transaction? And then how does that balance out versus - how many of those are for potential 2018 deliveries?

[William Talbot:]

Correct. Obviously with the mezz program is just a means to get to the presale to acquire core real estate. So in every case it's going to have that acquisition component to it. We're looking at a number of opportunities right now. It’s really too early to say how many we think will be added to 2018, but that is really the limited opportunity we have to add to 2018 development is through the presale program.

[Austin Wurschmidt:]

Great. Thanks for taking the questions.

[Operator:]

And our next question comes from Ryan Burke of Green Street Advisors.

[Ryan Burke:]

Thank you. The two new ACE deals, ANU and University of Arizona, were those widely marketed RFPs or did they come as a result of just your existing relationships with universities and border agents?

[Bill Bayless:]

The University of Arizona is actually a - there was an RFP about six years ago that was done by the university. At the time that RFP was done, and you may recall from some of the discussions we’ve had in the past, we have been land banking some very strategic off campus sites at the University of Arizona. And when we first responded to that RFP six years ago, we brought to the table at that point in time that we would be willing to contribute and donate our land into an on-campus project type structure. And we've always been prepared to move forward with those properties as off campus standalone developments. Obviously because the university owned contiguous sites next to ours, it made a lot more sense - much greater economies in pulling our land resources together. And so there's actually a lot of the administrative changes that have taken place at the University of Arizona may have been - excuse me, heck, it may have been eight years ago that that RFP took place. And so this transaction has been sitting there as a potential for the university for about five to six years. And so they, about a year ago and wanting - having their vision for an Honors College, this transaction made perfect sense in terms of bringing to fruition what came was an RFP many, many years ago. And certainly all the work that we have done with ABOR, the Arizona Board of Regents that governs University of Arizona, Arizona State University and Northern Arizona University, it is very easy to facilitate a transaction within the system. And so it was very well teed up to move forward. And in the case of Northern Arizona University, that was part of the original selection with us as their partner years ago on the first transactions that we did and additional adding to that. And so in both cases there was a competitive RFP at a point in time in which we've selected that have led to those two opportunities.

[Ryan Burke:]

Okay. Thanks, Bill. Separately, you do continue to focus on development as opposed to acquisitions, even though the acquisition as you mentioned, is pretty vibrant. I think your logic for doing so has been well explained. Curious if you can provide some color on where stabilized acquisition properties are trading versus the cap rates you guys would be willing to pay. So on the properties that you'd like to own that you're not buying, are the winning bidders paying cap rates that are 10 basis points below you or are they paying cap rates that are 100 basis points below you?

[Bill Bayless:]

it varies, Ryan and that you know, if you look at the CBRE report that a lot of folks were talking about at the Interface Conference, we did see trades - I think there were about a dozen trades, just under a dozen that were in the fours, low fours to mid fours typically in university markets that we’re part of, major metropolitan statistical areas. And so you had a little more institutional folks that like to play in those investment parameters. As we've always said, for us cap rate is an inversion of what is the growth rate that we see in those assets. And so it really comes more down into the underwrite. and there's certainly, you've heard us talk about five cap rates and sub five cap rates where we felt that it's not a three, three growth rate but it's a seven, five, four and then a three stabilization to where on an IRR basis, we know we can achieve the long term yields that we're looking for. And so for us that cap rate comes down more to - and this is where we do feel that we have a competitive advantage, in that we typically have more market data, more revenue oxy training data than anybody else, that we’re more better equipped to predict future growth in cash flows than other people when making that decision when you should play up and be competitive or when it's okay to lose by 100 basis points. So it runs the full spectrum of whether we win or how much we lose by, based on that type of analysis.

[Ryan Burke:]

Sure. So it all depends.

[Bill Bayless:]

Yes sir.

[Ryan Burke:]

Okay. Last question, a bit more macro in nature. New York appears or is headed in the direction of providing solution to the education. What’s your view on this? Would a broadening of this and across the country be a good thing or a bad thing for student housing owners and will the impact be different, sort of your higher quality educational institution versus your lower quality?

[Bill Bayless:]

Overall I think it's a good thing. And for free tuition to one degree equals more discretionary income for housing. And so that's not a bad thing and it's really not new. There’s the - Georgia years ago came up with the Hope Scholarship that was - it's probably 10, 15 years old now. My home state of West Virginia has a program and a lot of the states have focused on tuition assistance tied to maintaining academic performance. And so the thing we really like about these programs is they almost always have a hook in them that relates to better university retention of students and motivation for a lack of turnover in enrolment. And so in that regard they're, we believe, overall positive indicators. The broader macro that we see in the large public institutions that we serve where you're seeing some of these initiatives, is that the competition for the seats is so fierce, this is just another alternative for more people to have access to that. And again, given the fact that that free tuition typically has a component of it’s first given toward those that have the actual need, those students then also tend to qualify for Pell Grants and student loans and other forms of funding, which then can be used for housing. And so I certainly - we can't think of anything that we would derive that is a negative from those things taking place.

[Ryan Burke:]

Got it. Thanks Bill.

[Operator:]

And the next question comes from Jeffrey Powell of Goldman Sachs.

[Jeffrey Powell:]

Good morning. Thanks for all the color on your third party revenue earlier in the call. Current assumes about a - up to a 39% increase in third party revenue in 2017 with a large increase in third party development fees. Does this basically imply that in 2018, you expect to ramp in third party development fees from 2017 with all the announced third party developments?

[Bill Bayless:]

It is too early to call a new trend and a new growth curve on that, but I do think when you listen to our discussion about the build up of P3s across the country as it relates to both equity and third party opportunities, there's more transactions hitting the street. And so certainly this is a really good year for the potential for third party income. Typically based on the development cycle, we recognize 50% or more of those in the year in which they commence. And so there is a tail on anything that we start this year into 2018, but really the biggest portion of contribution comes from additional awards that then hit in 2018. And so we don't want to call a new trend as it relates to that income stream, but we're certainly pleased with where it is at this point in time and what the future horizon looks like based on the P3 environment on campus.

[Jeffrey Powell:]

Great. Thanks. And just on development pipeline for 2018, you have a few months to add a few projects. How much larger do you think 2018 could be and could 2019 potentially be lower than 2018 pipeline?

[Bill Bayless:]

2018 has a little bit of a window, certainly from William’s conversations, mezzanine is where you see the greater opportunity for things to come in at this point in the year. Those other folks have teed up well through the entitlement and they're in that final, talking to construction lenders and making decisions as to what was the best route to go. And 2019 has plenty of runway. Again, kind of the same comment as it related to how I just answered third party. When you look at 2019 opportunities. Certainly in the on-campus environment, there's many transactions that are out there that can still fit into the box for 2019. And also from an off campus perspective, also still plenty of time. And so there's no reason for us to believe at this point in time that 2019 should not have the opportunity potential that you see in 2018.

[Jeffrey Powell:]

Great. Thanks. That’s helpful.

[Operator:]

[Operator Instructions] And our next question comes from Tom Lesnick of Capital One.

[Tom Lesnick:]

Hey guys. Most of my questions have been answered at this point, but just wanted to circle back on expense growth for a minute. I think you mentioned that Austin perhaps drove a little bit of property tax pressure in the quarter. I was just wondering if you could elaborate on that a little bit and then if there are any other markets across the country where you see the potential for pressure, if any of those are about you, I would appreciate you pointing those out.

[Daniel Perry:]

Sure, Tom. This is Daniel. With regards to property tax, obviously that's not flowing through the numbers yet. We’re just starting to see initial assessments come in. we’re hesitant to make any changes, even with that large increase in the initial assessment we saw in Austin, because we had a big initial assessment last year in Austin and saw a significant decrease after the appeal. But with it being such a large increase, we wanted to note it. We're still waiting to see the rest of the markets come in and if those end up in some potential for savings, it might offset some increase we see in Austin. I don't know, Jim if there's any other markets that we would point to as significant risks markets for us, but.

[Jim Hopke:]

None more so than any other year, Daniel. We’re still waiting on assessments to come in and we'll have more color on this in the third and fourth quarters.

[Tom Lesnick:]

Got it. Thanks guys. Appreciate it.

[Operator:]

And this concludes our question-and answer-session I would like to turn the conference back over to Bill Bayless for any closing remarks.

[Bill Bayless:]

Again, we want to thank you all for joining us as we talk about the results for the first quarter. And again, thank the American Campus team for all their hard work and dedication. We look forward to talking with you all in June and in May I'm sure we’ll wish you a leasing update prior to the conference there to give you a little more color on how things are going, and in talking with you at the next call. Thank you much.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.