Essex Property Trust Q3 2021 Earnings Call Transcript

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Provided by Quartr
October 26, 2021

Key Takeaways

  • Essex reported Q3 core FFO of $3.12 per share, exceeding guidance, with net effective market rents now 6.4% above pre-COVID levels and same-property revenue up 2.7% year-over-year.
  • Regional rent recovery is uneven: Southern California rents are 17.2% above pre-COVID, Seattle is up 8.3%, and Northern California remains down 5.2% but is forecast to lead in 2022 with 8.7% rent growth due to hybrid office returns and strong affordability.
  • For 2022, Essex expects an average 7.7% net rent increase, 4.1% job growth versus only 0.6% housing supply growth, and continued West Coast outperformance supported by major tech investments and 38,000 open tech positions in its markets.
  • On the capital front, Essex raised a $660 million institutional joint venture, anticipates $290 million of preferred equity redemptions, raised full-year FFO guidance to $12.44 per share, and reduced net debt/EBITDA to 6.4×.
  • With California’s statewide eviction moratorium ending September 30 (though some local extensions remain), federal tenant relief has aided resident reimbursements but processing remains slow and requires extra team support.
AI Generated. May Contain Errors.
Earnings Conference Call
Essex Property Trust Q3 2021
00:00 / 00:00

There are 18 speakers on the call.

Operator

Good day,

Speaker 1

and welcome to the Essex Property Trust Third Quarter 2021 Earnings Conference Call. As a reminder, today's call is being recorded. Statements made on this conference call regarding expected operating results and other future events are forward looking statements that involve risks and uncertainties. Forward looking statements are made based on current expectations, assumptions and beliefs as well as information available to the company at this time. A number of factors could cause actual results to differ materially from those anticipated.

Speaker 1

Further information about these risks can be found on the company's filings with the SEC. It is now my pleasure to introduce your host, Mr. Michael Shaw, President and Chief Executive Officer for to Essex Property Trust. Thank you, Mr. Schall.

Speaker 1

You may begin.

Speaker 2

Good day, and welcome to our Q3 earnings conference call. Angela Kliman and Barb PAC will follow me with comments and Adam Barry is here for Q and A. I will provide an overview of our Q3 results, Our initial operational outlook for 2022, apartment market conditions and then conclude with the regulatory environment. Our Q3 results exceeded expectations, reflecting substantial improvement in West Coast economic conditions and housing demand. Net effective market rents are now 6.4% above pre COVID levels, and it's notable that we have exceeded Pre COVID market rents despite having recovered only about 63% of the jobs lost during the pandemic.

Speaker 2

As a result of improving market conditions, we reported quarterly core FFO of $3.12 per share, Southern California continues to deliver the strongest growth With net effective rents up 17.2% compared to pre COVID, while Northern California is still down 5.2%. Return to office delays at many tech companies and slower job growth compared to other West Coast areas were factors In the pace of recovery for Northern California, overall September job growth in the Essex markets was 5.2%, substantially above the U. S. Average of 4%. Turning to our outlook for 2022, We published our initial market rent estimates on Page S-seventeen of our supplemental package.

Speaker 2

We are expecting 7.7% net rent growth on average in 2022 with Northern California, the notable laggard in 2021 forecasted to lead the portfolio average end market rent growth next year. A key assumption driving our outlook for 2022 is the return to a predominantly hybrid office environment occurring over the first half of the year, supporting our 2022 job growth outlook and our expectation that the West Coast markets will resume their long term outperformance versus U. S. Averages. Our confidence in the Bay Area recovery next year is partially driven by rental affordability following a year of solid income growth, lower effective rents And exceptional growth in single family home prices.

Speaker 2

Median for sale home prices are up 17% in California And almost 16% in Seattle, making for sale housing more costly relative to rental housing and often impeding the transition from renter to homeowner. Finally, despite large increases in for sale housing prices, Our expectation for the production of for sale housing in 2022 remains very muted at only 0.4% of the single family housing stock. We previously noted that many large tech companies in our markets Nevertheless, Recent tech company announcements regarding office expansion, open positions in the Essex markets and new commitments to office space all support our belief That the leading employers remain fully committed to a hybrid office centric environment on the West Coast. Page S17.1 of our supplemental highlights recent investments by large tech companies, which have continued throughout the pandemic and include Apple's 550,000 Square Foot recent expansion in Culver City, their new 490,000 Square Foot Tech Campus That will soon begin construction in North San Jose and a recent acquisition of 5 office buildings with a total of 458 Google last quarter received needed approvals for its planned 80 acre campus near downtown San Jose And YouTube's 2,500,000 Square Foot Campus in San Bruno was just approved by the city last week.

Speaker 2

We continue to track the large tech companies hiring in terms of open positions and job locations, giving We continue to grow alongside the most dynamic sector in the U. S. Economy. Our most recent survey Open positions indicates 38,000 job openings in the Essex markets for the 10 largest tech companies, Up 9,000 jobs or 26% as compared to the Q1 of 2020. Strong economic growth on the West Coast is further of which 44% was directed to organizations in the Essex markets.

Speaker 2

Turning to our supply outlook for 2022, We are expecting 0.6 percent housing supply growth for the full year, including 0.9% growth for the multifamily stock, which is manageable relative to our expectations for job growth of 4.1% in 2022. Overall, our West Coast markets will remain well below the national rate of new housing supply growth and especially compared to the rapidly accelerating pace of housing deliveries across many low barrier markets next year. Longer term residential building permits in Essex markets saw a modest 3.5% increase on a trailing 12 month basis, which is favorable compared to the U. S. Where permits have increased 13.6% compared to 1 year ago.

Speaker 2

While our markets often temporarily underperform the national averages during recessions, we remain disciplined in our approach to capital allocation, including the cadence of housing supply deliveries with permitting data supporting our West Coast thesis. Turning to the apartment transaction market, we continue to see strong demand from institutional capital to invest in the multifamily sector along The West Coast as evidenced by increasing transaction volume and cap rates in the mid-three percent range. Apartment values across our markets are up approximately 15% on average compared to pre COVID valuations. The company has recently seen more development opportunities and we were able to purchase 2 commercial properties in the 3rd quarter, One located in South San Francisco that we expect to become a near term apartment development opportunity And another in Seattle that we will begin to entitle for apartments while earning an attractive 6% going in yield with a high quality tenant. We also recently closed 2 apartment acquisitions as noted in the press release and our acquisition pipeline is strong.

Speaker 2

Barb will discuss a new co investment program in a moment, which is strategically important given our preference not to issue common stock at the current market price. Finally, the California statewide eviction moratorium ended September 30. However, A few meaningful local jurisdictions have extended their separate eviction prohibitions. The net result is that a significant Fortunately, the federal tenant relief program has come to the aid of many of our residents, although the reimbursement Process continues to be slow and requires significant coordination and support from the Essex team. I am grateful for this extensive team effort.

Speaker 2

With that, I'll turn the call over to Angela Kleinman.

Speaker 3

Thanks, Mike. First, I'll start by expressing my appreciation for our operations team. As we are in the midst of a strong recovery, our team has been busier and working harder than ever. I also want to thank the support department, especially our delinquency collections team for their diligence to help our customers navigate the complex rent reimbursement legislations. On to today's comments.

Speaker 3

I'll provide an overview of our portfolio strategy relative to current market conditions, followed by some regional commentary and expectations for our markets. Our 3rd quarter results reflect a combination of the operating strategy implemented early in the And the healthy recovery in net effective rents that began in the Q2 as California and Washington Finally, we opened from the pandemic shutdowns. As you may recall, in the Q2 of 2020, when the pandemic mandated shutdowns halted our economy. Essex quickly pivoted to a strategy that focused on maintaining high occupancy And coupon rents were the use of significant concessions. Now over a year later, as our markets recover, We are starting to see the benefits of this strategy flow through our financial results.

Speaker 3

In the Q3, same property revenue grew Same property revenues grew by 2.7%, which is primarily attributable to a reduction in concessions compared to the previous period. By primarily utilizing concessions last year, we were able to limit the in place rent decline to only 1.1% in the 3rd quarter. The benefit of this strategy is also coming through our sequential revenue growth, which increased 3.2% this quarter from the 2nd quarter. With the market volatility we experienced over the past year, this is an extraordinary result and positions the company well going forward. From a portfolio wide perspective, market conditions remain strong compared to a year ago as demonstrated by the 12.6% Blended net effective rent growth in the quarter.

Speaker 3

In addition, rents relative to pre COVID levels have continued to improve, further enhanced by a delay to the typical seasonal slowdown in all our markets. Turning to some market specific commentary from North to South. Rents and jobs in the Seattle region have had a strong recovery with net effective rents up 8.3% compared to pre COVID levels And year over year job growth of 5.5% in September. New supply continues to be largely concentrated in the CBD, which is less impactful to Essex because 85% of our Seattle portfolio is located outside of CBD. Looking forward to 2022, as outlined in our S-seventeen supplemental, total housing supply deliveries The region is expected to decline compared to 2021, and we anticipate job recovery to continue, Led by Amazon, which recently announced plans to hire over 12,000 corporate and tech employees in Seattle.

Speaker 3

As such, We are forecasting market rent growth of 7.2% in 2022. Moving down to Northern California, which is our only region where net effective rents remain below pre COVID levels. Greater job loss and apartment supply deliveries caused net effective rents to fall further in Northern California since the onset of the pandemic. In addition, the job recovery in Northern California has been at a slower pace in our other regions with only 4.4% year over year improvement compared to a 5.2% for the entire Essex portfolio as of September. We believe this is partly driven by the more onerous mandates delaying normal business activities.

Speaker 3

Apartment supply, particularly in San Mateo and Oakland CBD are also presenting challenges for nearby properties, leading to financial concessions for stabilized properties for of over a week in these markets in September. On the other hand, we anticipate that Northern California will be our best performing region in 2022 with market rent growth forecast of 8.7% on our S-seventeen. As Mike discussed, we expect hybrid office reopenings to continue, which will drive additional job growth and healthy demand for apartment units, With similar level of supply delivery expected in 2022 as this year, we are optimistic to improve in the Q3 and net effective rents in September are 17.2% above pre COVID levels. As we have mentioned in the past, Southern California is a tale of 2 markets, the urban areas in the Downtown LA versus the more suburban communities, which have generally outperformed. In June, LA rents were still below pre COVID levels, but as of September, they are now 6.8% above, Job growth in Southern California continues to progress well, up 5.9% in September as the region's Economy continues to reopen and recover.

Speaker 3

With the exception of the Downtown L. A. Area where concessions average 1 week in September, The rest of our Southern California markets have demonstrated solid fundamentals with no concessions recognized in September. We expect Southern California's strong rent growth to continue in 2022 led by Los Angeles, which has just begun to recover the jobs lost during the COVID recession. Apartment supply in the region is forecasted to increase next year compared to this year and could present pockets of interim softness counterbalanced by a continued favorable job to supply ratio across the region.

Speaker 3

As you can see, on our S-seventeen market rent growth for Southern California of 7.1%, we anticipate this region to perform at a comparable level at Seattle. With this backdrop of stable occupancy amidst a favorable supply demand relationship, our portfolio is well positioned for the continued growth. I will now turn the call over to Barb Heck.

Speaker 4

Thanks, Angela. I'll start with a few comments on our Q3 results, Discuss changes to our full year guidance, followed by an update on investments and the balance sheet. I'm pleased to report core FFO for the 3rd Quarter exceeded the midpoint of our guidance range by $0.08 per share. The favorable outcome was due to stronger operating results at both our consolidated and co investment properties, higher commercial income and lower G and A expense. During the quarter, we saw an improvement in our delinquency rate, which declined to 1.4% of schedule rent on a cash basis compared to 2.6% in the 2nd quarter.

Speaker 4

The decline is attributable to an increase in income from the federal tenant relief programs that were established to repay landlords for past due rents. Year to date through September, we have received $11,600,000 from the various tenant relief Programs, of which $9,500,000 was received in the 3rd quarter. Given the increased pace of reimbursements, We began to reduce our net accounts receivable balance in order to maintain our conservative approach to delinquencies and collections. As a result of the strong Q3 results, we are raising the full year midpoint for same property revenues by 20 basis points to minus 1.2%. It should be noted, this was the prior high end of our range.

Speaker 4

There are two factors I want to highlight as it relates to our Q4 guidance. First, as Angela discussed, we are seeing strong rent growth in our markets. While there will be a small benefit to the 4th quarter, The vast majority of the benefit from higher rent growth won't be felt until 2022 when we have the opportunity to turn more leases. 2nd, our 4th quarter guidance assumes we continue to receive additional government reimbursements for past due rents and contemplates a continued reduction in our net accounts receivable balance. Thus, we expect our reported delinquencies as a percent of scheduled rents to be above our cash delinquencies, which is consistent with the Q3 reported results.

Speaker 4

As it relates to full year Core FFO, we are raising our midpoint by $0.11 per share to $12.44 This reflects the better than expected 3rd quarter results And changes to our full year outlook. Year to date, we have raised core FFO by $0.28 or 2.3 percent at the midpoint. Turning to the investment market. During the quarter, we raised a new institutional joint venture to fund acquisitions as we believe this is the most attractive source Capital today to maximize shareholder value. The new venture will have approximately $660,000,000 of buying power, a portion of which is expected to be invested by year end.

Speaker 4

As I discussed on our last call, we are seeing an elevated level of early redemptions of our preferred equity investments due to strong demand for West Coast Apartments and inexpensive debt financing, which is leading to sales and recapitalizations. For the year, we expect redemptions to be around 290,000,000 Roughly 40% of these redemptions are expected to occur in the Q4. Given the current environment, we could See continued elevated levels of early redemptions in 2022. In terms of new preferred equity and structured finance commitments, we are on track As a reminder, it typically takes 3 to 6 months post closing to fund our commitments given they tend to be tied to development projects. Moving to the balance sheet.

Speaker 4

As we expected, we are starting to see an improvement in our financial metrics driven by a recovery in our operating results. In the Q3, our net debt to EBITDA ratio declined from 6.6 times last quarter to 6.4 times. We believe this ratio will continue to decline through growth in EBITDA over the next several quarters. With limited near term debt maturities and ample liquidity, We remain in a strong financial position. That concludes my prepared remarks, and I will now turn the call back to the operator for questions.

Speaker 1

Thank you. We will now be conducting a question and answer Our first questions come from the line of Nick Joseph with Citi, please proceed with your questions.

Operator

Thanks. As we look to 2022, how do you think about Essex's ability to capture Sure. That MSA market rent growth of 7.7% that you discussed, I know either from a regulatory standpoint or the lease roll perspective, Just trying to tie the initial same store expectations to the market rate data that you provided.

Speaker 2

Hey, Nick, it's Mike and Angelo might follow me with comments. I think we're feeling very good about Conditions around us. Again, we have high occupancy throughout and a very strong loss to lease and that's been noted before. And everything looks like our markets are recovering. We expect to outperform the U.

Speaker 2

S. With respect to Job growth certainly going forward and we view the catalyst of the return to Office in Northern California has been sort of the last piece. That's probably the relative underperformance that we've had Thus far relative to the peer group and we see that as still being a very strong part of our portfolio. Historically, Northern California produces Highest CAGR of Brent growth over long periods of time and we expect that dominance to Show itself and a lot of the reasons why were embedded in the various comments that you heard from all of us. So hopefully that all made sense.

Speaker 2

The number of Open positions for tech companies, the big investments that the tech companies continue to make within the Northern California markets, Etcetera, I think it bodes well. So we feel really feel great throughout our footprint, but the key piece going forward, I think Northern California, we feel very good about that too.

Operator

Thanks. Maybe following up on that, the return of the office Or hybrid, how do you think that impacts seasonality over the next few months as employees maybe move back into Northern California specifically?

Speaker 2

I think that given that we carry high occupancy into this period of time, Any incremental growth in jobs should have a very positive impact on market rents. And so again, our expectation is, I would say, Northern California was probably shut down to a greater level than Most other markets, maybe LA would be number 2, but it has had the most muted recovery, Again, it has, I would say, the strongest and most dynamic job base. So again, we're looking forward to that. We're hoping it would happen earlier. But again, I think the Delta variant has postponed that.

Speaker 2

But again, we feel strong. We think All the things, all the conditions that we would expect to see from number of open positions for these companies, major commitments to Campuses and lease commitments for office space, etcetera, all seem to be focused on a return to office program probably in a hybrid sense for these companies. So I think that's before us in the not distant future.

Speaker 3

Thank you. Thank you.

Speaker 1

Thank you. Our next questions come from the line of Haendel St. Juste with Mizuho. Please proceed with your questions.

Speaker 5

Hey, thanks for taking my question. So first question, I guess, is on the topic de jure inflation and all the ways that it's impacting the business. How are you thinking about that impact In regards to payroll, R and M, utilities and what offsets could you perhaps what numbers can you pull to offset some of those costs into next year? And then maybe some broader comments on your technology platform, where you are in terms of the rollout of that and how that could be help here as well? Thanks.

Speaker 2

Okay, Haendel. Thanks for the question. It's a good one. And I'll let Angela Handle the technology piece of it.

Speaker 6

I'd love to hear you help me.

Speaker 2

What was your first question,

Speaker 3

Laurie? Inflation.

Speaker 6

Inflation, yes.

Speaker 4

Yes.

Speaker 2

So I mean we've studied the inflation thing, the historical precedent Going back a long time actually into the early 80s and no doubt we are feeling Quite a bit of pressure on the cost side. Certainly, finding positions, especially on-site positions is challenging And compensation is going up for sure. On the one piece that's good in California obviously is property tax Because Prop 13 limits that increase. And so I go but I go back to rents. Rents are obviously the big thing.

Speaker 2

We're a High gross margin type of company and therefore, the rent growth really matters in this equation. And I think In an inflationary world, rents do very well. And so I would expect that Our rents growth would more than compensate for whatever cost increases that we have. And I think It would be I'm not saying I want this to happen, but I think if

Speaker 7

we were

Speaker 2

in a more a stronger inflationary period, I think it would be I mean that's Positive in terms of the financial performance of the company. Obviously, if inflation goes up, all asset values decline in value. So maybe That would be one sticking point as well because probably cap rates change and some other things happen as well. So Andrea, you want to comment on?

Speaker 3

Sure. But I think Barb will add.

Speaker 4

Yes. I just want to follow-up on that one point, Haendel. The other thing that we've done over the last Next year and the following year. So we're not susceptible to rising rates from that perspective. We've locked in our interest expense effectively, and we have very little limited Variable rate exposure as well.

Speaker 4

So we feel good about where the balance sheet stands from an inflationary perspective.

Speaker 3

Great. And on the technology front, Tyndale, what we have been doing is really focused on ramping up the Contactless interactions, which also allows for efficiency and allows more flexibility for our site team. And so we are going to continue that path and further refine and enhance those technology. And what that means is that it will allow our staff to probably specialize more and hopefully continue to be more efficient And that will help. I don't think it will be, say, an immediate relief as far as the payroll expenses that you're looking for, but over time, it should benefit The business platform.

Speaker 5

So without putting words in your mouth, it sounds like the near term outlook for inflation. Does it necessarily spook you? Perhaps there's a little bit of pressure building in the business, but maybe not to the degree to perhaps put a Mid single digit type of expense growth outlook for next year?

Speaker 2

Well, we're not giving we are not guiding yet for next year.

Speaker 6

We're still working to the budget.

Speaker 2

And Barb drilled that into it prior to the call. Please don't give out any guidance for Steve.

Operator

We're still working on that.

Speaker 2

Yes, I guess the point I would make is in High gross margin businesses, even if you get some expense pressure, Yes, still the top line is so much more important. So I think in my view, we always look at rents, What's the relationship between rents and incomes? And so in an inflationary environment, if incomes are going up, we're probably able to pass through Most of that in the form of rent. And if that happens, we will do very well in that scenario.

Speaker 5

Got it. Fair enough. And second question, if I could ask about the 2 office acquisitions here in the quarter. Maybe some comments around the math, the thought process. And should we be thinking of these as opportunistic and more one offs Or some perhaps more reflective of the low cap rates in your markets, which could be making more conventional acquisitions more difficult.

Speaker 5

And if that's the case, thoughts on culling some of the portfolio a bit or maybe taking advantage of some of the pricing? Thanks.

Speaker 6

Hi, Haendel. This is Adam. So I'll touch on both of the 2 ops acquisitions that Mike touched on In the opening remarks, they're both kind of separate, which is why I'll cover them separately. The first one, which is in South San Francisco, We've had that tied up for over 3 years. And so during that time, we work with the city to determine what sort of zoning we could get.

Speaker 6

And During that time, we're basically able to increase the density by over 100 units. So coupled when you take that coupled with The cap rate compression that we've seen in the market, the deal made more sense than really any development deal that we've penciled In the last couple of years. So there is in place income on the existing use, which is in the call it high 3 Cap rate range, which is fine and that'll get us through 2 entitlements, which we would expect in 9 months to a year or so. The other one, somewhat of an outlier. It's a single tenant office deal in Seattle, Really good location.

Speaker 6

There's still another 9 years on the lease and we have a partial guarantee for that term. So It's north of 6% cap on current income. It does pencil on today's multifamily underwriting and it is actually zoned For multifamily, but we'll revisit that in the 5, 6, 7 years from now to see what makes the most sense. But for now, that's a very solid covered land play from our perspective.

Speaker 5

Great. I appreciate the color. Thank you.

Speaker 2

Sure. Thanks, Haendel.

Speaker 1

Thank you. Our next questions come from the line of John Kim with BMO Capital Markets. Please proceed with your questions.

Speaker 8

Hi. This is Valeria calling for John Kim. Thanks for taking my question. So I was just wondering a little bit about the regulatory Risks in your market, I know we've kind of touched on that here and there. But are these increased risks kind of being priced into valuation?

Speaker 8

Some of your other peers were citing that as a reason to reduce exposure in California. And I was just wondering how

Speaker 3

you guys are thinking about that?

Speaker 2

Adam, well, I'll start and I'll let Adam chime in here. Well, we've Obviously, dealt with regulatory issues over many, many years really for the 35 years I've been here. And historically, the bigger the loss to lease gets because of rent roll, let's say, the more Buyers and sellers will start pricing in a portion of it or want a higher cap rate given the delayed impact But generally speaking, all apartments are valued based on market rents today, not Again, the loss to lease is a determination based on facts and circumstances. So With California Rent Control Law, the statewide law, at CPI plus 5 max of 10% Annual increase, I don't think that that in and of itself will cause a significant valuation differential. And I think that's the key part that if you're moving rents by CPI plus 5, let's call that 8 or something like that, Most buyers will think that that is plenty of compensation for the transaction and I don't think cap rates move all that much Because of that.

Speaker 2

Adam, do you want to comment on that?

Speaker 6

Just one additional comment. The most onerous rent controls within California, you take San Francisco or Santa Monica or Berkeley, there's just very little of the trades there. So that's where you see that larger loss to lease, the bigger gap between And place and economic and that's where pricing would fluctuate more. But as far as AB1482 goes, the California Statewide one. It doesn't really factor in to really anyone's models from what I can tell.

Speaker 3

Okay. Thank you. Thanks for the color.

Speaker 8

Going back to the inflation piece too, How is that affecting your planned development? I know you briefly talked about the other commercial acquisitions and how Relative to multifamily, those are still good trades, but kind of moving forward in the development pipeline, like is that something that you're really thinking about?

Speaker 6

It's something we consider in all of our strategic decisions. We're not focused on the office market. I want to be very clear. The 2 opportunities that we had are like Really one offs, but no, I mean, we look at all of those factors in determining where and what to invest on.

Speaker 2

Yes. I think we estimated about 9% between today and when we would start construction, for example, on The South San Francisco deal that Adam talked about earlier, could that be high or we don't know, but we build in an estimated cost escalation. And but what really drives all these deals, if cap rates go from 4.25 ish down to 3.5 or so, The built in value of those transactions of a development transaction until

Operator

of course

Speaker 2

Until land sellers adjust their price, it makes a ton of sense and there's a lot more value created in that process.

Speaker 6

Adam, do you? Yes. So just one final follow-up there. We're always looking at the spread between where stabilized Acquisitions or stabilized assets are trading versus our development yield. And so whether a deal is entitled or unentitled, we're going to look for A different spread between what in place cap rates are.

Speaker 6

And so that escalation that Mike referred to, we assume on everything, whether it's 3 months out, 6 months out or 2 years out, and then that factors into the denominator. And so with this cap rate compression, we've seen, Especially on these two deals and there are a couple of others potentially in the pipeline where that spread has increased and those are the deals that we are pursuing aggressively.

Speaker 1

Thank you. Our next questions come from the line of Rich Hill with Morgan Stanley. Please proceed with your

Speaker 9

Hey, guys. Just a quick question. Could you maybe provide us some details on your loss to lease across the various different markets, so we can compare them to the rental rates you disclosed your macro forecasts?

Speaker 3

Sure. Happy to. It's Angela here. At September, the portfolio loss lease It was 9.8%. And but it's a wide spread from Northern California in the 4s to Southern California in the low single digits around 13%.

Speaker 3

And so and we understand that typically analysts look to this loss release to model next year. And so I want to just make sure that I provide a little more context on that because we want to consider a couple of factors. First, this year was an unprecedented year because we started out the year with A huge negative rent growth and have turned positive. So it's a very steep curve. And so this trajectory is not likely to repeat next year.

Speaker 3

And so but because of that and the delay in the seasonal peak It has created a small drag on revenue for next year. And secondly, some markets, those over 10%, which is Robbie speaking will be our Orange County, San Diego and Ventura Counties. They have They're above the 10% cap rent control cap. And so that will be a factor as well.

Speaker 9

Got it. Angela, that was actually exactly what I was looking for. Just maybe one other question. When we think about the leasing spreads versus list rates, is there a lead lag there? Some of the data we look at is Listing rates seem to be a lot higher than the signed leasing spreads.

Speaker 9

So I'm just wondering if the listing rate is a leading indicator and how you think about that?

Speaker 3

I'm not sure if I am following your question.

Speaker 9

Yes. So what I'm suggesting is

Speaker 3

Are you talking about asking versus achieved? Is that what you mean?

Speaker 9

Yes. Yes. And I'm suggesting are you asking in October, November, December higher than where you've been signed?

Speaker 3

Yes, I see what you mean. Normally, it is well, let's put it It has been higher, but that's pretty typical. What we try to do is forecast what The rent level is going to be 1 or 2 months out whenever we send a renewal. And so what that means is sometimes it's higher and sometimes slower. So if we think that we're now in we are sending out renewals now for say December, January, it's not likely to be a whole lot higher.

Speaker 3

But back in if we're sending renewals out in March for renewals in May or June, it tends to be higher. So it really depends on the timing And the market conditions.

Speaker 1

Thank you. Our next questions come from the line of Austin Wurschmidt with KeyBanc. Please proceed with your questions.

Speaker 10

Yes, thanks everybody. I was curious Going back to the market rent growth forecast, if you could just give some additional detail of kind of how you thought about a baseline scenario that Maybe doesn't include some type of hybrid back to office and how you went about determining what that additional growth would be layered on top With that back to office scenario playing out, we know you guys tend to take a conservative approach. So just trying to understand the Baseline versus what the upside look like?

Speaker 2

Yes. It's a great question. And Yes, I'm not sure we approach it that way. I mean, our research group, Paul Morgan, he they use a variety of datasets And they're not looking at any one thing, not creating some base case scenario. The simple part of it is Looking at what we expect job growth to do and how many units of demand are represented by the job growth and then how much supply do we And so fortunately, again, we're 96% occupied in all these markets.

Speaker 2

So it isn't like we have a hole to fill before That before the demand over supply situation takes hold. So we're already there. But Included in some of the things he looks at, which I think is some pretty interesting data. For example, Seattle has Recovered 79% of the jobs that they lost in the pandemic and he's expecting them to be at 110% by the end of Q4. So they will actually be above their pre COVID employment level, whereas almost all the other markets are still below pre COVID level by the end of 2022.

Speaker 2

So it's not that simple. HEAT considers affordability, which Affordability is a key part of what we do. And if we look at things now because there's been such incredible Growth in rents in Southern California, they screen and the way we do affordability is on a market basis, not a property by property basis, because we're trying to look at the overall dynamic in the marketplace. And Southern California because it has such great rent growth Is screening a little bit expensive and Northern California, which has the highest incomes and rents that are Pretty moderate given what's happened here. So that's what leads to the better growth rate for Northern California next year.

Speaker 2

And By way of background, I'll give you a quick comparison. So rents in Seattle and Los Angeles, the median rent, the market rent, not Essex portfolio is about $18.16 in both cases. But in Seattle, The median household income is $102,000 and in LA it's about $88,000 So Paul would look at that Relationship and say, you know what, that's a positive for Seattle. It has about the same rents, has a lot more room to run with respect to income And that would factor into his equation in terms of what we expect market rents to do. That makes sense.

Speaker 10

Yes. No, that's very helpful color. And so in that scenario, if demand were to exceed Just from a job growth perspective, you talked about kind of the jobs versus supply piece. So if back to office does drive increment All demands above and beyond that, is it conceivable to think that you could benefit from a pricing power perspective, but also see some upside to occupancy as well?

Speaker 2

Well, occupancy is a little bit different element and that really It has to do with how aggressively we're pushing rents. And so occupancy, some have noted, has actually declined a little bit, but that's really because we're Pushing rents, when you push rents, you hold out a little bit longer and you are willing to accept a little bit lower occupancy level. But going back to our basic thesis, if we have 530,000 jobs created next year and the typical Relationship between a household and a job is 2:one. So we have somewhere around 265,000 Units of demand for apartments and we produce a total supply of 64,000 homes, we should do pretty darn well in that scenario. Again, affordability becomes the key issue and affordability is different by market.

Speaker 2

Screen relatively inexpensive in Northern California and relatively expensive in Southern California. But just looking at basic supply demand, we should be in great shape next year. And so we don't know exactly what's going to happen. We think 7.7% is a big number, but we'll wait and see.

Speaker 1

Thank you. Our next questions come from the line of Rich Hightower with Evercore. Please proceed with your questions.

Speaker 11

Everybody, thanks for taking the question here. So I guess outside of restrictions Within the confines of AB1482 in California, are you guys self limiting any markets or submarkets with respect to renewal rents, just kind of in that sort of corporate spirit and being the good guy from Vis a vis your tenants that you guys have employed in the past, thereby sort of exacerbating that growth in the loss to leases as things go forward?

Speaker 3

That's a good question and this goes towards the social responsibilities Part of our corporate governance, right? We have a self imposed cap of 10% for many, many years. And really the approach behind that is to avoid being viewed as anti gouging. And so and that strategy has worked well for us for many, many years and it really has not materially negatively impacted the returns of our shareholders.

Speaker 11

Okay. And Angela, Which markets are you sort of employing that strategy at this moment, if you don't mind?

Speaker 3

Well, it's broadly across the portfolio and so it's wherever we have That hitting the loss of lease above 10%. And so it happens to coincide with 1482. So it's Orange County, San Diego and Ventura, because they're all above 10% lost lease.

Speaker 11

Then Seattle perhaps?

Speaker 3

Yes, Seattle as well.

Speaker 11

Okay. All right, great. Thank you.

Speaker 2

Not 1482, but yes. Right.

Speaker 11

I mean, separate from 1482. That's what I meant. Yes. That's perfect. Thank you.

Speaker 2

Thanks, Rich.

Speaker 1

Thank you. Our next questions come from the line of Brad Heffern with RBC Capital Markets. Please proceed with your

Speaker 12

Hey, everyone. I was just curious in the Bay Area, if you've seen any change on the move in stats, If maybe more people are coming in from outside the metro versus what you've seen more recently?

Speaker 2

It's a good question. And the granularity of that data is kind of difficult to follow. And so It's hard to say exactly what's happening recently. We do have job growth and the job growth is exceeding the national average. From that statistic alone, we feel like there was some positive movement back to the Bay Area and clearly occupancy etcetera Has confirmed that.

Speaker 2

And so but we don't think that the major Shift has happened. We expect it to pick up here in the next couple of months as we approach year end and hopefully accelerate into 2022. And that's the premise. But again, we don't we need I'd say we need More job growth than what we have currently to achieve the 2022 forecast that is on S-seventeen, But we'll do fine either way.

Speaker 12

Okay, okay. Got it. And then on delinquency, can you walk through Sort of what the underlying trend has been? I know there's noise obviously related to the rental relief payments, but has the underlying level come down and how do you see that sort of playing out?

Speaker 4

Yes. Hi, Brad. This is Barb. So you can see we report our delinquencies. For the quarter, we were at 1.4% on a cash basis.

Speaker 4

And keep in mind, we did report July last quarter and that was at 2.2%. So that implies August, September had come down. That was around 1% on a cash basis. And then October, It's about 1% and that's really being driven by the reimbursement. As I mentioned during the call, we got $9,500,000 in the 3rd quarter.

Speaker 4

Most of that hit in August September, and we've seen in October, we've seen a commensurate amount. So that's kind of where we've been at. We've been stable, I would think, the last 3 months, it's been pretty stable, in terms of our net delinquencies.

Speaker 1

Thank you. Our next questions come from the line of Neil Moffatt with Capital One Securities. Please proceed with your questions.

Speaker 13

Hey, thank you. Still morning out there for you. Just on that last question, when you say the delinquency is 1%, that is net of the amount that you collected From the delinquency reimbursements from California and other jurisdictions, is that correct?

Speaker 4

Correct. Correct.

Speaker 13

So without that, it would still it would be in that like 2 plus range. Is that around or it would be?

Speaker 4

Exactly. It would be higher without those reimbursements. The reimbursements is what is driving that number lower, correct?

Speaker 13

Yes, sure. Yes, I was trying to understand what's baked in and if anything's changed and how you recognize bad debt and how That looks, I get you. Okay.

Speaker 4

No, not yet. Okay.

Speaker 13

And just in terms of The people moving into San Francisco, I guess, we'll focus on that one. You mentioned that In general, your portfolio has seen people come back. And I wonder, just given in San Francisco that rents are still down from

Speaker 10

pre COVID

Speaker 13

levels, Can you comment on are the demographics changing a little bit from the people who are moving Are they the same in terms of income, jobs or are more people who are coming in sort of moving in from the outskirts looking for a deal of some kind that would potentially impact your ability to retain those once market rents come back?

Speaker 3

Yes, it's Angela here. That's a good question. We have not seen any meaningful change in the demographic profile. And I think this question was also posed early on when rents declined or when we were giving out Significant concessions. I think at the end of the day, it's It's all about jobs.

Speaker 3

And so while it's slightly more affordable, People are not going we just don't see people randomly moving into the city and then not being able To stay. Does that make sense?

Speaker 13

Yes, yes. I appreciate that. Yes. So just the other one follow-up, maybe just talk about development and the sort of mezz outlook. You kind of touched on this earlier, but given everyone understands there's a lot of inflation with input cost, supply chain disruption, Hard to get labor, etcetera.

Speaker 13

But you made the comment that you're seeing increase in developments And a commensurate increase then in mezz opportunities. Can you just maybe elucidate that a little bit? Just Yes. You think that that it would be a tougher environment, but can you talk about what's driving that? And then what kind of opportunities Evaluating right now and potentially the size.

Speaker 2

Actually, maybe I think there are several parts to that and I think We may need to clarify the question a bit here. But overall, we think 2022 will have roughly 4% More supply than 2021 and part of that is because there was the delivery delays caused by COVID And eventually they will catch up into 2022, but not enough to be really meaningful in the scheme of things, especially again when When you go through the job numbers that we have and the implied demand from 530,000 new jobs across our Footprint, notably on the supply side, Seattle is the one market that's down pretty substantially about 12%. So that's Another gold star, let's say, for the Seattle market there. Barb, do you

Speaker 6

want to add them? Neil, as far as on the street opportunities That we're seeing to kind of echo your point, with costs having risen. Now that being said, Costs are well down from where we were kind of at the lumber peak in mid summer. But Taking all that into account, we're seeing a steady flow of deals, but fewer deals, It seems that are penciling, and that's both on the mezzan pref side as well as on the direct development side. The one thing the one point I made earlier about With cap rates compressing on existing products, they're also diminishing some on the development yields.

Speaker 6

So there are kind of competing factors as to how deals are being made today. But Like I started with, there is a flow of deals happening, but again, those that are actually penciling are, I would say fewer and further

Speaker 4

And then, Neil, I just want to make sure that in my prepared comments, I did say that we had $290,000,000 of preferred redemptions this year. And given the current environment, if it is to continue low interest rates and high valuations for West Coast assets, We could expect early redemptions of a comparable amount in 2022, I would imagine. So we could still face headwinds there Just given this environment, we're seeing a lot of developers able to take us out early for a variety of reasons. And so I want to make sure that you heard that as well.

Speaker 1

Thank you. Our next questions come from the line of John Pawlowski with Green Street. Please proceed with your questions.

Speaker 14

Thanks. I have a question for Adam. I think in the prepared remarks, Mike referred to apartment values being up 15% versus pre COVID levels. Curious in the hardest hit markets to the Bay Area, where you think current values are relative to pre COVID levels?

Speaker 6

Yes. Thanks, John. As Mike pointed out in the opening remarks, that's an average. So As it relates specifically to the Bay Area, there's been very little to trade, very little of substance. I think that number in the Bay Area is going to be anywhere between 5% and maybe upwards of 20%.

Speaker 6

But again, there's been really Just 2 Class A deals that have traded and then some kind of B and C deals that have traded. So we're talking about a very limited data set.

Speaker 14

And that's, sorry to clarify, 5% to 20% down or up?

Speaker 2

Okay. You know nothing, John. I'm just kidding.

Speaker 14

Well, if nothing trades, it means that yes. Okay. One final question for me and then I'll jump out. I'd like to just drill down on San Mateo. Obviously, job growth is improving, migration is up, but sequentially each and every quarter Revenues keep declining in San Mateo.

Speaker 14

Could you just tell me what's going on in terms of the renter behavior, the durability of Demand gains over the last few quarters and when does it turn the corner?

Speaker 3

Yes, that's an interesting Question in that the data set itself, I wanted to just give a little context because I think that matters. Our San Mateo market only actually has 4 properties in the same store. And so because of that, you are going to see a lot more volatility. And in addition, there has been well, Good job growth and it's a good market for us. There has been lease up competition in the area.

Speaker 3

And so you're We're talking about an interim period where you have competition from lease up. It's a while their job growth is Still at a slower pace relative to our other markets and you add that with a small data set, it's going to just Be a lot more volatile. It's not that there's anything fundamentally that we're concerned about with this market.

Speaker 1

Thank you. Our next questions come from the line of Amanda Switzer with Baird. Please proceed with your questions.

Speaker 8

Thanks. Apologies if I missed this, but on your co investment platform, has the interest from Institutional Capital to partner with you changed the economics So those deals at all or is the increased attractiveness that you talked about really been driven by lower debt cost in the market today and The higher LTVs that you can use in those agreements?

Speaker 4

Hi, Amanda. This is Barb. We've used the co investment platform For many, many years and we like it because it is an alternative source of capital when we don't like our equity, our stock price. And so We've used it from time to time. We do think it's a good source of capital for us.

Speaker 4

And in terms of economics, We were able to reduce the hurdle rates and improve the economics for FX. Cap rates have come down over the past 75 to 100 basis points and we were able to change terms accordingly. So the economics of the joint venture didn't change materially from what we've done in the past, but We'll continue to use this source of capital going forward depending on market conditions. That's helpful. That's it for me.

Speaker 1

Thank you. Our next question comes from the line of Shanne Luthra with Goldman Sachs. Please proceed with your question.

Speaker 15

I think it's officially noon on the West Coast, so I'll say good afternoon, everyone. I'll start with your redevelopment program. If you could perhaps give some color, I believe you started that last quarter, where you're at and how you thinking about it in 2022?

Speaker 3

Sure. Happy to. It's Angela here. We started ramping up and I mentioned that last Quarter and we're going to continue to do so, especially in light of the recovery and the strength of the recovery and of course our expectations for market trend growth next year. And our goal At this point, it's really to double the number of renovations for next year compared to this year.

Speaker 3

And then ultimately get back to pre COVID levels because it does take a little more time to ramp up these activities. And As market conditions prove, we also make sure that we underwrite the improvements and ensure we don't have capital destruction And make sure that we are meeting the market and optimizing our returns. And so it's not a turn the switch on, we just we are just much more we just want to be diligent about it.

Speaker 15

And then Angela, as a follow-up to that, I mean, how's ROI looking at on Those redevelopments, is that consistent with pre COVID levels? And is there a big range to think about there? Just Trying to understand that if you could throw some color on that as well, please?

Speaker 3

Sure. No, happy to. We target our ROI at pre COVID level. So but keep in mind, it's driven by market rents. And so what that means is That ROI, unlike the way we approach it is that we wouldn't proceed with a reinvestment opportunity if we're not achieving our target ROI.

Speaker 3

And therefore, if you're concerned that there's been any compression or deterioration, there

Speaker 15

Got you. And then my sort of second question would be your peer one of your peers talked about earlier today about some impact leasing velocity from Amazon's policy shift on return to office. Just wanted to Check with you what are you guys seeing from your standpoint? Thank you.

Speaker 3

Let me make sure I understand your question. Are you Are you asking about our leasing velocity, whether it has changed because of Amazon?

Speaker 15

Yes, I mean Amazon's policy shift on return to office, the announcement a couple of days ago.

Speaker 3

Yes, I see what you mean. So we have not seen any impact from the Amazon shift, Because keep in mind, while yes, they have the corporate mandate, but they also have a lot of workers throughout the region. And so that's and of course all the businesses that support Amazon. But practically speaking, We have not seen an impact on our turnover. We have not seen an impact on our occupancy and certainly not an impact on our ability to raise rents.

Speaker 16

So my first one is on your stock price. You didn't issue equity in the Q3 yet on our estimate. And Based on the Street estimate of NAV, you're trading at a premium, instead of issuing equity sort of are going to disposition and JV route. So I just I was wondering if you could give more comments, Terry, on your views on your stock price and maybe using more equity going forward.

Speaker 4

Yes, that's a good question. I mean, we've always remained very disciplined as it relates to What source of capital we use? So we look at a variety of different sources, one being the equity, one joint venture equity and one disposition. And keep in mind with values up 15% from pre COVID levels that puts our NAV and where we think the value of the company is up quite a bit from where we were at the start of the pandemic. And so that's a factor that we look at when whether we want to issue equity today or not.

Speaker 4

The other factor to keep in mind is we have a lot of money coming back from preferred equity redemptions. We're using that to fund The new investments we're making along with using the joint venture platform, we really do think it creates a lot more value for our shareholders given The fees and the potential for Promote hurdle and given where our stock price is trading, we don't believe we're at a Material premium to NAV at this point.

Speaker 16

Okay. That's helpful. And then lastly, How much more are you expecting benefit from SmartRent and what's your timing on that?

Speaker 4

Yes. No, that's a great question. The value of our SmartRent investment is about $75,000,000 today. And Our Q3 financials, there's a lag effect there because we report them, the shares are still held in RETV until we come out of lockout and their financials are 1 quarter in arrears for us. And so we would expect a fairly Substantial gain in the Q4, it could be up to $40,000,000 and then we would also have to recognize an unrealized deferred tax For Vision as well, that could be up to $12,000,000 Both of those numbers are not reflected in our full year guidance for total FFO.

Speaker 4

Just given the uncertainty, there's a lot of other moving parts within RETV that we don't try to predict that gain or loss. But those are the numbers related to SmartRent in and of itself.

Speaker 1

Thank you. Our next questions come from the line of Alex Kalmus with Zelman and Associates. Please proceed with your questions.

Speaker 17

Hi. Thank you for taking the question. I want to touch on SB 9 and 10 And what you expect the long term impact to be on California housing supply therewhat you're seeing on the ground, if anything yet?

Speaker 2

Yes. This is Mike and good question. We are still waiting and sort of guessing as to what Might happen with SB 9 and 10. And of the 2, the one that's more impactful is SB 9 because that Would effectively have the state override local zoning laws as it relates to the development of ADU units. And so Potentially allowing more ADU units to be built in the suburbs.

Speaker 2

So I want to note that there previously was an ADU law that was passed earlier this year and this whole situation has been quite Politically active with respect to the YIMBYs, the Yes in My Backyard versus the NIMBYs, the No in My Backyard groups. And that's going to be an ongoing battle. So I think personally given that there was an ADU law that was out there before and it had relatively little impact That's going to continue to be the case. There was a LA Times article That was recently written and it said it estimated, I don't know where this estimate came from, but I'll just mention it for the sake of Transparency, it mentioned that estimated 1.5% of single family homes are likely to use SB 9. So I suspect that will be high.

Speaker 2

But the backdrop of this is that Governor Newsom and various other sources have Indicated that the state is short millions of homes and the likelihood that SB 9 and SB 10 We'll change that, I think is very unlikely.

Speaker 17

All right. Thank you very much there. And just wanted to touch on The trajectory of potential renewals going forward given the CPI regulation, Would you consider pushing a little more on that lever in future rent negotiations To make sure that over the span of a few years, you're able to get to market quicker or Do you see that being just playing out similarly how it has in the past in terms of the difference between renewals and new move in spreads?

Speaker 3

Well, CPI plus 5, it's that, but it's capped at 10. So it's not a metric that we have, say, a flexibility to push at our discretion. And we've been operating in this market even before AB 1482. We have assets that had rent control and over a long period of time, it had comparable growth rates and we've operated Well, under these circumstances, so we just we don't think this is going to fundamentally change our ability to achieve our return targets.

Speaker 1

Thank you. Our next questions come from the line of Joshua Dennerlein with Bank of America, please proceed with your question.

Speaker 2

Yes. Hey, guys. Thanks for the question. I was just Kind of curious how you're thinking about pushing rate in the fall winter. It looks like some of your markets you saw a little bit

Speaker 7

of an occupancy dip. Maybe if it's a different strategy across markets, it would be great to discuss that as well.

Speaker 3

Yes, happy to. What we're so this isn't an unusual year and that normally we peak around July. And so starting say end of July, we start to have a deceleration for 6 months. This is an unusual year and that we had this huge ramp up. We went from this a big negative, I think it's like negative 10% Market rent growth in Q1 and we peaked around It depends on which markets, but Seattle and Northern California peaked around August And Southern California is just peaking now like as we speak.

Speaker 3

So it's Very different from that perspective. Having said that, that natural seasonality does And so the question is really a magnitude issue. And what you're going to what we're going We'll continue to do is focus on at this point, wherever we can push rents, but More likely as we head into November, December now focusing on occupancy. And I think some people noted that In the Q3, we allow occupancy to follow a bit, but I want to emphasize that was because of the strength of the market. And now We are going to preserve those trends and focus on occupancy if we see that deceleration continue to continue.

Speaker 7

That's great. And maybe just a follow-up on that comment that SoCal is just taking now. Is that late October peak? Has it been a leveling off or starting And you see a little bit of pullback, just kind of curious where it is?

Speaker 3

It's kind of between mid October now. So say in the past week.

Speaker 17

Okay.

Speaker 2

Okay, great. Appreciate it.

Speaker 1

Thank you. There are no further questions at this time. I would like to turn the call Back over to Michael Shaw for any closing remarks.

Speaker 2

Thank you, operator, and thanks, everyone, for joining our call today. We look forward to seeing many of you virtually speaking at the upcoming NAREIT. Until then, stay well and again, thank you for joining the call.

Speaker 1

Thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time. Have a great day.

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